3 Reasons to Sell Spectrum Pharmaceuticals

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This is the sequel to my recent article outlining three reasons Spectrum Pharmaceuticals (Nasdaq: SPPI  ) ¬†looks like a good investment. If you'd like to hear the good news first, follow this link.

But there's another side of the story investors should hear. Understanding the risks is just as important to an investment thesis as knowing what's so great about a company.

Shortages rarely last forever
The biggest risk for Spectrum is the same one that's been present for nearly two years now. The company has seen a sharp increase in sales of Fusilev while generic-drug makers -- Teva Pharmaceuticals (NYSE: TEVA  ) , APP Pharmaceuticals, and Bedford Laboratories -- have struggled to keep a related generic product available for doctors.

The longer the shortage goes on, the more used to using Fusilev doctors get, and the easier it will be for Spectrum to hold onto the market share it's gained after the generic becomes available again.

That makes sense in theory, but it's difficult to know exactly what doctors will do until the shortage subsides. And even if doctors want to prescribe the branded drug, they might come under pressure from hospital formularies and insurance companies to prescribe the generic if it's readily available.

Still a drug developer
Spectrum doesn't discover drugs; it in-licenses all the drugs it sells. Fusilev came from Targent, and the company's non-Hodgkin's lymphoma drug, Zevalin, was originally developed by Biogen Idec (Nasdaq: BIIB  ) and sold to Cell Therapeutics (Nasdaq: CTIC  ) before Spectrum eventually gained full control of the drug.

But not all of the cast-offs Spectrum licenses are for drugs ready to sell. The company also licenses drug candidates that still have to pass clinical trials before they'll start producing revenue. While Spectrum eliminates some risk by licensing drugs after they've been through at least some clinical trials, the risk profile for their pipeline isn't that much different from the average biotech's, because late-stage molecules tend to cost more to develop.

The company has two late-stage assets: belinostat for T-cell lymhopmas and other solid tumors and apaziquone for bladder cancer. There are also six drugs in earlier stages of development.

Data from a pivotal clinical trial for belinostat is due out in the fourth quarter. Spectrum is more insulated than a drug developer like MannKind (Nasdaq: MNKD  ) , which will crash and burn if its lead product doesn't pass upcoming clinical trials, but Spectrum is nowhere near the level of a big pharma that can just shake off a phase 3 trial failure.

Hard to value
Spectrum has more than doubled over the past two years, handily beating a biotech index.

SPPI Chart

SPPI data by YCharts

But it's not the overall run-up that worries me. The company became profitable, and the P/E sits at only 11, so it's not as if investors are pricing in monster growth.

The bigger problem investors should notice from the chart is the huge up and down drafts on the chart. As far as I know, there weren't any major changes that caused the huge run-ups or the decreases. I think investors are rightfully a little anxious about Fusilev's sales, and that causes jitters every time the stock runs up.

Foolish take
If you can confidently say that Fusilev sales are here to stay for the long term, Spectrum is probably a good buy at this point. I don't have that confidence; I'm not confident they'll go away, either, so I wouldn't short the stock.

Sometimes you can lay out the risks and benefits of own a company and decide the company is just too hard to read to justify an investment. In that case, most investors would be best off watching from the sidelines.

The corollary, of course, is to invest in what you know. The Fool's free report has three suggestions for companies that middle-class America should be keenly aware of. Get your copy for free.

Fool contributor Brian Orelli holds no position in any company mentioned. Check out his holdings and a short bio. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 01, 2012, at 7:27 PM, Emperor2 wrote:

    Brian, first, as a service to your readers, I wish you would put your reasons to buy a company and a reason to sell a company in the same article. It is tough to have to wait a week to hear round 2.

    Second, as you mention, there has been a shortage of generic leucovorin for about 2 years. Think about this. Why would generic drug manufacturers not produce a drug if it is very profitable for them? They wouldn't. Would it take over 2 years to get generic leucovorin back on line, particularly when the FDA is apparently strongly pushing them to do so? Of course not. To my uneducated mind there is only one reason that generic leucovorin is still short. It is just not profitable enough for someone to make or prescribe it.

    Do you realize that generic leucovorin has a different reimbursement schedule that Fusilev? Do you understand that doctors make more money prescribing Fusilev than they do generic leucovorin? If I was a doctor, making X amount of money each time I prescribed Fusilev, and I knew that Fusilev worked well (studies have reportedly shown it even better that generic leucovorin - but that is a discussion for another day), why would I switch to another product that I may or may not be able to get, plus I make less money prescribing? Do you think that doctor's are totally stupid? Fusilev (can get all I need + make good money each dose) versus generic leucovorin (may or may not be able to get it + make less money). Which do you think I will choose? Teva is probably producing just enough to keep the FDA off their back. Unfortunately for them, the doctors just aren't proscribing it as doctors want to make as much money as they can (plus doctors know that Fusilev works). It is the perfect storm for doctor's. They make more money and the drug works.

    One other comment. Teva had issues with the FDA in the plant where they were producing generic leucovorin. They fixed those issues months ago yet they still are not producing enough generic leucovorin to get it out of the "shortage" category. They are producing other drugs in that plant. Why not generic leucovorin? It goes back to making a profit. If I can make a lot more money using my production line for product A, why switch to product B that will make less money?

    While your article tried to make a balanced case for the pros and cons of SPPI, I think you neglected to include Gordon Gecko's favorite reason for SPPi's success- GREED. This shortage will continue as both doctor's and manufacturer's both want to maximize profits. And I'd be willing to bet you money that if TEVA announced today that they are producing enough generic leucovorin to treat every patient in the US, that doctors would still look out for number 1 and prescribe Fusilev.

  • Report this Comment On August 08, 2012, at 11:23 AM, will1946 wrote:

    The reason for the "run-ups" and downs are for sure the big institutional investors (funds) who do it for their gain and coordinate it. There is NO reason for the loss today after sppi reported good earnings. The big money manipulates for their managers´gains, not for the little guys who invest their hardearned money with them.

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