A rapidly increasing short interest in a stock is sometimes a good signal that an investment may not be a good idea. Even so, it's critical to understand why shorts are moving into the stock before making any investment decisions.
Raptor Pharmaceuticals (NASDAQ: RPTP) saw its shares rise by more than 300% following the 2013 FDA approval of Procysbi (RP103), the company's orphan drug for nephropathic cystinosis. Although the stock gave back some of that monstrous gain earlier this year, Raptor shares have started to move higher again over the past month.
Short-sellers have nonetheless moved into the stock in lockstep with Raptor's rising share price. With that in mind, let's consider two reasons why shorts think this stock is setting up for a reversal.
Reason No. 1
While getting a drug approved is no small feat, it's only half the battle. Successfully commercializing a drug requires substantial resources and know-how. This is always a major challenge for biopharmas like Raptor that are transitioning from a developmental to a commercial operation.
Following Procysbi's approval, Raptor's selling, general, and administrative expenses increased markedly. Raptor reported last month that such costs hit $12.1 million in the first quarter, a 53% increase over the same period a year ago. Interest expense also climbed to $2.8 million for the quarter, compared to only $0.7 million for the same period a year ago.
Because of these costs associated with commercializing Procysbi and rising research expenses, Raptor lost $14.9 million in the first quarter (excluding one-time costs), or $0.24 per share, despite earning $12.1 million in net product sales.
Reason No. 2
Raptor also provided a much lower annual guidance for Procysbi sales than expected by Wall Street. Specifically, the company expects annual sales to come in between $55 to $65 million for 2014. The Street was expecting a figure closer to $70 million.
Although Raptor didn't provide much insight into this annual sales projection, Procysbi's commercial opportunity in Europe may be smaller than previously believed. Experts believe there are fewer patients in Europe afflicted with nephropathic cystinosis than indicated by earlier sales models. This could be a strong contributor to Raptor's weak annual sales guidance for Procysbi.
More important, consider what this lower guidance means in terms of Raptor's valuation. At its present market cap of roughly $700 million, Raptor's shares are trading at about 11 times annual revenue.
While this may not be an astronomical figure for a biopharma, it's also not cheap. And considering that overall expenses are expected to increase for the foreseeable future, Raptor's bottom line may not improve enough to create a compelling valuation going forward.
Foolish wrap-up
While Raptor's problems appear to center around its sudden stock-price rise and disappointing sales projections, there are reasons to be optimistic. Specifically, Raptor is developing RP103 as a potential treatment for nonalcoholic fatty liver disease, or NAFLD, and Huntington's disease. Raptor's midstage trial for NAFLD in children is now fully enrolled, with top-line results expected in early 2015.
NAFLD and related liver diseases are believed to be potentially lucrative indications. Earlier this year, shares of Intercept Pharmaceuticals (ICPT) more than tripled after the company reported positive top-line results for obeticholic acid, its experimental treatment for nonalcoholic steatohepatitis.
Moreover, top biotechs such as Gilead Sciences (GILD 0.12%) have taken a keen interest in developing drugs for liver diseases in hopes of capturing some of this rapidly growing market. Gilead's simtuzumab is in a midstage trial for the treatment of liver fibrosis.
Raptor's midstage trial for NAFLD in children could thus be a major catalyst for the stock in the next 12 months and may create interest in a possible takeover.
I believe Raptor's rising short interest is linked to the difficulties associated with commercializing a new drug and an uncertain market opportunity for a rare disease. At the same time, Raptor has other irons in the fire that are worth watching closely.
