Don't Bet Against This Biotech IPO

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Betting on biotech IPOs has been hit and miss recently. Clovis Oncology (NAS: CLVS) came flying out of the gate, trading well above its IPO price, while Endocyte (NAS: ECYT) crashed and burned after overall survival data for its ovarian cancer drug EC145 was inconclusive.

Verastem (NAS: VSTM) , the latest on the IPO market, is focused on stem cells, a term that doesn't have the best associations in the biotech community. Geron (NAS: GERN) abandoned the space, and others like Advanced Cell Technology have been pegged to the OTC boards because of a lack of interest from investors.

Still, I wouldn't bet against Verastem.

Reason No. 1: Look who's running Verastem
It's Christoph Westphal, the former CEO of Sirtris Pharmaceuticals. Westphal managed to convince GlaxoSmithKline (NYS: GSK) to buy Sirtris for a cool $720 million a few years ago. The sale came less than a year after Sirtris IPOed and well before the biotech had proven its anti-aging drugs did anything more than a glass of red wine could do.

Since then Glaxo hasn't done much with the sirtuin modulators, but that's not Westphal's fault.

Betting against Verastem would be a dangerous because mergers and acquisitions can be a death sentence for short-sellers. You can be completely right -- a drug isn't worth what investors are valuing it at -- but along comes some big pharma stupid enough to take on the development risk.

It doesn't matter if the drug fails after it reaches the pharma giant. Short sellers have already lost at that point.

Reason No. 2: It's stem cells, but it's not really stem cells
A typical stem cell company uses stem cells as a treatment. Verastem, on the other hand, is hoping to kill stem cells, at least the pesky ones causing cancer.

Tumors are formed from stem cells that are growing when they shouldn't be. Most current cancer treatments attack the cells in the tumor than have grown from the cancer stem cells, but don't kill the cancer stem cells. Since the cancer stem cells are the lifeblood of the tumor, they're able to regrow the tumor after the treatment shrinks it.

So Verastem is more like a typical oncology drugmaker looking for drugs to kill tumors, but it's going after a specific type of cell. A specialized knowledge of stem cells is still required -- you've got to be able to grow the cells in a laboratory in order to test whether drugs can kill them -- but it doesn't take the finesse required if the cells were going to be injected into a patient. And who knows, perhaps Verastem's research will lead to better stem cell therapies. The biggest knock on stem cell treatments is that they could cause cancer if they keep growing beyond their intended job.

Investor interest
Verastem is a very risky endeavor given that it doesn't have any drugs in the clinic. And yet it priced in the middle of its proposed range and increased the number of shares it sold by 1 million, raising an additional $10 million for its pre-clinical program. In its third day of trading, it's still well above its IPO price.

The relatively strong IPO of a very early stage company is good news for the entire biotech industry. If investors are willing to take on that kind of risk, they should be more willing to back secondary offerings of more established players, which decreases the cost of capital raises.

The only companies not benefiting from a stronger IPO market are large pharma and the larger biotech companies. IPOs are an alternative to getting acquired or licensing the drugs for private companies; once the venture capital money runs out, they need to get capital from somewhere. With a weak IPO market, established drugmakers were able to get better deals licensing drugs and acquiring companies because the alternative wasn't there.

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At the time this article was published Fool contributor Brian Orelli holds no position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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