Why I'm Going Long 1 Biotech And Short Another: Earnings

Includes: ATRC, VRTX
by: Matt Schilling

When a company in any sector misses estimates, it tends to result in a sell-off unless there is significant news countering such behavior. On Thursday, November 1st, there were two biotech firms which not only missed EPS estimates, but missed revenue estimates as well. In the wake of such a dismal performance, I wanted to demonstrate why I think investors should adopt a short strategy with regard to one and a near-term long strategy when it comes to the other.

Vertex Pharmaceutical (NASDAQ:VRTX) - The Cambridge, Massachusetts based firm which "engages in discovering, developing, manufacturing, and commercializing small molecule drugs for the treatment of serious diseases worldwide" reported earnings of $0.13/share which missed estimates by $0.07; and revenue of $336M, which missed estimates by $41M. Analysts were looking for earnings of $0.20/share on revenue of $377M. Could this be an anomaly when it comes to revenue? After four consecutive quarters of revenue growth, I'd think so, but the third straight miss with regard to net income concerns me and makes me shy away from the anomaly theory.

Since Vertex missed estimates in terms of both revenue and net income, I'd adopt a short strategy over the next 30 days and look to cover my short position at around $42.50/share to $44.00/share and here's why. Although Dr. Jeffrey Leiden, noted that Vertex had made significant strides during the quarter in terms of VX-135 (an orally administered Hepatitis C regiment) and VX-809 (a cystic fibrosis solution currently in clinical trials), sales of the company's primary hepatitis drug, Incivek, fell 40% to $254.30M. Most investors could live with a decrease of maybe 10% - 15%, but if we consider the fact that major drug makers such as Johnson & Johnson (NYSE:JNJ) and GlaxoSmithKline (NYSE:GSK) have begun testing hepatitis C solutions, a drop in sales of 40% is enough for me to become very bearish, very quickly in terms of Vertex.

AtriCure, Inc. (NASDAQ:ATRC) - The West Chester, Ohio based firm which "engages in developing, manufacturing, and selling cardiac surgical ablation systems designed to create precise lesions or scars in cardiac tissue in the United States and internationally" reported earnings of -$0.16/share which missed estimates by $0.05, and revenue of $16.1M which missed estimates by $1.0M. Analysts were looking for earnings of $0.06/share on revenue of $17.1M. After examining the company's earnings conference call transcript a bit further, the strategy isn't your textbook short and cover as was the case with Vertex.

There are three variables to consider from a near-term standpoint, two of which are positive and one which is clearly negative. The first thing to consider is the fact the company missed both top and bottom line estimates by roughly 6%. In my opinion, such a miss would justify the establishment of a near-term short position (after Friday's rally of 11%, we may want to reconsider this). Next, we need to consider the fact that AtriCare did demonstrate significant sales growth, which would be something of a positive moving forward. Lastly, and probably the most significant development after all, would be the fact that the company named Michael Carrel, Chief Executive Officer on Thursday in an effort to turn the company around after former CEO David Drachman left in August.

So what exactly does one do in a situation like this? The answer is simple, any potential investor looking to establish a position should implement a long strategy to best capitalize on some of the company's positive catalysts. Should the miss on bottom and top line estimates play a factor? Of course it should, but not as much as one would think. I think the direction in which the company is headed, especially under Mike Carrel, who brings over 10 years of industry experience to the table, is a very positive one.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.