Seeking Alpha
Long only
Profile| Send Message|
( followers)  

My Recent History on Discovery Laboratories

On February 22, 2012, I initiated coverage of Discover Laboratories (NASDAQ:DSCO) with a Buy and at a price of $2.82; the report was called Surfaxin Should Be Approved on its March 6th PDUFA Date. I urged investors to buy the stock before the PDUFA date. When I issued the report, my target price was $8 to $11 by 2016. My call went against Wall Street consensus and when Surfaxin was approved, the stock rose to a closing price of $4.08 on March 7.

However, the company needed to shore up its balance sheet and it did a stock offering on March 28, 2012 that took the wind out of the stock's sails. The offering was done at $2.80 and raised $45 million. Investors were disappointed by doing the deal at such a sharp discount to the post Surfaxin approval highs. Since then the stock has traded in a range of $2.21 to $3.00 based on closing prices.

The Need for Wall Street Analyst Support

I think that one of the major problems causing this disappointing stock performance in the face of positive news was lack of coverage and support by Wall Street analysts. As much as I would like to think that my articles have some impact, I am not singlehandedly going to move a stock, particularly one as controversial as DSCO. I am encouraged that Bill Tanner of Lazard initiated coverage of Discovery Laboratories on August 7 with a price target of $8. On August 23, Joel Sendek of Stifel Nicholas initiated coverage with a price target of $5.

My understanding is that both analysts are impressed (as am I) that Discovery will be launching two new products, Afectair and Surfaxin, by year end and also like the pipeline prospects provided by Surfaxin LS and Aerosurf. My view of DSCO is heavily driven by enthusiasm for Aerosurf, which I believe has the potential to change the paradigm for treatment of premature infants. I consider Aerosurf to be one of the most exciting new product prospects in biotechnology.

It is important to point out that Mr. Tanner works for Lazard and Mr. Sendek for Stifel, Nicholas. These two firms underwrote the offering in March, 2012. Cynics will quickly say that these analysts reached their opinions because of pressure from investment bankers. In the old days before Elliott Spitzer, it was often the case that bankers could pressure or bully analysts, but not so today. Veteran analysts have the power to decide which companies they want to cover and they no longer get paid to cover investment banking clients as used to be the case.

Mr. Tanner and Mr. Sendek are seasoned analysts whose work I have followed for some years with interest and respect. Mr. Tanner has been the primary bull on Jazz Pharmaceuticals (NASDAQ:JAZZ) starting with a Buy recommendation on September 28, 2010 at a price of $10 and continuing to recommend it through to the current price of $46. Mr. Sendek was the first and most prominent bear on Dendreon (NASDAQ:DNDN) starting in 2010 when the stock was in the $30s and $40s; it is now at $5. I don't mean to imply that all of their calls have such striking results as all good analysts make mistakes. However, these examples show that they have the ability to make courageous calls that go against prevailing thinking (certainly the case here); they have respect and clout on Wall Street.

New Analyst Coverage is A Reason to Re-iterate my Buy

Biotechnology stocks are driven more than almost any other stocks by perceptions. Traditional valuation models tied to current sales, EPS, cash flow or dividends are not applicable to biotechnology during the five to ten years needed to develop a drug and bring it to the approval stage. Even after product approval, it can take some years before positive earnings and cash flow are achieved. During this time perceptions usually set by Street analysts and guidance issued by managements combine to drive the stock price.

The credibility of Discovery management is at rock bottom low. DSCO filed the Surfaxin NDA on May 13, 2004 and received a complete response letter on October 5, 2005. Over the ensuing years, DSCO has filed and refilled the Surfaxin NDA four times resulting in three more complete response letters on April 5, 2006; May 8, 2008; and April 20, 2009. Finally, on the fifth submission of the NDA they received approval on March 6, 2012. These setbacks gave rise to the need for serial financings at ever decreasing price levels. This has led to the loss of a lot on money by investors over the years and virtually no one who bought the stock over the last seven years has a profit. Shorts on the other hand have done exceedingly well.

The reason for the long string of complete response letters was related to the validation of an assay that is used during the manufacturing process to determine if Surfaxin has remained within specifications required for efficacy. There were no questions on the efficacy and safety of the product or any other important points. This was an issue that if addressed properly by the FDA and DSCO could have resulted in approval one to two years after the first CRL was received in 2005 and Surfaxin would have been approved in 2007 instead of 2012. The delay was equally attributable to Wall Street pressure on previous management to quickly resubmit the NDA before being sure what the FDA required and the FDA changing its mind several times on what it would accept as validation of the test. There was a basic failure to communicate until the FDA decided in 2010 what it required and DSCO determined how to do the studies needed to gain approval.

I think that the new management team has done a heroic job in getting Surfaxin approved; however they are wrongly tarred with the brush of lack of credibility placed on previous management. They need support in explaining the DSCO story and getting investors to listen. This is why it is so important in the near term to bring the coverage and credibility of respected Wall Street analysts to bear. Having Mr. Sendek and Mr. Tanner on board may help the stock to break out of its $2.21 to $3.00 trading range..

Source: Discovery Laboratories: Reiterating Buy, The Street Is Getting On Board