The biotechnology sector is among the market's top-performing sectors. Over just the past five trailing years, the SPDR S&P Biotech ETF has quadrupled, all while the broader market S&P 500 has risen by just 75%. That's a sizable outperformance on the part of biotech stocks. In fact, around one in 10 biotech stocks has seen its valuation double over the trailing 12-month period.
Short-sellers take aim at biotech
However, the incredible returns that biotech stocks have generated could also leave them exposed to the wrath of short-sellers (investors who make money when stock prices fall) if our latest stock market correction continues. Because biotech stocks' valuations are based more on future sales projections and emotions than those of stocks in any other sector of the market, they could find themselves under substantial pressure if fear replaces greed in investors' minds.
With that in mind, let's have a brief look at three biotech stocks that short-sellers are targeting the most and determine whether or not that pessimism is warranted. I've excluded biotech companies with a market valuation of less than $1 billion for the sake of argument, as small-caps can be especially volatile and susceptible to the effects of short-sellers.
Insys Therapeutics (INSY): 70% of float held by short-sellers
I was a bit surprised to find that Insys Therapeutics is the most short-sold biotech company, considering that it's healthy and profitable.
One possible reason short-sellers have pounced on Insys is its association with "marijuana stocks." Insys is in the process of developing an oral solution that uses the cannabinoid CBD from the cannabis plant to treat two rare types of childhood-onset epilepsy, known as Dravet syndrome and Lennox-Gastaut syndrome. At the moment, Insys' research into its CBD therapy is still in the early stages. It also has its dronabinol oral solution, which uses a synthetic version of the cannabinoid THC for the treatment of chemotherapy-induced nausea and vomiting. With pretty much all marijuana-based stocks losing money, short-sellers may have lumped Insys in with the mix and decided to bet against it.
Another possibility is that investors are concerned with Insys' highly specialized portfolio. The company's lead drug is Subsys, a sublingual breakthrough pain therapy for cancer patients that comprised 99% of Insys' total revenue in the second quarter. If something were to happen with Subsys in the future, or if competition in the breakthrough cancer space were to increase, Insys could be in trouble.
Now for the important question: Is this pessimism warranted? While I can understand short-sellers' skepticism regarding Insys' reliance on a single drug (which, for the record, is not a marijuana drug -- making it questionable whether Insys can even be called a "marijuana stock"), the company is, and should remain, very profitable. Subsys has established itself as a steadily growing cancer care product, and Insys has a genuine shot at $2 in EPS as soon as 2017. In other words, short-sellers could be playing with fire here, and they may get burned if they aren't careful.
MannKind (MNKD -0.27%): 49% of float held by short-sellers
On the flip side of Insys we have MannKind, which may well deserve the pessimism currently being thrown its way.
MannKind also leans heavily on a single drug, but that's because it has only had a single drug in development for years. Afrezza is a revolutionary inhaled diabetes therapy for type 1 and type 2 patients that could eliminate the need for insulin injections. Not only is it a major advance in convenience from an injection (something a needle-phobe like myself can appreciate), but it's also fast-acting and can leave the body quicker than other insulin products on the market. The implication is that there could be fewer instances of hypoglycemia, or low blood sugar, among diabetics.
However, there are plenty of reasons for short-sellers to be pouncing on MannKind. First of all, sales of Afrezza have been pitiful since it entered the market in early February. MannKind's licensing partner for the drug, Sanofi, announced that year-to-date sales have totaled just $3.3 million. It's such a small figure that it doesn't even register in terms of diabetes drug market share. It's tough to tell exactly what could be causing Afrezza's painfully slow launch, but it's probably some combination of doctors being unaware of the new therapy, insurers still not covering Afrezza, and Afrezza's premium price point compared to traditional injections.
MannKind is also facing financial woes that short-sellers have clearly focused on. Despite securing $150 million upfront from Sanofi for its licensing deal, and another $175 million as Sanofi's share of collaboration expenses, MannKind still has to borrow money to meet its portion of the loss-share agreement stemming from Afrezza's poor sales. Future financing needs for MannKind, which didn't seem like much of a worry when the licensing deal was forged, are once again a front-and-center issue.
With nearly 122 million MannKind shares currently sold short, I'd recommend you give this stock a wide berth.
Sarepta Therapeutics (SRPT 0.62%): 29% of float held by short-sellers
The real wild card of the bunch is clinical-stage biopharmaceutical company Sarepta Therapeutics, which may explode or implode based on whether or not the Food and Drug Administration approves eteplirsen as a treatment for Duchenne muscular dystrophy, or DMD, caused by exon 51.
DMD is a disease that currently has no cure or FDA-approved treatments, so a first-in-class treatment would likely come to market with minimal competition and a high price point, considering that DMD is a rare disease. But as you can see, there are a lot of concerns heading into the February 2016 PDUFA decision by the FDA.
To begin with, Saretpa and the FDA haven't always seen eye-to-eye. Sarepta's management team, including its now-former CEO, often misinterpreted what the FDA believed was needed to demonstrate the efficacy of eteplirsen in clinical trials. The miscommunication between both parties wound up delaying the filing of eteplirsen's new-drug application with the FDA, and there are no guarantees that another breakdown in communication won't occur.
Also, Sarepta's valuation is strongly swayed toward its exon-skipping drug development platform for DMD. If eteplirsen misses the mark in ongoing late-stage studies, or if the FDA fails to approve eteplirsen, it could cast doubt on a big chunk of Sarepta's remaining pipeline and crush the stock.
So who's right? Honestly, it's a coin flip at the moment, which is why this is a stock the faint-of-heart investor shouldn't own. Sarepta's phase 2b extension study has showed statistically significant improvement in the 6-minute walk test over 168 weeks (that's more than three years), but the patient population of the study is fairly small. With an FDA decision that could swing either way, short-sellers will either be popping open the champagne or the antacid -- along with their wallets to meet a margin call.