Push-back on pricing, trial failures, and management misdeeds have bloodied biotech investors this year, and unfortunately, Alexion Pharmaceuticals (ALXN) and Ophthotech Corp (ISEE) have just delivered investors even more crushing news.

At Alexion Pharmaceuticals, the sudden departure of top executives in the midst of an ongoing internal investigation caused its shares to tumble 13%. Meanwhile, a surprising phase 3 failure at Ophthotech caused its shares to crash 85%.

What's this bout of bad news mean for investors? 

In this episode of The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and contributor Todd Campbell discuss these two disappointing revelations, and their impact on shareholders.

A full transcript follows the video.

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This podcast was recorded on Dec. 14, 2016.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Kristine Harjes, and it is Dec. 14. As usual for a Wednesday, will be talking about the healthcare sector, and I have healthcare contributor Todd Campbell on the line. Todd, is there anything new and exciting in your life since last Wednesday when we spoke?

Todd Campbell: No, not too much, just battling a little bit of a cold, I suppose. I suppose there is one good thing. My son, who's in the Navy, is off to Seattle for his next post. It's pretty exciting to see him moving on to that next area of his life.

Harjes: Very cool, does that mean that you get to take a trip out there?

Campbell: Oh yeah. We're already starting to plan it out. I'm looking forward to getting all sorts of recommendations of great places to eat and hang out.

Harjes: Hey, if we have any listeners out in that area, send them on in to [email protected], tell Todd where to go.

Campbell: (laughs) Fantastic.

Harjes: So, for today's episode, we will be discussing two news items from Monday of this week, one of them involving an eye-disease drugmaker's clinical trial flop, and the other one is about a management shake-up at a rare-disease drug company. But first, I want to do a quick update from last week's episode, and point out that Obama has officially signed 21st Century Cures Act into law as of yesterday. As a reminder, this provides over $6 billion in spending on medical innovation, and it also streamlines the drug and device approval process at the FDA [Food and Drug Administration]. If you missed last week's episode, you can find it at podcasts.fool.com. You can also find all of The Motley Fool's podcasts on there. And, while you're online, if you're interested in learning about the Foolish approach to options, we've been talking about that a little bit here and there on the show, and it always gets a lot of people excited and writing in, so we have a landing page for it now. You can check it out at fool.com/optionsfocus. There's a bunch of good free material on there. Our Foolish approach to options has been extremely successful, so check it out if you're interested.

Todd, do you want to tee off the first topic for today?

Campbell: Absolutely. You mentioned last week. We tried to bring some positive news to biotech land, but we're back again this week with some negative news. Can you believe, Kristine, we're talking about yet another, we'll call it a high-profile flop?

Harjes: Yeah, biotech is having a rough go of it lately.

Campbell: It is. There's almost an investor's crisis of confidence that's building, especially in the clinical stage biotechnology companies. You have some pretty high-profile disappointments recently. We had Juno, obviously. Eli Lilly stumbled with an Alzheimer's disease drug earlier in the year. There were some setbacks to some stuff that was going on at Portola Pharmaceuticals, which we discussed on the show. The latest incarnation of this crisis of confidence is Ophthotech and its failure of its age-related macular degeneration drug, Fovista.

Harjes: Right. They were testing Fovista in combination with Lucentis, in wet AMD, which is the age-related macular degeneration that you mentioned. This was being tested in two phase 3 trials across a total of 1,248 people. And it just flopped. They reported that it just didn't improve anything, more or less. They were testing Lucentis alone versus the combination of Fovista and Lucentis, and the two groups were essentially the same, which is a humongous disappointment. This was a drug that a lot of people were very excited about. Novartis (NVS -0.69%) was partnered on the drug. And phase 2 data from the drug looked really fantastic, so I think this caught a lot of people off guard.

Campbell: Yeah, Kristine, I think that's one of the reasons this was...it's not a surprise when clinical drugs fail. Even in ophthalmology alone, only 58% of phase 3 trials succeed. Slightly better than a coin flip. So, it's not a complete surprise that they came up short. But, if you look at the press release from the phase 2b results and you read through it, it's hard to come away not feeling pretty good about it. And then you look at the fact that Novartis, after that phase 2b data came out -- and Novartis, just to give a little background, markets Lucentis, which is one of the largest or most commonly used drugs to treat this indication. And, the fact that they were willing to give essentially $330 million early on, plus promises up to another $670 million, just to get the outside U.S. rights to this drug --

Harjes: Right, that's important. That was just the ex-U.S. rights.

Campbell: Right. So, you have the company and industry people saying, "Wow, those phase 2b results were really good." You have Novartis, which markets one of the most-used drugs in the indication, saying, "We think this is good enough that we're going to license the ex-U.S. rights to it." There were a lot of reasons for investors to feel pretty confident, more confident, maybe, than they would normally with coin-flip success rate in phase 3 for ophthalmology indications.

Harjes: And the way that you test this is how many letters of vision the patient improves. It's on something called the Early Treatment of Diabetic Retinopathy Study standardized chart. We'll just called them letters. When you looked at the phase 2 trial, the Lucentis-alone group, those patients improved an average of 6.5 letters after 24 weeks, as opposed to the combination group, which improved 10.6. So, 6.5 letters versus 10.6 letters, that was definitely significant. That was a really favorable improvement. And then you look at the phase 3, and this was measured after 12 months, the combination group improved 10.24 letters, which is pretty consistent with what we saw after 24 weeks in the phase 2 trial. But the Lucentis group alone, the control group, improved 10.01 letters.

Campbell: Right. And you just brought up a great point, Kristine.

Harjes: Yeah. There's two ways to look at this. You could say, was Lucentis just weirdly ineffective in that phase 2 trial? Or is the phase 3 trial flukey in how effective the Lucentis-alone group was?

Campbell: Or, does Lucentis' efficacy improve over time? 

Harjes: Exactly, because you have two very different time frames.

Campbell: Right. Not long ago, Regeneron (REGN -0.27%), which is another big player in this space, they make a drug called Eylea, which, by the way, does more than $5 billion in sales targeting ophthalmology indications, they tried a drug that worked similarly to Fovista, alongside their own Eylea, and that trial failed in mid-stage studies. But what was interesting to me about that wasn't just that it failed and it worked similarly to Fovista, which is interesting in and of itself, but the fact that the letter improvement in the monotherapy arm for Eylea wasn't that great, either. It was mid- to high-single-digit letter improvements. So, it could be that the efficacy of this class of anti-VEGF -- Lucentis, Avistan, which is widely used as well, and Eylea -- the efficacy just improves over time, and eventually closed the gap between the Fovista plus and the monotherapy arms.

Harjes: And I do think the Regeneron data should have been a little bit of a warning sign for investors with this one. After that happened, on Ophthotech's next conference call, they were actually asked, "Hey, are you bothered by this data? What do you think? Does this affect you guys going forward?" And they were essentially like, "No, we think our drug is really good," and they just kind of moved on. But you had Regeneron doing essentially the same thing that Ophthotech was trying to do in this trial, taking two drugs that each worked in a parallel way and putting them together, and it failed back in September.

Campbell: Yeah, that was very prescient. Obviously, I imagine that all the results were blinded in the phase 3 trials, so it's not like management had anything other to go on than their phase 2b results, which were very good. They could have been looking at it and being like, "This was a phase 2 trial that stunk, and our phase 2 trial was awesome," and maybe that was influencing their positivity on the conference call. In the end, you're left with a clinical-stage company that once again shows investors the risk, the hit-and-miss risk, of investing in biotech.

Harjes: Yeah, I don't think we stated yet, but this company fell 85%.

Campbell: 85%. This was an $80 stock at one point, and I think it's trading at like $5 now. Just an absolute bloodbath for the company. And again, hit and miss. When you're investing in clinical-stage companies, they're usually focusing on one indication, or one mechanism of action -- and that's very different than, say, a Lilly failure, where they're fairly diversified across a lot of indications. When something goes wrong in these clinical-stage companies, it goes wrong in a bad way.

Harjes: And that's what makes them so exciting to watch. But there are also definitely lessons to learn every time you see this. I need to go on record here saying I was flat-out wrong on this one. I'm a shareholder, I still am. I will probably sell my shares some time soon, as soon as Fool trading rules allow me to do so after talking about it on this show. Honestly, I was beating myself up over this one when I first heard the news on Monday. But, I was reminded of some really good lessons for investing. You're not going to be right every single time. The best investors in the world only get it right 60% of the time. But, the advantage here of being in it for the long haul, taking the truly Foolish approach, is that you can afford to be wrong every once in a while. Your biggest winners will often more than offset your biggest losers. We talk a lot about diversification on this show, particularly the Healthcare show. That's really important here, it's important as ever. You take one loss like this, and hopefully it's only a very small portion of your portfolio, and you can move on, learn your lessons, and hopefully have many more winners make up for it.

Campbell: Amen. That's the way to approach it. If there's one thing that you and I have said over the course of the last few months especially, every week's show, when it comes to biotech, diversify, diversify, diversify. I got stung on this one, too. Again, it just reminds you to make sure that you do spread those eggs around.

Harjes: All right. Shall we cut our losses and move on?

Campbell: Yes.

Harjes: OK. Second topic of the day for this show is a management shake-up at a rare-disease company called Alexion. This was another news item that came out on Monday, and the stock was down 13%. This is a pretty big company, so that actually erased $3 billion of market cap.

Campbell: Kristine, is this going to be a "where there's smoke, there's fire" kind of situation?

Harjes: It could be. (laughs) We've yet to see the fire, but there is certainly smoke. Do you want to explain what that smoke is?

Campbell: All right. We have a situation where, we'll call them the two most important executives in the C-suite of Alexion have been shown the door. Now, the official line is that the CEO left because of personal reasons and the CFO has left to explore other opportunities. But that's boilerplate conversation that always comes out in the press releases. The reality is that somewhere along the line recently, both of these long-term executives -- these people that have been employed by Alexion for a decade -- have lost the confidence of the board. You can't help but wonder if that loss of confidence stems from an investigation that's been ongoing at this company for the last month-and-a-half into their sales practices.

Harjes: Right. There were allegations made by a former employee about how their main drug, Soliris, is sold. This caused Alexion to delay its filing of its 10-Q for the third quarter with the SEC. In this latest press release, we hear that they are almost finished with this investigation that's going on, and they probably won't end up having to resubmit historical results. They are still expecting to submit this 10-Q in January, which, they'd better, if they don't that's Bad News Bears right there. But, you have to think that the timing of this couldn't be coincidental.

Campbell: Yeah. I'm reading between the lines here and I'm seeing that press release, when they're saying, "We won't have to restate anything," that doesn't address the whole investigation. The investigation was into the sales practices, and whether or not those sales practices were within their code of conduct. If I take that and extrapolate that out a little bit, you can't help but wonder whether or not there were, dare I say shenanigans, that may have been going on, as far as either obtaining reimbursement, or how they're handling patients, or whatever. Investors have seen this over the course of the last year or so with a couple different companies, Valeant obviously being one of them, where there were some behaviors that were embraced in the sales force that weren't up to snuff, or up to the sniff test.

Harjes: That kind of begs the question, will this company beat the next Valeant?

Campbell: Right. And it's way too soon to tell, and there's a lot of differences between this company and Valeant. This company, for one, is extremely profitable. They are already making a lot of money.

Harjes: Right, the rare-disease space is extremely lucrative.

Campbell: Yeah. But, I think you do have to look at that, and Soliris is an extremely expensive drug, we're talking more than $500,000 a year for this drug. It treats a very, very small patient indication. Addressable market is tiny. So, if you have anything that jeopardizes either their pricing power or their reputation among payers, prescribers, and patients, then there could be some fallout that could be Valeant-like to this company. We just don't know. We have this information gap that we're sitting in right now, because we know that the leaders are gone, and we know new leaders have been put in place. And both of those leaders, by the way, they're solid people. You have David Brennan taking over as CEO, he came from AstraZeneca, where he was --

Harjes: And that's interim, right?

Campbell: Right. He ran that for about six years. You have David Anderson, he's the CFO now, he was the CFO of Honeywell, and he did that job for a decade or so. These are highly talented or experienced people that theoretically can navigate some pretty crazy waters. The question is, how crazy will those waters be? And investors just don't know. We don't know.

Harjes: Yeah, you're kind of waiting for the other shoe to drop there. I will point out, given that David Brennan, the new interim CEO, is just that -- a placeholder for now. There is an executive search firm that's been hired to find a permanent replacement. That, to me, suggests that this was abrupt, unexpected, and again, makes it seem like it's possibly due to some uncovered bad news. So, definitely, something smells a little fishy here.

Campbell: "Here's your hat, what's your hurry?", right?

Harjes: What is that?

Campbell: I don't know if you've ever heard the saying, but, "Here's your hat, what's your hurry?" Basically, showing them the door relatively quickly. I think, you have to wonder. When you have someone from the board who's taking over now in that role, you're right, this is not what you call a smooth and planned transition.

Harjes: Yeah. So, you look at this company. They have Soliris. They also have another ultra-rare disease drug called Strensiq. They also have another one called Kanuma. All three are very expensive, they are for ultra-rare diseases. The company has a little over $1 billion in cash on the balance sheet. What do you think? Is this dip a good buying opportunity, or...? What do you think?

Campbell: I am always very hesitant to buy...I don't necessarily know if this is a dip, or if this is the beginning of an avalanche.

Harjes: Well, it wouldn't even be the beginning. This company is down 40% year to date.

Campbell: Yeah. And yet, it's still a pretty highly priced stock. We won't bring valuation into the issue on biotech at this point. I think there's a lot of risk. There's a lot of potential. Like anything else we've talked about, Kristine, it's a matter of diversification and risk tolerance when you're talking about biotech. If you can't stand the thought that this stock could collapse another 50% from here, then you should not be investing in it, even if you feel it's "on sale."

Harjes: Right. I kind of agree as well, but I think my personal risk tolerance might have just gone down temporarily after this Ophthotech blow-up.

Campbell: (laughs) I can understand that.

Harjes: Yeah. Todd, thank you so much for your insights, as always. Folks listening, do you have any questions for us, or if you just want to say, "Hey," shoot us an email. Our email address is [email protected]. You can also tweet at us @MFIndustryFocus. Also, we are still compiling a list of investment book recommendations, so send them our way. As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes. Thanks so much for listening and Fool on!