Small cap biotechnology stocks are usually speculative situations where good news can cause the stocks to soar quickly. The sobering yin to that intoxicating yang is that bad news can mean the stocks plummet.
So there is big money to be made (and lost) shorting biotechs just like there is big money going long. Plenty of people are speculating on these biotechs on the short side and that leads us to what the ancients called a "short squeeze." Investopedia:
During a short squeeze, individuals holding short positions are typically forced to purchase shares in situations where the price increases rapidly, in order to exit their short position. Short squeezes occur more often in smaller-cap stocks with small floats...If a stock starts to rise rapidly, the trend may continue to escalate because the short sellers will likely want out. For example, if a stock rises 15% in one day, those with short positions may be forced to liquidate and cover their position by purchasing the stock. If enough short sellers buy back the stock, the price is pushed even higher.
We like the sound of that! From the long side at least. Let's investigate small cap biotechnology stocks to see which might be short squeezes in the making.
We'll start with the "short ratio." Investopedia:
A sentiment indicator that is derived by dividing the short interest by the average daily volume for a stock...This ratio provides a number that is used by investors to determine how long it will take short sellers, in days, to cover their entire positions if the price of a stock begins to rise. The short interest ratio can also be applied to entire exchanges to determine the sentiment of the market as a whole. If an exchange has a high short interest ratio of around five or greater, this can be taken as a bearish signal, and vice versa.
So 5 days to cover is a rough threshold for a high short interest in a stock. According to Yahoo Finance there are 47 small cap biotechnology stocks (market cap $100 million to $2 billion). Of these, how many would you say have a short ratio higher than 5?
36. Wow. Small cap biotechnology is speculation city and there are plenty of players on the short side. Let's quadruple that and see how many stocks have a short ratio higher than 20. By this measure it would take more than 4 average trading weeks for the short sellers to cover their positions - if they were the only buyers in the market. According to Yahoo Finance there are 6:
So there is a starting point for identifying small cap biotech stocks that could be in for a short squeeze. Below we will offer a first blush look at each stock's chances and provide some links for further research.
1) BioTime, Inc.
Let's hear from Martin Shkreli, who was short as of April:
My hedge fund is short BioTime, a speculative "regenerative medicine" company. BioTime trades for a value of $221 million, but I think the company's enterprise is worth something closer to $20 million. With only $22 million in cash, and limited operations that seem to be ramping up, BioTime has a need for raising cash in the future. Without any great assets to attract investors, I predict BioTime shares will drop at least 50% in the next 12 months.
BioTime is a collection of stem cell assets. None are particularly exciting. Start with the pedestrian stem cell research tools the company offers. WhileBioTime tries to do their best "Life Technologies impression", sales of these products were a paltry $500,000 last year, hardly material.
Martin goes on to give a review of the rest of the business and is not a fan. There is, however, a stir at BioTime over their cancer detection technology. Check out BioTime's press release this past week when a study was released in the journal Future Oncology:
..describes the microarray-based approach used to identify COL10A1 as a pan-cancer biomarker with significantly elevated expression in diverse malignant tumor types including cancers of the breast, stomach, colon, lung, bladder, pancreas, and ovaries..."This low background expression, taken together with the significant expression that we observed in many tumor types, underscores the potential use of this biomarker as a novel diagnostic and therapeutic target for many cancer types."..."Upon validation of their performance in detecting cancers from patient samples, these antibodies are candidates for inclusion in PanC-DxTM, a low-cost, easy-to-use product with broad cancer detection ability slated for launch in 2014."
We like Martin's analysis but the idea of shorting any stem cell company right now is too scary for us. We are willing to believe that stem cells may be key in cancer detection and if these guys get lucky in early detection of cancer of the "breast, stomach, colon, lung, bladder, pancreas, and ovaries" then the moon is not high enough for this stock to fly. We don't think a squeeze is likely here, but if it happened it would be huge.
2) Clovis Oncology Inc.
There is very little written on this early stage oncology play, we had to go to the Yahoo message boards to get a vaguely negative voice:
Seems like the folks running this company are going to burn through cash at an alarming rate. Startup pharmas are huge risks -- and lightning rarely strikes twice
Clovis seems pleased with their progress after the mostly uneventful second quarter. A catalyst looms before the end of the year as the results for their trial of CO-101 in metastatic pancreatic cancer are due and the company sounds optimistic:
"We had a productive second quarter and continued to make progress in each of our programs," said Patrick J. Mahaffy, President and CEO of Clovis Oncology. "We are seeking to expand our pipeline through our collaboration with Array BioPharma for the discovery of a novel mutant KIT inhibitor; each of our three current clinical programs continues to advance, and most importantly, we remain on track to announce the results from our pivotal LEAP trial of CO-101 in metastatic pancreatic cancer during the fourth quarter this year."
I believe the stock could have a run-up leading into the LEAP study results in the fourth quarter. I believe we could see at least a $25 share price if the results are positive. If the results are negative we could dip below $10.
We like this one. As Scott Matusow notes the "Obama directive" to fast track orphan drugs to market is bullish for companies like this one:
In 2010, there were 178 shortages reported by the FDA with confirmed cases of patients dying, in part because of shortages of potential new and innovative life-saving drugs, also known as "orphan drugs."
Obama's order will require the FDA to expand reporting on potential drug shortages, accelerate review of new drug applications
We don't see a bear case here. You could say this company is so young that it is a long way from being profitable, sure, but that is not a bear case. Clovis is one to look into.
3) ChemoCentryx, Inc.
Matt Schilling likes ChemoCentryx:
the driving force behind my attraction is the company's current pipeline which includes CCX354. The company recently announced positive peer review data with regard to the Phase II clinical trials of CCX354 when applied to patients with Rheumatoid Arthritis...The company currently has $1.3 million in total debt and $119.49 million in total cash
Like with Clovis we don't see a bear case outside of it being an early stage, recently IPO'd company. This one is not as exciting to us as Clovis but we think the short interest is too high to be justified and ChemoCentryx is worth further investigation.
4) Optimer Pharmaceuticals
Back in February Scott Matusow was bearish on Optimer:
I feel Dendreon (NASDAQ:DNDN) and Ariad (NASDAQ:ARIA), are better speculative longer-term buys at this time. I recommend investors take a pass on a long-term investment in Optimer until we see strong revenue numbers from fidaxomicin, and how effective the current management proves to be with this money.
Fidaxomicin (DIFICID) revenues have now been coming in with Optimer beating analysts estimates by 10% in the most recent quarter.
Optimer looks to have some life, with the short interest as high as it is we think this one merits further investigation.
5) AVEO Pharmaceuticals
Derek Lowe gives us the short and long side of AVEO's cancer drug tivozanib:
Dying in the same amount of time, albeit with redistributed tumor tissue, is not the endpoint that people are waiting for.
The company is, of course, monitoring the patients that it's treated. And there's the problem: the current data show, after one year, that 77% of the tivozanib-treated patients are still alive. But 81% of the sorafenib patients have survived, and the FDA has officially expressed concern about the way things are going. That sent Aveo's stock down sharply the other day, as well it might. But there could be a way out:
Aveo said in today's statement that basically it's possible the preliminary survival data could be misleading. That's because in cancer trials like this one, cancer patients whose disease worsens on one drug can then go on to get a second drug which may help them. In this case, Aveo said 53 percent of the patients who were randomly assigned to get the Bayer/Onyx drug went on to get subsequent therapy after their disease worsened-and "nearly all" of them were given Aveo's tivozanib. By contrast, only 17 percent of the patients who were randomly assigned to initially get the Aveo drug went on to get a subsequent therapy. So it's possible that the patients in the Bayer/Onyx control group may be ending up living longer at least partly because of the Aveo drug they got later on.
So Aveo has been battered, is highly shorted, and may be in for a surprise bounce. This is a definite short squeeze possibility.
6) Protalix BioTherapeutics
This first of its kind expression system can manufacture human proteins with significantly lower capital and production costs and is easily scalable. The company now has an FDA approved drug, ELELYSO, developed out of its partnership with Pfizer (NYSE:PFE). This proves that the technology works and produces safe and consistent results...We also know that this is a lower cost method for producing drugs; so the company will be able to produce its approved Gaucher's disease drug at a lower cost than its competitors. This will be a compelling feature in the future as it looks to apply the technology to generics or biosimilars with its existing partner Teva (NYSE:TEVA) or others. Because of the unique manufacturing process, the company is expected to have better luck bringing generics to market without infringing on patents while having a less expensive cost structure
You can balance that with this older bearish piece by Steve Johannsen for the alternate view.
We side with Mr. Bulwa and think this company could be a winner. With the short interest that high we think this is clear candidate for a short squeeze.
We looked at the 6 small cap biotech stocks with the highest short ratio, but there are other short squeeze candidates in the space that came in at just under 20: Targacept, Inc (NASDAQ:TRGT) 18.8, Achillion Pharmaceuticals (NASDAQ:ACHN) 18.5, Pain Therapeutics (NASDAQ:PTIE) 18, Exelixis Inc. (NASDAQ:EXEL) 17.2, Enzon Pharmaceuticals (NASDAQ:ENZN) 17, China BiologicProducts, Inc. (NASDAQ:CBPO) 15.5, PROLOR BiotechInc. (NYSEAMEX:PBTH) 15.4, and Nektar Therapeutics (NASDAQ:NKTR) 15.3.
As long as there is big money to made shorting biotechs there are going to be back-firing short squeezes, identifying them beforehand is the key. Using the short ratio as a starting point is a great way to begin looking for squeeze candidates, and we think the 6 we looked at could have a squeeze in the cards and are worth further investigation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.