Of These 5 Hated Biotech Stocks, Only 1 Is a Potential Disaster in the Making

Image source: Flickr user Hobvias Sudoneighm.

The easiest investment strategy, and the one that's proven to work best over the long run, is to pick out high-quality businesses and hold them for long periods of time. However, for some investors the ability to bet against seemingly bad businesses can also be profitable.

The profits and perils of short-selling There are risks that come with betting against a stock (known as short-selling a stock) that just aren't present when buying shares of a company and holding them for a long time. For example, gains are capped at 100% when shorting a stock (a company's share price can't dip below $0), whereas losses are limitless. The opposite is true when you buy a stock. Betting against a company also requires a margin account, meaning you'll be charged interest on the money borrowed to hold your short position. In theory, you could lose more money betting against a stock than what you initially put in.

Yet, historically speaking, short-sellers have just as much chance of being right, if not slightly more, than the buy-and-hold crowd over the long run. Thus, it can often be worthwhile to see what stocks they're really piling into to get a feel for whether a company's business model is truly in trouble, or if short-term investors are merely overreacting to news.

Biotech's hated stocks One such industry that's attracted pessimists like they're going out of style lately is biotech. The vast majority of biotech stocks are losing money, and tend to be priced based on the emotions of investors and the peak sales potential of their leading drug(s). This can sometimes make them easy prey for short-sellers.

Within the biotech industry, five companies stand out as being among the most-hated of all, based on the percentage of shares held by short-sellers compared to their float, according to Yahoo Finance. These biotech companies are:

  • Insys Therapeutics : 88.4% of float held by short-sellers
  • MannKind : 48.5%
  • Relypsa : 44%
  • Ziopharm Oncology : 34.6%
  • Sarepta Therapeutics : 28.1%

The interesting point is that a majority of these companies, while facing challenges, aren't exactly in dire straits.

Image source: Insys Therapeutics.

For example, Insys Therapeutics is facing an investigation for alleged off-label sales involving its lead product Subsys, a breakthrough pain treatment for cancer patients. In a worst case scenario, based on what we've historically seen happen when a company's marketing practices are investigated, Insys could be hit with a financial penalty.

Yet in spite of these allegations, Subsys sales galloped higher by 38% in the fourth quarter to $91.1 million, and the company ended the year with $202.3 million in cash, cash equivalents, and investments. Though not a resounding case for optimism, Insys hardly resembles a company that should bear as high a short share percentage as it does currently.

Ziopharm Oncology is an entirely clinical-stage company and is likely to lose money for many years to come. Based on its fourth-quarter press release, its management believes it has enough liquidity to last two more years before it needs to seek additional funding. This ongoing cash concern is what keeps attracting short-sellers.

But there's another side to Ziopharm Oncology: it's a player in the evolving CAR-T cancer space. CAR-T involves the extraction of a cancer patient's T-cells, the genetic modification of those T-cells outside the body so they induce cancer cells to express CAR (a carbohydrate we're naturally immune to), and then reinjection into the patient to help stimulate the immune system to locate cancer cells. CAR-T could be a transformative pathway to treating cancer, and making a bet against Ziopharm could prove somewhat risky.

Even Relypsa's and Sarepta Therapeutics' pessimism may be overdone.

Image source: Relypsa.

Relypsa's lead drug, Veltassa, a treatment for hyperkalemia, was approved by the Food and Drug Administration last year, and is projected to hit $600 million in sales by 2020. However, hiring a sales staff, marketing Veltassa, and potentially running additional studies on Veltassa are all proving costly. The company's 2016 capital expenditures about equal its remaining cash on hand, meaning a capital raise may be likely.

Nonetheless, Relypsa has plenty of cash-raising options open, including selling stock, licensing its drug, or perhaps even seeking a loan. The business model for Relypsa is far from broken.

The same can be said of Sarepta Therapeutics, which continues to get absolutely no love from the FDA. On a few occasions we've witnessed skepticism regarding Sarepta's lead drug, eteplirsen, a treatment for Duchenne muscular dystrophy. If the FDA winds up rejecting eteplirsen, despite its small, but extremely positive, phase 2b extension study, it definitely puts a kink in Sarepta's plans.

But what Wall Street overlooks is that Sarepta has an entirely separate infectious disease research unit that could deliver game-changing medicines. Though DMD is the primary focus of Sarepta, it's not a one trick pony. Sarepta also has a healthy $204 million in cash and cash equivalents as of year-end.

This hated biotech stock looks like a disaster in the makingNow, MannKind is an entirely different story. MannKind looks to be a disaster in the making, and it's the one hated stock among short-sellers that I believe they have spot on.

Image source: MannKind.

On paper MannKind looked like it had a blockbuster on its hands with Afrezza, an inhaled type 1 and type 2 diabetes medication. Afrezza was fast-acting compared to traditional insulin shots, convenient in that it was not an injection, and it metabolized through the body faster than traditional insulin, reducing the potential for a hypoglycemic event. MannKind even wound up snagging one of the largest pharmaceutical giants, Sanofi, as its marketing partner, along with $150 million in an upfront payment. Sanofi also fronted MannKind $175 million in collaboration expenses as part of the deal.

Everything looked great until Afrezza hit pharmacy shelves. A lack of physician education, little in the way of marketing, and a higher price point than traditional insulin injections stymied sales of Afrezza. Expected to initially hit $2 billion in sales, Afrezza managed less than $6 million in sales through its first two-and-a-half quarters of being on sale. Meanwhile, MannKind suffered a devastating $368.4 million loss in 2015, of which $206.6 were non-cash impairment charges.

Making matters worse, Sanofi walked out of its agreement in early January, essentially tipping its hand that it'd rather forgo the $325 million it had already fronted MannKind, plus its share of losses, than try to buoy Afrezza any longer.

Image source: Flickr user Mike Poresky.

And finally the salt in the wound: MannKind is running out of capital, and options to access additional capital. Cash and cash equivalents totaled $59.1 million at the end of the fourth quarter, thanks in part to money raised from is dual-stock listing on the Tel Aviv Stock Exchange, and $13.6 million in common stock sold. Having to turn to Tel Aviv to raise cash (and even then only raising around a quarter of what it had been seeking) implies that U.S. paths to capital raises are narrowing for MannMind. All that remains is a $30.1 million credit line with The Mann Group.

Even with a reduced cost structure, MannKind's days look numbered. Perhaps its only meaningful hope left is to drastically drop the price on Afrezza and hope physicians and consumers get hooked on the convenience and efficacy of the product. Even so, doing so would crush whatever margins MannKind hoped to enjoy from Afrezza and make it even harder for the company to ever turn a profit.

If short-sellers have one biotech company dead to rights, I believe it's MannKind.

The article Of These 5 Hated Biotech Stocks, Only 1 Is a Potential Disaster in the Making originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.