Is Pessimism Warranted for These 3 Most Hated Biotech Stocks?


You could certainly argue that the biotech sector is the roulette wheel of the investment world. There really isn't any other industry where potential earnings vis-a-vis pipeline account for so much of a company's valuation.

The biotech sector has bred its fair share of incredible success stories, such as Pharmacyclics , which is up more than 21,000% since its intraday low four years ago on the blockbuster potential of experimental blood cancer drug ibrutinib. The orally administered drug is under review by the Food and Drug Administration as a treatment for mantle cell lymphoma and chronic lymphocytic leuekemia. In trials, ibrutinib delivered overall response rates between 68% and 71%, which is remarkably encouraging when it comes to treating these two types of blood cancers.

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But for every success story, there's likely an equal or greater number of failures. To take a very recent example, we have Ariad Pharmaceuticals whose blood cancer drug Iclusig was found to cause a higher-than-anticipated number of blood clots in patients in a two-year follow-up study. This disturbing news led Ariad to halt enrollment of new patients in studies involving Iclusig; shortly thereafter the company shelved the chronic myeloid leukemia trial known as Epic that could have greatly expanded Iclusig's indications. Shares are down 79% in just the past three weeks and serve as a reminder to investors that biotech stocks can just as easily plummet as soar.

Keeping that incredible push-and-pull dynamic of the biotech sector in perspective, let's look at the three most short-sold biotech stocks to determine if pessimism is warranted or if emotions may have gotten the better of investors.

Dendreon:36.99% of float shares sold short
Now here's a company that possibly deserves every bit of the pessimism thrown its way. There was a ton of optimism surrounding Dendreon following the approval of its cancer immunotherapy vaccine, known as Provenge, to treat advanced prostate cancer. Unfortunately, it never came close to meeting its peak sales potential of $3 billion.

One reason for its shortfall is its lofty treatment price of $93,000, which proved pricier than Johnson & Johnson's Zytiga and Medivation's Xtandi therapies as numerous competitors with deep pockets jumped into the market.

Other problems for Dendreon's Provenge involved expanding abroad and trying to gain additional indications for Provenge outside of just being a late-stage therapy. Xtandi, for instance, has shown promise as an early-stage pre-chemo treatment for prostate cancer, which is an area where Provenge didn't really excel.

The end result is that Dendreon has already been through an extensive restructuring that's resulted in the loss of 600 jobs and the closure of its New Jersey manufacturing facility. Rumors spread late last week via Bloomberg that the company could be looking for a buyer. Short-sellers could be in for a bit of a squeeze if that comes to fruition, but they definitely (and rightly) smell a sinking ship with the way Dendreon has been losing money over the past couple of years.

Sarepta Therapeutics:33.21% of float shares sold short
It's probably not hard to understand why pessimists have flocked to Sarepta Therapeutics, either, given its huge run-up in share price since reporting midstage results for its Duchenne muscular dystrophy drug, eteplirsen, a year ago, and watching rival drug drisapersen fail miserably in a late-stage trial.

On one hand, the failure of drisapersen is a great thing because it would potentially open up the entire DMD market (at least the 13% share that fit the particular exon that eteplirsen is targeting) for Sarepta to take.

But the failure of GlaxoSmithKline and Prosensa's drisapersen is also bad news because it also works along a similar pathway as eteplirsen, and it was a much larger late-stage study. By comparison, eteplirsen's incredible six-minute walking distance results, which actually showed not only regression of the disease but improvement at 48 weeks, was just a trial involving just 12 patients. The FDA may now look at eteplirsen with a more discerning eye given drisapersen's poor phase 3 results and could ultimately require Sarepta to run a costly late-stage trial to prove the efficacy of its drug in a larger setting.

In sum, you could definitely say short-sellers are justified in their pessimism, but the impressiveness of Sarepta's small phase 2 study could just as easily send shares higher and can't be ignored until proven otherwise.

Spectrum Pharmaceuticals:31.11% of float shares sold short
The bearishness in Spectrum Pharmaceuticals really came to a head in March when the company drastically slashed its full-year revenue guidance by 40%-47% (depending on the high and low estimates) due to increasing generic competition for Fusilev, a palliative care treatment used in patients with metastatic colorectal cancer.

It wasn't always like this for Spectrum, which knew earlier this year that there was generic competition available to challenge Fusilev sales but presumed an announced shortage of the generic version of the drug would allow its lead product one more year of robust sales. That went for naught when Sagent Pharmaceuticals announced it would pick up the slack in generic Fusilev production in March, necessitating a sizable revenue cut on Spectrum's part.

However, not all hope is lost for Spectrum optimists as it does have a pipeline of FDA-approved treatments beyond Fusilev that it's been growing via acquisition. Spectrum acquired Allos Therapeutics last year to get its hands on Folotyn, a treatment used for relapsed or refractory peripheral T-cell lymphoma that could offer double-digit growth potential. It also acquired Talon Therapeutics earlier this year to add Marqibo to its cancer products portfolio for the treatment of Philadelphia chromosome-negative acute lymphoblastic leukemia. In addition, Spectrum also has Zevelin, which is used to treat follicular B-cell lymphoma, but sales of that particular treatment have flattened out.

The real question here is when these drugs will contribute enough to push Spectrum back in the black. As of now, it doesn't look as if Spectrum will turn a profit before 2015, making the case for short-sellers strong for at least the next couple of quarters.

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