Because short-sellers are exposed to potentially unlimited losses, they tend to be cautious in choosing their targets. So whenever the short interest picks up in a stock, it's important to understand why.
Durata Therapeutics (UNKNOWN:DRTX.DL) has seen a rapidly rising short interest over the past few months heading into the company's regulatory review of Dalvance, an injected antibiotic indicated for acute bacterial skin and skin structure infections, or ABSSSI. Although late-stage clinical trials showed that Dalvance is noninferior to vancomycin in the treatment of ABSSSI and offers patients the benefit of shorter treatment periods, shorts have still pushed into this stock even after its FDA approval last month. With that in mind, let's take a look at three potential reasons why shorts are taking an interest in this small-cap biopharma.
Reason No. 1
As shown by the chart above, Durata shares have been moving higher at a good clip for months now. Specifically, shares have risen over 118% in the past year alone. So one clear reason why shorts could be targeting Durata is that they believe the stock is ready for a pullback following such a tremendous run.
That being said, I think it's important to keep Durata's market cap and value proposition in mind. Presently, Durata sports a market cap of about $408 million, yet Dalvance sales are expected to peak at around nearly the same figure, i.e. $400 million. If commercialization pans out, then Durata's shares look cheap, despite their strong run over the past year.
Reason No. 2
Whenever a biotech transitions from a purely clinical operation to a commercial one, it's important to remember that financing is almost always a major issue. And Durata is no exception. Not only does the company have to fund a commercial launch of Dalvance, but it is also paying for additional clinical trials.
To help meet these financial obligations, Durata entered into a credit agreement with PDL BioPharma (NASDAQ:PDLI) in October 2013 that could total up to $70 million. Durata will also owe Pfizer a $25 million milestone payment for the commercialization of Dalvance in certain territories and will incur expenses for initiating additional clinical trials for indications such as osteomyelitis, diabetic foot infection, and pneumonia. Taken together, Durata is likely to remain cash flow negative for the next few years and could be forced to seek out additional financing sources if Dalvance sales don't get off to a quick start.
Reason No. 3
The antibiotic drug market is plagued by rapidly evolving bacteria that lessen the effectiveness of treatments over time, mediocre margins, and increasing competition for growing markets like ABSSSI. For example, Cubist Pharmaceuticals (UNKNOWN:CBST.DL)is also seeking FDA approval for its rival ABSSSI antibiotic called Sivextro, which received a unanimous recommendation from an Advisory Panel earlier this year.
In my view, this looks like one of the chief reasons shorts have started to move into Durata of late. Cubist is experienced in the process of commercializing antibiotics and already has a sales force in place as a result. In short, Sivextro could have a negative impact on Dalvance's market penetration rate, and subsequently hurt Durata's top-line growth.
Although Durata's short interest has been climbing, you should bear in mind that it's far from being one of the most shorted stocks on Wall Street. All told, I think shorts expect the stock to pullback from recent highs, and Cubist's drug to be a strong competitor in the ABSSSI space.
At the end of the day, however, Dalvance's sales numbers will ultimately dictate how the stock will perform in the long term. If Dalvance can show strong market penetration in its first full quarter on the market, Durata should have little trouble meeting its financial obligations. And with ABSSSI infection rates soaring in the U.S. in recent years, there is good reason to believe the market could support multiple drugs. In sum, I think Durata is an intriguing growth stock that you should keep a close watch on moving forward.
George Budwell has no position in any stocks mentioned. The Motley Fool recommends Cubist Pharmaceuticals. The Motley Fool owns shares of Cubist Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.