Bad News Bashes Biotech Investors... Again

By Todd Campbell and Kristine Harjes Markets Fool.com

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

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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, andit is Dec. 14. As usual for a Wednesday,will be talking about the healthcare sector,and I have healthcare contributor Todd Campbellon the line. Todd, is thereanything new and exciting in your lifesince 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 forhis next post. It's pretty exciting to seehim moving on to that next areaof his life.

Harjes: Verycool, does that mean that you getto take a trip out there?

Campbell: Oh yeah. We'realready starting to plan it out. I'm looking forward to gettingall sorts of recommendations ofgreat places to eat and hang out.

Harjes: Hey,if we have any listeners outin that area, send them on in to industryfocus@fool.com, tell Todd where to go.

Campbell: (laughs) Fantastic.

Harjes: So, fortoday's episode,we will be discussing twonews items from Monday of this week,one of them involving an eye-disease drugmaker'sclinical trial flop,and the other one is about a management shake-upat a rare-disease drug company. But first, I want to doa quick update from last week'sepisode, and point out that Obamahas officially signed 21st Century Cures Actinto law as of yesterday. As a reminder, this provides over $6 billion inspending on medical innovation,and it also streamlinesthe 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 canalso find all of The Motley Fool's podcasts on there. And, while you'reonline, 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 excitedand writing in, so we have a landing page for it now. You can check it out at fool.com/optionsfocus. There'sa bunch of good free material on there. Our Foolishapproach to options has been extremely successful, so check it out if you're interested.

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

Campbell: Absolutely. You mentioned last week. We tried to bringsome positive news to biotech land,but we're back again this weekwith some negative news. Can you believe, Kristine, we'retalking 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'salmost an investor's crisis of confidencethat's building,especially in the clinical stagebiotechnology companies. You have some pretty high-profile disappointmentsrecently. We hadJuno,obviously.Eli Lillystumbled with anAlzheimer's disease drug earlierin the year. There were somesetbacks to some stuff that was going on atPortola Pharmaceuticals, which we discussed on the show. The latestincarnation of thiscrisis of confidence is Ophthotechand its failure of itsage-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 thata lot of people were very excited about.Novartis(NYSE: NVS) was partneredon the drug. And phase 2 datafrom 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 inophthalmology 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 awaynot feeling pretty good about it. And then you look atthe fact that Novartis, after that phase 2b data came out -- andNovartis, 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 haveNovartis, which markets one of the most-used drugsin the indication, saying, "We think this isgood enough that we're going to license the ex-U.S. rights to it." There werea lot of reasons for investorsto feel pretty confident, more confident, maybe, than they wouldnormally with coin-flipsuccess rate in phase 3 forophthalmology indications.

Harjes: Andthe way that you test this is how many letters of vision the patient improves. It'son something called the Early Treatment ofDiabetic Retinopathy Study standardized chart. We'lljust called them letters. When you looked at the phase 2 trial, the Lucentis-alone group, those patientsimproved an average of 6.5 letters after 24 weeks,as opposed to the combination group, whichimproved 10.6. So, 6.5 lettersversus 10.6 letters, that wasdefinitely 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 ispretty 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. Andyou just brought up a great point, Kristine.

Harjes: Yeah. There's two ways to look at this. You could say, was Lucentis just weirdlyineffective 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(NASDAQ: REGN), 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 toapproach it. If there's one thingthat you and I have saidover the course of the last fewmonths especially,every week's show,when it comes to biotech, diversify, diversify, diversify. I got stung on this one, too. Again,it just reminds youto make sure that you do spreadthose eggs around.

Harjes: All right. Shall wecut 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 calledAlexion. This wasanother 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'veyet to see the fire, but there is certainly smoke. Do you want to explainwhat that smoke is?

Campbell: All right. We have asituation where, we'll call them the two most important executives in the C-suiteof Alexion have been shown the door. Now,the official line is thatthe CEO left because of personal reasonsand the CFO has leftto explore other opportunities. But that's boilerplate conversationthat always comes out in the press releases. The reality isthat somewhere along the line recently,both of these long-term executives --these people that have been employed by Alexion for a decade -- havelost the confidence of the board. You can't help but wonderif that loss of confidence stemsfrom an investigation that's been ongoing at this companyfor the last month-and-a-halfinto their sales practices.

Harjes: Right. There were allegations made by a former employee abouthow 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 thislatest press release, we hear that they arealmost finished with this investigation that's going on,and they probably won't end up having to resubmithistorical 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 thiscouldn'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. Theinvestigation 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 thisover the course of the last year or sowith a couple different companies,Valeantobviously 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: Thatkind of begs the question,will this company beat the next Valeant?

Campbell: Right. And it'sway too soon to tell, and there's a lot of differencesbetween this company and Valeant. This company, for one, isextremely profitable. They are already making a lot of money.

Harjes: Right, the rare-disease space isextremely lucrative.

Campbell: Yeah. But,I think you do have to look at that, and Soliris is anextremely 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 poweror their reputation among payers,prescribers, and patients,then there could be some fallout that could be Valeant-like to this company. Wejust don't know. We have this information gap that we're sitting inright now, because we know that the leaders are gone, and we know new leaders have been put in place. Andboth of those leaders, by the way, they're solid people. You have David Brennantaking over as CEO, he came fromAstraZeneca, 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 ofHoneywell, and he did that job for a decade or so. These are highly talented orexperienced people that theoretically can navigate some pretty crazy waters. The question is, how crazy will those waters be? Andinvestors just don't know. We don't know.

Harjes: Yeah, you'rekind 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 apermanent replacement. That, to me, suggeststhat 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. Whenyou 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, youlook 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 arevery 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 stilla 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 ofdiversification and risk tolerancewhen 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 havejust gone down temporarily after thisOphthotech blow-up.

Campbell: (laughs) I can understand that.

Harjes: Yeah. Todd,thank you so much for your insights, as always. Folkslistening, do you have any questions for us,or if you just want to say, "Hey," shoot us an email. Our email address is industryfocus@fool.com. You can also tweet at us @MFIndustryFocus. Also,we are still compiling a list of investment bookrecommendations, so send them our way. As always, people on the program may have interestsin the stocks that they talk about, and The Motley Fool may have formal recommendationsfor 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!

Kristine Harjes owns shares of Juno, Ophthotech, and Portola Pharmaceuticals.Todd Campbell owns shares of Ophthotech and Portola Pharmaceuticals. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool recommends Juno. 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.