Biotechs are extremely appealing to investors because of their potential huge returns. However picking the right ones can be challenging as many of them can crash overnight. Sometimes the reason for the crash is logical: one of their pipeline drugs doesn't receive FDA approval, like when Aveo Pharmaceuticals' (NASDAQ:AVEO) drug tivozanib was rejected by the FDA. Shares are down -96% from their highs. Other times it can crash on seemingly mundane issues arbitrary like when Kindred Biosciences (NASDAQ:KIN) discontinued one of its pipeline drugs, Atokin. Shares dropped -31% overnight.
But sometimes a biotech can literally triple your money overnight. This happened for investors of Idenix Pharmaceuticals (NASDAQ:IDIX) when Merck (NYSE:MRK) acquired the company this year at a 248% premium or when Abbott Pharmaceuticals bought out Facet Pharmaceuticals (FACT) at a 67% premium in 2010.
There's something that all of these stocks have in common: they have all been in the illustrious Baupost portfolio managed by Seth Klarman.
I admire Seth, if I may address him on first name basis. As an investor, I try to incorporate his value investing strategy. But that can be very difficult. Sometimes it is just easier to buy what Seth buys and ask questions later.
But it is important to recognize that for all of Seth's successes, he has had his misses. And if you held shares of AVEO like Seth has, your investment would be worth about four cents on the dollar. But Seth continues to hold, which makes you wonder if there's any value to the company or he has just simply forgotten about it.
Recent 'Baupost Biotech Picks' deserve a closer look.
On November 11th, 2014 Baupost disclosed a position in Atara Biotherapeutics (NASDAQ:ATRA) and a position in Forward Pharma A/S (NASDAQ:FWP). Recently, the hedge fund also disclosed on December 11th, 2014 a position in Paratek Pharmaceuticals (NASDAQ:PRTK).
Atara has two pipeline drugs PINTA 745, which is in phase 2 clinical trial for ESRD patients with a protein-energy wasting condition and STM 434, which is in phase 1 clinical study for ovarian cancer. The company holds worldwide rights to their entire portfolio, except for PINTA 745 in Japan.
The company IPO on October 16th, 2014 was priced at $16 a share and is now trading at $26. Baupost's 13% stake represents a $64 million investment. This position is larger than his $27 million position in KIN and $30 million but smaller than his $339 million investment in Theravance (THRX) $251 million in Keryx Biopharmaceuticals (NASDAQ:KERX) and $140 million in Theravance (NASDAQ:TBPH).
The Phase 2 for PINTA 745 began in January of this year and the study is expected to be completed by October 2015. Phase 1 for STM 434 began September of this year and is still enrolling participants. Results for STM 434 are expected to be completed by July 2016. The study will examine the effect of STM 434 on patients with ovarian cancer alone or with Liposomal Doxorubicin.
Because the stock shot up so quickly and since it will be at least a year before we get the results for Phase 2 of PINTA 745, I am on the sidelines. I will continue to monitor the company and if the market offers a cheaper entry, I'll consider opening a position.
Forward Pharma is a Danish pharmaceutical company founded in 2005. The company is preparing its only drug candidate, FP187, for phase 3 efficacy study on the treatment of relapsing remitting multiple sclerosis RRMS and psoriasis.
There are several reasons to be bullish on this company. For starters, Baupost's $107 million investment is a sign of confidence. On top of that, the company is already beginning phase 3 trials. Sounds good?
There's just one problem. Biogen (NASDAQ:BIIB) is already using the proprietary formula in FP187, dimethyl fumarate, or DMF, for an FDA approved drug Tecfidera. Forward Pharma believes that it owns the rights to DMF since it acquired it from Aditech in 2005. The solution? Sue Biogen.
It is always messy when the courts get involved but it might be worth it. Biogen's global sales generated from DMF were $2.02 billion. According to the prospectus, USPTO examiner recommended that "an interference be declared against Biogen's U.S. Patent No. 8,399,514" in order to determine who filed the first patent and thereby the original inventor of DMF. This strongly suggests that the USPTO believes that Forward Pharma has the rights to DMF.
If Forward Pharma wins, this company is worth at least $40 a share. I see numerous catalysts that could boost the valuation higher: positive updates in regards to the dispute with Biogen, results from phase 3 studies of FP187 on psoriasis and RRMS, and updates on developments on the international front.
Paratek is the outcome of a reverse merger and a reverse stock split with Transcept Pharmaceuticals (TPST).
Paratek has two drugs in its pipeline: Sarecycline for the treatment of acne (phase 2) and rosacea (phase 1); and Omadacycline for acute bacterial skin and skin structure infections ("ABSSI"), moderate to severe community-acquired bacterial pneumonia ("CABP") and complicated urinary tract infections ("cUTI"). The company will start enrolling patients for phase 3 clinical trials of Omadacycline in 2015.
In addition, the company also retains ownership of Transcept's FDA approved drug Intermezzo and TO-2070, a preclinical stage drug for the treatment of migraines.
Paratek has institutional investors chomping at the bit.
- FMR disclosed the purchase of a 12.035% stake on December 10th, 2014
- Baupost disclosed a purchase of a 12.04% stake on December 11th, 2014.
At $29 a share, this represents a $50 million position for the Baupost fund.
I think Paratek is an attractive investment opportunity given the numerous indications of Sarecycline and Omadacycline. The added bonus is that the company already has an FDA approved drug, albeit one that has not had commercial success. Perhaps with the reorganization of the company, Paratek can find a way to capitalize Intermezzo. But if it doesn't, no problem. Paratek's other drug candidates have a lot of potential value.
Forward Pharma is the largest new position out of the three recent Baupost Biotech Picks and Paratek is the smallest. Forward Pharma has not budged much from its IPO price of $21 a share whereas Atara and Paratek have both seen recent spikes in share price.
All three companies have huge risks as well as potential upside. As stated in the beginning of this piece, Seth's picks don't always turn out for the best. But he seems to have an eye for biotechs with buyout potential.
The only way that Forward Pharma would be a buyout candidate is if Biogen decides that it would be cheaper to acquire the company than go through the litigation, pay royalty fees, and lose its right to future sales of DMF. Atara's candidates are still in early development and Paratek just executed its reverse merger.
There's no way to know which one will be successful or if any of them will have success. But if you are interested in following Baupost's Biotech Picks, it may also be wise to practice a degree of margin of safety and not bet the house on any one company. In total, the three biotechs represent just 3.3% of Baupost's long portfolio and .007% if you consider the fund's AUM.
Disclosure: The author is long KERX, FWP, AVEO, PRTK.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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