Many investors are drawn to biopharma stocks because of the potential for outsized rewards. While it's possible to hit home runs, it's also possible to lose quite a lot of money. The binary outcomes of biotech investing -- major success or disappointing failure -- are familiar to most investors, but there are best practices you can follow to increase your chances of success and help you to avoid crushing failures. Here are three biotech investing tips that could earn you thousands, as illustrated by MannKind Corporation (NASDAQ:56400P706), Keryx Biopharmaceuticals (NASDAQ:KERX), and Ziopharm (NASDAQ:ZIOP).
Don't fall for storytelling traps
What clinical stage companies lack in marketable products they often make up for with a great story. It helps to communicate their vision, explain complex technical aspects of their platforms in digestible language, and stand out among peers. However, sometimes investors forget that a great story has to eventually be backed up with execution and market traction. Too often, investors make excuses for story stocks that begin to encounter worrisome problems rather than hold management accountable and admit that a stock won't live up to its original potential. Storytelling is great, but clinical data and market traction ultimately decide a biopharma stock's fate.
Unfortunately, there are a lot of examples that illustrate this point. Biopharma investors may familiar with MannKind Corporation, which developed an inhalable insulin product called Afrezza. The company's story was incredible: remove the worst part of the diabetes patient's experience (injecting insulin) with an easy-to-use product. It sounded great on paper, but finding commercial success has been anything but easy.
After a long development period, the U.S. Food and Drug Administration approved Afrezza in 2014. MannKind Corporation had the backing of diabetes expert Sanofi and looked primed to take over market share from injectable insulin products. However, Afrezza never gained traction. Sanofi pulled out of the partnership in January 2016. And MannKind only managed to achieve sales of $573,000 during the third quarter of this year. It may seem like a cruel joke on investors, especially considering that Afrezza passed a major bar in gaining regulatory approval and did improve the patient experience, but real-world performance is what ultimately drives a stock's success.
Beware balance sheet warning signs
MannKind's problems only appear to get worse when Afrezza's minimal sales are combined with red flags on its balance sheet. Unfortunately, balance sheet woes aren't uncommon for clinical-stage biopharma companies, which almost always burn through considerable amounts of cash.
Investors should pay special attention to a young biopharma's cash balance and debt-to-assets ratio. If a company has an early stage pipeline and a dwindling cash pile, then it will likely need to close additional financing rounds. The two most common options are issuing shares (which will dilute existing shareholders) and issuing debt notes (which will convert into shares at a later date). But if a company already has a relatively high amount of debt, then it could be difficult to find buyers for additional debt notes. Willing buyers may demand high interest rates to offset risk, which could further limit a company's financial flexibility.
Keryx Biopharmaceuticals illustrates this point. The company actually doesn't have a pipeline, but it has one approved drug on the market: Auryxia, for treating iron deficiency anemia in patients with chronic kidney disease. Peak sales have been estimated at $1 billion, but initial market traction doesn't look so promising. Auryxia has generated less than $19 million in sales in the first nine months of 2016.
Management is optimistic it can overcome obstacles and increase prescriptions, but it closed the third quarter of 2016 with just $132 million in cash. Keryx Biopharmaceuticals is burning through roughly $20 million per quarter and, worse yet, has raised over $126 million in debt in the last year. The company will need considerably more cash to fund expansion of its lone drug in the coming years, but without quick improvements in sales, it could find its financial options relatively limited.
Investors don't need to be expert statisticians to avoid costly biotech investing mistakes, but knowing some general rules can go a long way. When it comes to clinical trials, larger populations (the "n" in statistics) are almost always better. Why? They can tease out placebo effects and other randomness that inevitably shows up in data. Investors can have more confidence in results from a major pharma company's phase 3 trial that evaluated 500 patients than they can in data from a micro-cap's phase 3 trial evaluating only 20 patients. The latter usually don't reach primary outcomes for that very reason.
Small populations is one reason I would caution investors eyeing Ziopharm. The company has a market cap of just $787 million, a relatively high cash burn rate, and an early stage oncology pipeline. To limit expenses incurred from clinical trials the company has proceeded with very small patient populations. A phase 2 trial in breast cancer included just 12 patients (only one showed a partial response). A phase 1 trial in a type of brain cancer included just 11 patients at the last update. Investors should be cautious when interpreting outcomes for these small trials.
What does it mean for investors?
A penny saved is a penny earned. The same holds true for investing in biopharma stocks -- a thousand-dollar mistake avoided is a thousand dollars earned. Avoiding the storytelling trap, being aware of balance-sheet red flags, and noting weak data can also help you to invest in companies that offer better chances of success.
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