A Leading Indicator Of Success: Failure And Risk In Biotechnology

by: Avi Greenberg

A Leading Indicator of Success: Failure and Risk in Biotechnology

If you are a retail investor, it can be difficult to find a suitable biotechnology stock with upside potential. If you are seeking an investment in the developmental space, it can be even more difficult, although the potential upside makes it enticing. Not only do you have to sort through data (that you may or may not understand), but you also have to sort through the varied opinions and inherent volatility that comes with the investment. However, if you're looking to add a tool to your assessment analysis, then you might want to start gauging the ownership of institutions, as these might very well be the best measure of risk and development success.

Why Is Ownership Important?

Unfortunately, almost any drug can appear to work effectively on paper and in a presentation. A company can use a variety of tools to weave "data" in its favor. It can handpick a small group of patients from a trial of larger test subjects to design a study. Then, investigators can find some similarity between those patients, so the retail investment community will buy. Once the drug begins a new trial, a company can take this "handpick" mentality to an entirely different level, as the science crew can monitor patient dropouts within the allotted period of time for the trial to find a subset where results look better than the reality.

While this might sound like a conspiracy theory, it happens every day in biotechnology. In my late 20s, I worked for a laboratory in Chicago that dealt specifically in clinical trial design, therapeutic development and, in some cases, served as a site for clinical trials (due to associations with various hospitals). At the time, I did not invest nor did I have extensive knowledge of biotechnology companies; but after several conversations and personal experiences, I have seen how confusing a clinical study can become for the general public.

If assessing data is not hard enough, retail investors must also deal with analyst opinions. In biotechnology, I think most would agree that it's not uncommon for a small company to obtain coverage from several analysts, most of which are extremely bullish. Most of the time "far-out" price targets come from unknown firms, and these are then weighed heavily among retail investors. However, institutional investors have a different method of research--many of which consider research firms, but use sell-side research for the most comprehensive reports.

Individual companies do not pay these research firms to conduct the research -- but rather institutional funds float the bill -- and institutional investors place much import on these "opinions". Thus, institutional ownership in a stock is perhaps a fitting gauge of the sell-side analyst community; firms that have access to the best research, the most knowledgeable staffs, and have a clear understanding of success in biotechnology.

Most use institutional ownership data as a way to determine the source of ownership for a company. In many cases, high ownership insinuates stability in an investment, but in biotechnology, I think it signals a company's chances for success. Think about it like a 0-100 scale, with 100 being the greatest chance of success, along with the safest, and 0 being the lowest, and also the riskiest. This can serve as a great indicator of risk, and upside in biotechnology.

What Is A Good Ownership Ratio?

Biotechnology in the clinical development phase is unpredictable, especially ahead of key data. Sarepta Therapeutics (NASDAQ:SRPT) had ownership of just 30% ahead of its data. The company was testing its drug in an exceedingly small trial and was testing it on a disease that had not previously been treated with success. The company's ownership has more than doubled after reporting data in October 2012. Pharmacyclics (NASDAQ:PCYC) had ownership of 38.8% back in January 2011 before ibrutinib demonstrated such clear upside. Thus, 30%-40% for speculative, small-cap stocks indicates risk - but also a good percentage of upside combined with optimism among institutions. Then there are also companies such as ACADIA Pharmaceuticals (NASDAQ:ACAD), which looked poised for success from day one.

Prior to ACADIA Pharmaceuticals' market-changing pimavanserin data, the stock had institutional ownership of 56%. At that time, ACADIA traded around $2.00, and many were skeptical because Pimavanserin had previously failed in a clinical study. However, its 56% institutional ownership indicated that "Big Money" was confident. Obviously, Big Money was right as ACADIA increased by more than 500% after strong data. But how did institutions know? And why were they so confident?

ACADIA's eventual success wasn't a home run, but there were many indications that it would be successful. Firstly, pimavanserin did fail a previous study, but it was because ACADIA tested the drug at two different doses-- the higher of the two doses was statistically significant in the failed study. Ergo, ACADIA built a study around the higher dosage…and it succeeded. Today, the company's institutional ownership of 75% is exceedingly high for a biotechnology company. To put it in perspective, Pharmacyclics has institutional ownership of just 69%. ACADIA Pharmaceuticals is clearly a heralded stock on Wall Street, one that analysts and institutions anticipate a successful product launch with--and further gains from this point forward.

The Retail Madness With Low Institutional Support

More importantly than companies with high ownership, are those that have traded significantly higher due to retail investors --as it could indicate a lousy investment. Remember, we are using this ownership as a tool, a way to assess risk according to the actions of institutional investors --those who have access to the best sell-side reports.

MannKind Corporation (NASDAQ:MNKD) has a market cap of $2.2 billion and has seen its valuation increase by 330% in the last year. The stock has seen its run-up into top-line results from its Phase 3 drug, Afrezza, with trials being conducted for both type 1 and 2 diabetes. Those who are optimistic will argue that Afrezza works better than any other inhaled insulin on the market and that its inhaled insulin device will attract high demand.

Afrezza has already been rejected twice by the FDA, and the company continuously attempts to modify its trials to achieve the best response to the drug (which is perfectly acceptable). In the process, the company has racked up an accumulated deficit of more than $2.1 billion (which is not acceptable) - and there are many who believe that the drug will be a commercial failure even if approved.

These bears point to the wide use of Exubera and those other drugs, such as Sanofi's (NYSE:SNY) Apidra, have been unable to make a dent in a market that is already well developed with preferred therapies. Yet despite these concerns, bullish retail investors don't want to hear anything about potential risks. The retail investment community has single handily driven the price of this stock, as its institutional ownership sits at just 18%!

When a bearish position is presented to the bulls, it is met with heavy offense. Seeking Alpha contributor Brian Wilson's clinical assessment of Afrezza and his belief that it will fail one of its Phase III trials, created 114 comments (many of them offensive). Martin Shkreli's fundamental analysis concluded that MannKind is running out of cash --racked up 81 comments from the retail investment community (most of which were negative). This volume of feedback is even more than we typically see for an Apple article, yet these companies are only a fraction the size. Personally, I don't own MannKind shares, although I have no opinion of whether or not it will succeed or fail. My observation is simply to show the "retail cult" that exists and the lack of confidence among institutional investors, which is in fact evident.

The True Retail Madness

While MannKind's 18% ownership might look bleak compared to that of ACADIA Pharmaceuticals or others, such as Celldex Therapeutics, its ownership looks superb compared to that of Galena Biopharma (GALE). Galena is a $185 million company that has seen its valuation increase 370% since January 2012 -- all of those gains have been from the retail community -- since the stock has institutional ownership of just 8%. Yet, the stock has seen seven different initiations of coverage since June 2012-- all of which are buy ratings-- and no institutional buying pressure. To me, this might be the first warning sign (as previously explained).

With this stock in particular, I am going to take a little more time, as it's a name that I have covered in the past, one that has a very small chance (about 8%) of ever seeing an FDA approval. Not to mention, its retail cult following far exceeds that of MannKind. Seeking Alpha contributor Robert Schwartz's fact-only assessment of the company's lead product, NeuVax, garnered 150 comments, and my "Stock First, Science Second" article generated over 100 comments-- many of which were from the co-developer and inventor of NeuVax, Dr. Constantin Ioannides, who essentially points to the shady behavior of Galena management, specifically that of CEO, Mark Ahn, who I accused of being a "stock first, science second" CEO.

If you don't want to take my word that Galena is a stock first company, just check out some of the comments left by Constantin Ioannides. This shady behavior he's discussing further illustrates the reason as to why institutional investors want nothing to do with Galena. The comments below show how CEO Mark Ahn paid just $1,800 for stock that is now worth almost $2,000,000. Furthermore, his comments show that those "unbiased experts" that investors continuously referenced after my first article, have been paid a great amount for their "opinions". Take a look at a few excerpts from Mr. Ioannides' comments (exactly as they appeared, except for my parenthetical insertions):

MDACC Inventors did not sell their stock and Board Stock. Much more Board and independent inventor were never told, Managers Wright and Masek secretly gave 843,750.00 shares to Ahn through Kennedy and Schwartz as part of a hypothetical reverse merger for $ 1,875.00. Expected income for MDACC $1,180,000.00.

Results reported to ASCO in 2012 suggest that prediction could be feasible, but managers ignored science (just like I said) and we cannot do a retrospective analysis.

I presented to the public my opinion that in the Neu/Vax vaccine there were and are significant amounts of Research Funds, which are not used as agreed in the Contracts, but secretly (by attorneys and Managers) were shuttled away by secret agreements followed by misleading/ incomplete reports to SEC and secret codicils. The property licensed to, (received for use by Mr. Ahn), differs from what he wrote to SEC.

One threatened to hold me responsible if his E75 trial will not work - Show me how I am responsible for failures and will admit it.

Back when my opinion of Galena Biopharma management was published (on May 13), I attempted to answer the comments one by one. I quickly learned that it was impossible, and saw first-hand the retail insanity of this stock. These people continuously defend data that is simply no good. Hence, I find it very interesting that NeuVax's own inventor is calling out the company with behind-closed-doors information, including compensations for Dr. George Peoples. However, this is just a few of the operational reasons that institutions have not purchased, however there are more.

Galena's NeuVax vaccine, in theory, is intended to prevent recurrence in breast cancer patients expressing low to intermediate levels of HER2. The company's Phase II trial WAS NOT statistically significant -- but the company used a small sub-group of patients from that larger trial that did show some levels of efficacy. The Phase III trial has a positive control, meaning it will be difficult for Galena to data-mine and get "positives" from negative data--if, in fact, data is negative.

After producing large 16-month gains, solely by retail investors, I find it highly problematic that institutions are not yet investing in the company. In my opinion, this signals that there is little support or expectations of a successful study, and it also indicates that the retail investors' vision of a buyout is unlikely. The company still has an expected three years until final data from the Phase III NeuVax study. Accordingly, I conclude that no one, with the exception of retail investors, is buying Galena Biopharma-- both because of its product and its management.

What Does This All Mean?

Sometimes the large institutions are going to be wrong. Celsion Corporation (NASDAQ:CLSN) has ownership of over 35%, and we all know the outcome of its failed clinical story. However, for clinical stage biotechnology companies, ownership can be an indication of how institutions assess a product's chance for success. These institutions have more resources than you, and can see things that you might miss. For example, after a failed late stage study of the product CO-101, shares of Clovis Oncology (NASDAQ:CLVS) fell from $22 to $12. Yet, the stock more than doubled after presenting positive data for two of its early phase clinical products on June 3, and is currently trading near $70. While very few expected such a strong showing, the company's institutional ownership stayed over 70%! This shows that Big Money was buying the stock-- even after a failed late stage study-- and that retail investors got this one wrong.

With this topic in mind, you shouldn't let one indicator confirm your investment decisions-- but monitoring ownership and using it as a tool looks to be a smart idea, especially in a complex biotechnology industry. More or less, Big Money has a high success rate, and with very few retail investors being experts in clinical design and biology/chemistry, it's much easier for us to fall in love with trends and the idea of greatness. Thus, use the information how you'd like, and pay attention to where the market's brightest are putting their money to work.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.