Are Short-Sellers Onto Something at Spectrum Pharmaceuticals?

Since everyone loves a winner, it's reasonable to assume that everyone hates a loser -- everyone but short-sellers, at least. These contrarian investors bet that hot stocks are primed to fall, aiming to turn their pessimism into profits.

Below we take a look at drug developer Spectrum Pharmaceuticals (SPPI), which has nearly 60% of its float sold short with its short interest ratio hitting more than 33 days to cover. Sales of its top two drugs fell in the latest quarter, while its acquisition of Folotyn had raised concerns before the deal was completed in September, so let's see if this tiny pharmaceutical has the power to make short work of short-sellers.

Spectrum Pharmaceuticals snapshot

Sources: Nasdaq.com, FinViz.com. N/A = not available; Spectrum Pharmaceuticals doesn't pay a dividend.

Just because the shorts are piling in doesn't mean you should too. Such stocks could have serious problems that warrant their short interest, but they might also just be stricken by short-term troubles. Only Foolish due diligence will tell you for certain.

The short story
Sales of colorectal cancer treatment Fusilev sales were up 27% year over year but fell 8% sequentially , while its other home-grown drug Zevalin -- which is used to treat B-cell non-Hodgkin lymphoma -- rose 14% from the year ago period, but slipped 11% sequentially. It's in a tough market fighting competing therapy Rituxan, which is manufactured by Roche and Biogen Idec (BIIB 2.03%), who saw an 8% rise in sales last quarter to $288 million.

While there's a shortage of Fusilev's generic leucovorin that was fueling the rise in the more expensive branded version, it's likely going to come to an end sooner or later meaning that Teva Pharmaceuticals (TEVA 0.63%), Sagent Pharmaceuticals (NASDAQ: SGNT), and Bedford Labs will profit at Spectrum's expense as generic sales perk up again. Spectrum's still convinced it will come out ahead regardless because international sales, where there is no shortage, have held up well and it's increased market penetration to 31% from 29% last quarter.

Three's a crowd
Yet it still explains why it was in such hot pursuit of Folotyn, the drug it acquired from Allos Therapeutics, as sales jumped 18% sequentially even when one-time purchase for a clinical trial is backed out of the equation. Many had questioned why Spectrum would want a drug that AMAG Pharmaceuticals (AMAG) gave up on acquiring, but sales seem to have perked up and it's expecting the synergistic savings from the tie up to come in at the high end of its guidance of $40 million to $50 million, if not more.

Obviously, short-sellers think the weight of competition and slack organic growth will cause Spectrum's stock to collapse further. It's down 27% in 2012 and sits 38% off its 52-week highs. But it's going to have to put together more than one quarter of strong growth from Folotyn and it needs to show that Fusilev and Zevalin can bulk up sales more than they are. At $10 a share, though, I'm rating Spectrum Pharmaceuticals to outperform the market indexes on Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion into stock ratings of one to five stars.

With three drugs available to it now to fuel revenue growth, it should be able to exceed expectations, which have been set awfully low.