Although the ranks of extremist biotech investors don't like to admit it, the Feuerstein-Ratain Rule has a perfect record when predicting micro-cap phase 3 oncology trial success. The rule is named after Adam Feuerstein, a senior columnist at TheStreet.com, and Dr. Mark Ratain, an oncologist from the University of Chicago, who published a study in JNCI in October 2011 explaining their observations. After looking at the outcomes of 58 phase 3 cancer trials over the past 10 years, the pair found that companies with a market cap less than $300 million several months before the release of trial results were 0-for-21, whereas companies with a market cap exceeding $1 billion were a respectable 21-for-27. Ouch.
The study opened the door for fierce battles every time a micro-cap biotech challenges the rule. Unfortunately for the bandwidth limits of message boards, there is at least one phase 3 trial expected to test the Feuerstein-Ratain Rule in 2013. Does the rule have any validity? Should investors jump ship and take their gains with them or hang on for an even bigger possible gain?
Passing the test
The rule was tested for the first time last year when Keryx Biopharmaceuticals (KERX +0.00%) and Aeterna Zentaris (AEZS 0.51%) conducted the X-PECT phase 3 trial for the drug perifosine in colorectal cancer. Despite the company botching the phase 2 trial design (which still got the nod from the Food and Drug Administration) and evaluating results from only 38 patients (of an enrollment target of 381), Keryx faithfuls stood behind the company, hoping to realize huge gains on successful phase 3 results. Those results never came. After months of delays, the companies finally announced a disappointing end to the 468 patient study that failed to meet its primary endpoint.
On April 2, shares of Keryx and Aeterna fell by more than 60%. The Feuerstein-Ratain Rule successfully predicted the outcome of its first post-JNCI trial, and their track record became a perfect 22 for 22.
Nonetheless, Aeterna is determined to forge ahead with plans for a phase 3 trial treating multiple myeloma patients with perifosine, which could challenge the rule again in 2014 or 2015.
Why the rule works
Arguments against the Feuerstein-Ratain Rule try to find fault in its simplicity. Investors often ask, "How does market cap have anything to do with the science behind the therapy?" At first glance, the two are seemingly disconnected. But Feuerstein offers a concrete explanation:
"Ratain and I recognized that one reason micro-cap cancer drugs had a perfectly dismal record with phase III trials is because the drugs being developed had already been vetted by both the market (i.e., investors) and larger, more successful cancer drug companies and found to have a low probability of success.
Cancer drugs are scarce and valuable commodities. Larger drug companies are way more likely to acquire, or at least partner with, a smaller drug company if that smaller company has a cancer drug in development with a strong shot at being successful.
Market cap, therefore, becomes a reliable and accurate proxy for predicting cancer drug trial outcomes."
Let's go through that. Feuerstein maintains that should a cancer drug have a reasonable shot at success, a larger company will acknowledge, acquire, or partner with the owner of the molecule (a micro-cap biotech, in our case) long before the 120-day threshold. It appears that market cap has everything to do with the science behind the drug.
Be blue or be sorry?
The rule is particularly bad news for Celsion (CLSN 4.67%), which is due to announce the results from the phase 3 HEAT trial this month. Uh-oh. The company had a market cap of $164.5 million just three months ago. Uh-oh. The trial is designed to significantly delay the regrowth of liver tumors with a combination of ThermoDox and radio frequency ablation, or RFA. Failure to reach the primary endpoint would surely punish the stock, which has gained 320% in the last year on high hopes for success.
Fellow Fool Rich Duprey recently penned that Celsion would yield even bigger gains for investors should positive results be achieved. He correctly noted that RFA has become a popular method for treating cancerous tumors, but the Feuerstein-Ratain Rule suggests Celsion's platform will disappoint investors.
One to watch, just don't get dizzy
Late last year, Peregrine Pharmaceuticals (NASDAQ: PPHM) pulled the rug out from under investors after a strange and messy series of events. The company originally announced positive results for a promising phase 2 trial. Or did it? Major labeling errors in the phase 2 trial data seemed to show that the company's leading drug bavituximab did not show statistical significance in treating second-line non-small-cell lung cancer. Or did it?!?
Now, the company claims it has found discrepancies in labeling that support advancing the drug to a phase 3 study. Regardless if that happens -- and it could take years -- it appears that Peregrine could be a prime candidate in challenging the rule down the road. Controversy, mind-blowing pops, and crushing collapses. What else do you need?
My confession
Believe me; I know what it's like to fantasize about hitting a home run with a sleepy, under-the-radar biotech stock. Back in college, before I truly understood how to gauge the health of a balance sheet, I invested in Keryx. Yep, me. Sometime after buying shares and before the trial results were announced, I began to refine my investing principles and couldn't sell out of my position soon enough.
Now, I'm not saying that those who choose to invest in micro-cap biotech stocks don't understand investing. In fact, I find that some of the most intelligent investors stake positions in the industry. Everyone has a different appetite for risk, and I simply realized it wasn't for me.
