Why Shorts Are Betting Against Enanta Pharmaceuticals

Shares of Enanta Pharmaceuticals have surged heading in a pivotal regulatory review of the company's lead hepatitis C therapy. Short-sellers apparently don't share the market's outlook and have started moving into the stock. Should you be worried?

Jun 15, 2014 at 6:00PM

Short interest is often a key metric that investors can use to gain some insight into how the Street feels about a particular stock. And when short interest picks up dramatically, it's generally a good idea to know why.

Shares of little-known Enanta Pharmaceuticals (NASDAQ:ENTA) have been on a tear over the past year, as the company's lead protease inhibitor, ABT-450, heads into a regulatory review as part of a triple-therapy combo indicated for chronic genotype 1 hepatitis C infections. Specifically, shares have now headed higher by a noteworthy 43% year to date.

By the same token, short interest has risen in lock step with share price lately, with shorts now holding close to 15% of the float. With this in mind, let's take a look at why shorts have started to jump into the stock. 

ENTA Chart

ENTA data by YCharts

Enanta and AbbVie are on track to gain approval for their all-oral hepatitis drug
Last April, AbbVie (NYSE:ABBV) submitted a New Drug Application, or NDA, for its triple-therapy regimen for genotype 1 hepatitis C infections, with Enanta's ABT-450 being a key component of the cocktail. Based on data from six late-stage studies, the therapy showed sustained virologic responses topping 90% in many cases after 12 weeks of treatment, with few patients dropping out due to adverse events. Put simply, the therapy looks comparable to Gilead Sciences(NASDAQ:GILD) Sovaldi in terms of its effectiveness and safety profile for genotype 1 patients. The therapy is also now under regulatory review in Europe. 

Based on these regulatory milestones, Enanta has reportedly earned $40 million in milestone payments from AbbVie this quarter. What's key to understand is that Enanta stands to earn another $155 million if the therapy gains approval in selected world markets, as well as double-digit royalties on net sales.

So we are looking at a small-cap biopharma with a current market cap of $725 million that could earn well over $200 million over the next year or so. Taken together, this begs the question, what are shorts seeing that makes them think the stock is poised for a downturn?

The hepatitis C market might be tapped out
Enanta's projections place a value of between $10 to $20 billion on hepatitis C therapies within the next 10 years. With an estimated 180 million people afflicted with the disease, this estimate certainly doesn't sound outlandish. But there are issues that could dramatically lower the commercial value of newer therapies going forward.

First and foremost, hepatitis C infections have naturally been on the decline in the U.S. for the last decade. What's key to know is that hepatitis C therapies garner a significant premium in the U.S. compared to other markets, which has led, at least partly, to the contentious pricing debate for these drugs. As this market slowly evaporates through natural mechanisms and the introduction of functional cures like Sovaldi, one of the most lucrative markets could literally dry up.  

Secondly, unfortunately the vast majority of hepatitis C infections occur in countries and often among populations with little access to health care. Although these large numbers of individuals suffering from the disease may sound impressive, shorts likely see these demographic issues as roadblocks to monetizing newer therapies. Put simply, Sovaldi is exploiting its first-mover advantage in a big way by pushing hard in the most profitable markets.

Foolish wrap-up
While I think the shorts certainly have a point about the long-term outlook of the hepatitis C market, the large milestone payments owed to Enanta are reason enough to think the stock still has remaining upside. Indeed, this is the main reason why I added Enanta to my portfolio.  

Barring an unexpected and undisclosed surprise in the clinical data, I expect AbbVie and Enanta's therapy to gain approval in the U.S. later this year, especially since insurance companies are clamoring for new therapies to potentially force Gilead to lower Sovaldi's price tag. After that, I wouldn't be surprised if Enanta becomes a takeover candidate by either AbbVie or its other major partner Novartis. At the end of the day, Enanta still looks cheap in light of its lucrative deal with AbbVie, and even more so following the eye-popping deal Merck made for Idenix's hepatitis C pipeline.

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George Budwell owns shares of Enanta Pharmaceuticals. The Motley Fool recommends Gilead Sciences. The Motley Fool owns shares of Gilead Sciences. 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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