Spectrum Pharmaceuticals: a short story

Shlomi Cohen

Those shorting a small, thriving biotech company called Spectrum Pharmaceuticals face an unhappy ending.

In recent months, a mini drama has been taking place on Wall Street, involving the managers of a small, prosperous biotechnology company called Spectrum Pharmaceuticals (SPPI), which I am considering bringing into the portfolio I manage here soon, and the short players that have latched onto it. Other cast members are a journalist, over-zealous to my mind, on thestreet.com, and Teva Pharmaceutical Industries Ltd. (Nasdaq: TEVA; TASE: TEVA), as an unwilling bit player.

Spectrum is run by a well-known figure in the US biotechnology world, Dr. Rajesh Shrotriya (67). His philosophy is that a small company should not develop drugs from scratch, because the costs are huge, but should focus on buying rights to drugs that are at advanced stages of development, and have been abandoned for one reason of another.

Spectrum currently sells two life-extending treatments for colorectal cancer and lymphoma, and it has in its pipeline two more drugs at advanced stages of development, and with large potential.

The company has a low market cap, of $430 million, even though its financial numbers are excellent, the kind one does not often find in small biotech companies of this type. At the end of March, it had $141 million dollars cash, with no debt. First quarter sales totaled $44 million, representing four-fold year-on-year growth, and it made a profit in the quarter of $13 million, or $0.25 per share, despite the high costs of two drugs still undergoing trials. Analysts project sales of at least $130 million this year, compared with just $61 million in 2010, and half that in 2009.

Most of the sales in the past year have come from colorectal cancer treatment Fusilev, which the company sells in the US, but Teva has a similar, and cheaper, generic injection, and so in the past year the short players have turned their attention to Spectrum, on the assumption that it has no chance against Teva. They ramped up the short position to an annual record of 7 million shares, while the share price rose from a rock-bottom $4 to over $10 at the end of April, just before the FDA meeting to decide whether to approve expanded use of Fuzilev.

Spectrum's share price has jumped in the past year, among other things because contamination was discovered at the Teva plant in the US that produces the generic injection, leading to a temporary shutdown, and a shortage that boosted Spectrum's sales. The short players built their position against the stock on the basis of two assumptions. The first, and more important of the two, was that on April 29, the FDA would not allow expanded use of Fusilev, as had happened a year earlier, sending the stock tumbling. The second was that Teva's plant was due to resume production, and so sales of Spectrum's Fusilev would drop, being similar to but costlier than Teva's.

Thestreet.com biotech reporter Adam Feuerstein had taken a position against investing in Spectrum all year, which made investors suspect him of being connected to the hedge funds that were shorting the stock. The climax came on Monday, May 2, after Spectrum announced that it had obtained the FDA approval for expanding use of the Fusilev injection to advanced metastatic colorectal cancer patients, and that it was gearing up to boost production at the FDA's request, because of the shortage brought about by the continued closure of the Teva plant.

On the back of the positive announcement, Spectrum's share price opened with a 14% leap on May 2, to a record $10.3, but in the course of the session, when the momentum was at its peak, Feuerstein published an article on thestreet.com against the company, claiming that the approval was worthless, since Teva would resume production at any moment, and its injection was similar but cheaper. The damage was done. The stock changed direction and headed south, tumbling to almost $7 within two weeks, and the strong first quarter results released two days after the article was published failed to help.

On their blogs, investors went crazy at the precise timing of Feuerstein's article, at the stock's intraday peak, which, they claimed, played quite fantastically to the short players' benefit. On his personal blog, Feuerstein denies having anything against the company or its CEO, claiming him as old friend. Despite that, he renewed the attack last week, but this time Shrotriya was armed and ready, with ammunition that prevented the stock from collapsing.

The zealous Feuerstein discovered that Teva had reported on a professional website that although the US plant was still being tested, and was not producing in large quantities, at the request of the FDA, which feared a shortage, it was importing large consignments of the injection into the US from Europe. On the basis of that discovery, he came out with another negative article, claiming that Spectrum would be hurt by Teva's imports, and that its advantage was at an end. On a normal day, that would have been enough to undermine the share, but it seems that Shrotriya also saw Teva's report, and knew who would use it against him.

Spectrum anticipated with an announcement of its own, at the end of which it stated that "We expect record second quarter and full-year 2011 revenues." The announcement said, "We are now able to meet the growing needs of the tens of thousands of patients who depend upon FUSILEV's availability. Having multiple US suppliers also reduces the risk of supply interruptions, so physicians who prefer to use FUSILEV in their treatment regimens do not have to seek alternative treatment options," a hint at Teva. Incidentally, as far as Teva is concerned, this is something negligible relative to its sales, and there are those who say that Teva has no interest in promoting its drug, because of its low profitability, but that the company is acting under pressure from the FDA, which fears a shortage.

The point is that I see Spectrum as an attractive stock for anyone looking for a big biotech dream that could come true through the two new drugs it has in development, and that are slated to be submitted for FDA approval next year. They are aimed at very large markets in oncology. But until then, the financial risk is very low, because the company has lots of cash, which is not typical of small companies, and what is more it has the two drugs that are already selling and earning profits, and it is not at all clear how much of a threat Teva really presents to the colorectal cancer treatment.

In my view, this being the case, sooner or later the large short position will lead to the short players being wiped out, which in turn will make the share price soar. In addition, Spectrum's CEO does not deny that the company is a potential takeover target for one of the pharmaceutical giants, and so he has taken care to arrange a bonus for himself if the sale is at a valuation above $750 million, a bonus that will also be paid if the company reaches that market cap without a sale, through a normal rise in the share price thanks to business growth.

Published by Globes [online], Israel business news - www.globes-online.com - on June 30, 2011

© Copyright of Globes Publisher Itonut (1983) Ltd. 2011

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