Sunday, 16 October 2016

The Best Short In The Biotech Sector Right Now

The biotech industry has been getting slammed in October. The Nasdaq Biotechnology iShares (IBB) have dropped from $290 to $266 so far this month. While this creates buying opportunities like the one we recommended on Supernus Pharmaceuticals, Inc. (SUPN) on Wednesday evening, investors should protect themselves in this shaky market by shorting some overvalued biotech or pharmaceutical stocks as well. We think the best short out there in the biotech sector right now (other than GBSN-like death spiral companies which you can never find borrows on) is Aerie Pharmaceuticals, Inc. (AERI) while it sits at $37.29. AERI makes a great short for four reasons:

1. AERI has a billion dollar market cap even with no revenue and no marketable product. The company submitted an NDA for Rhopressa in September and plans to submit an NDA for Roclatan at the end of 2017, so substantial revenue will not start flowing until 2018 at the earliest.

2. A recent financing at $29.50 should provide some downward pressure on the stock.

3. The pumped up stock price looks about ready to fall off a cliff on the charts.

4. AERI's presentation of its data, drug efficacy and safety profile has come under attack. The analyst (who happens to be the company's bookrunner) response to these attacks have been weak.

A comparison of two billion dollar pharmaceutical plays

There are just a handful of pharma or biotech stocks that can sustain over a billion dollar market cap with no revenue and no FDA-approved product in the market. AERI bulls will make the argument that there hasn't been a new treatment for glaucoma for years and AERI's potential ability to do so in the next couple of years justifies its market cap. We prefer to look at the biotech industry more agnostically. An FDA-approved and patent-protected drug is going to have a gross margin in the 90% range, no matter what industry. Orphan drugs may be the exception, but AERI is not that. Therefore we believe that biotech or young pharmaceutical companies are more or less interchangeable as investments even if they treat vastly different diseases as long as their peak expected sales are similar in size.

When comparing AERI to our long pick SUPN, you can see how ridiculously overvalued AERI is:

Both companies have a little over $1 billion market cap, valued as essentially the same even though SUPN has existing revenue from two epilepsy drugs on the market. It is making over $50 million in revenue a quarter today and that is expected to grow to $278 million next year, driving a $1.37 expected EPS. AERI has no revenue today, essentially no revenue until at least 2018 (and that's only if the FDA approves the company's two upcoming NDAs) and is burning cash to the tune of an expected $2.61 loss per share next year. Analyst data is courtesy of Yahoo Finance for AERI and SUPN.

While SUPN is making money as we speak, it also has slightly higher potential peak sales if its pipeline succeeds. An analyst forecasts peak annual sales of $1.3 billion for AERI. This could be a challenge since AERI admits that its drug only applies to around 75% of U.S. glaucoma patients (more on this in the fourth section) and the company is aiming to replace latanoprost which has $1.6 billion in annual sales.  SUPN projects about $500 million of peak sales for its two epilepsy drugs currently in the market and $800 million to $1.2 billion in peak sales of SPN-810. SPN-810 is in phase 3 trials right now for impulsive aggression and results are expected in 2017. So SPN-810 is behind AERI's two drugs by about a year, but is on its way to achieving $500 million in revenue with its two products currently in the market.

So you can either pay a billion dollar market cap for:

1. A company with guaranteed sales of an FDA-approved product of $200M+, with peak sales potential of $500M. There is another $1B+ annual sales potential, but phase 3 results are still pending.

2. Or a company with no products in the market, phase 3 results that are presented as positive, but there is no guarantee that the FDA will give its approval. And we don't know what restrictions, if any, the FDA will put on the drug candidates if it happens to accept the NDAs.

Readers will have to determine for themselves which one should be valued higher, but for us it is clear - you take the company with the money already coming in.

We can see the argument from AERI longs as they read this: "YOU CAN'T COMPARE A GLAUCOMA STOCK TO AN EPILEPSY STOCK!!!!"

Why not? As stated above, looking at this agnostically, both of these companies project to have similar peak annual sales at similar gross margins in similarly-sized markets. The difference being that SUPN is much further along that success curve than AERI. Of course, SUPN has potential competition from everyone's favorite cure-all solution right now - cannabinoids - but those face an uphill battle and we believe once legislation-driven speculation cools off, SUPN's epilepsy drugs will still be seen as a viable treatment and the stock will recover back to $25 or higher. But in case it doesn't, let's remind readers that the only disease more strongly associated with medicinal uses of cannabis than epilepsy is glaucoma:

Recent financing should put downward pressure on AERI

On September 16, AERI announced the details of a $125 million financing:

"IRVINE, Calif.--(BUSINESS WIRE)-- Aerie Pharmaceuticals, Inc. (NASDAQ:AERI), a clinical-stage pharmaceutical company focused on the discovery, development and commercialization of first-in-class therapies for the treatment of glaucoma and other diseases of the eye, today announced the pricing of a registered underwritten public offering of $75 million of shares of its common stock at a price to the public of $29.50 per share, before deducting underwriting discounts and commissions and other estimated offering expenses. The offering was upsized by $25 million over the offering amount anticipated to be sold as previously announced. This is in addition to $50 million raised separately through the completion and full utilization of an at-the-market (ATM) program with Cantor Fitzgerald & Co. filed prior to market open on September 15, 2016. Total gross proceeds raised through these offerings were $125 million. The shares sold through the $50 million ATM program will be issued on or about September 20, 2016, and the $75 million public offering is expected to close on or about September 21, 2016, subject to the satisfaction of customary closing conditions.

Cantor Fitzgerald & Co. is acting as sole bookrunner for the $75 million public offering and sole manager for the $50 million ATM program."

As such, the company appears to have sufficient cash resources for the next two years:

"Based upon current business plans, the Company has updated full-year 2016 cash burn guidance to approximately $85 million, an increase from the previous guidance of $75 million. The updated guidance reflects new initiatives such as start-up efforts for clinical trials in Japan and commencement of construction of a manufacturing plant in Ireland. With this updated full-year 2016 cash burn guidance, the Company expects cash and cash equivalents to total approximately $230 million as of December 31, 2016."

So AERI will probably have enough cash to complete the submission of the NDAs, but the dilution that occurred last month should push the stock lower in the near-term. The financing took place at $29.50 which means the stock is trading at over 25% of a premium right now. Anyone with experience in the market knows that premiums that high over a recent financing do not last long, even in times of strength. If the biotech sector continues to get slammed, AERI could easily tank 10% to 15% in one day as the financiers look to exit or hedge their position while there are still gains to be had.

And what a surprise! Cantor Fitzgerald, the analyst which has slapped a $50 target on AERI and has so weakly come to its defense against "misconceptions" against AERI is the bookrunner! Whether you are a bull, bear or neutral on AERI and its management team, you must admit that this part of the financing stinks. It reminds us of the pushers of GPRO or TWTR stock by bookrunners who had to divest large amounts of cheap paper onto the market before abandoning those stocks and letting them go to hell as their operating performances did not meet market demands.

Chart analysis: The pump part seems over and the dump part looks ready to begin

We are not experts at chart analysis and never presented ourselves as such. But sometimes anyone can read a chart:

Stockta shows AERI's indicators as bullish as of October 13th, but that was before it smashed through the first support point at $38.22 on Friday:

When the chart gets updated we expect these indicators to decline. We find that the best time to short a stock is when the indicators which are already as bullish as they can be start to slip  The intraday analysis shows a clear bearish trend and American Bulls recommended to sell the stock on October 12.

Clearing up the misconceptions surrounding the misconceptions on AERI

Finally, we have gotten to the most controversial point around AERI's long investment thesis. How good are its drug candidates? Famous, or infamous depending on your opinion, biotech blogger Adam Feuerstein published an article called "Cloudy Outlook for Aerie Pharma's Glaucoma Drug" on September 21. This was very inconvenient timing for AERI's bookrunner who just finished closing the aforementioned financing at that time. Whether you like Feuerstein or not should not come into consideration when reading his article. It should be all about the content and we think he provides a fair analysis of AERI's situation.

On October 6 an article titled "Clearing Up Misconceptions Surrounding Aerie Pharmaceuticals" was released which appears to be Cantor's rebuttal to Mr. Feuerstein's article, using AERI's investor day presentation from the previous day as ammunition:

"Cantor Fitzgerald reiterated its Buy rating and $50 price target on Aerie Pharmaceuticals Inc (NASDAQ: AERI), as the company provided new clinical data to clear up residual misconceptions and uncertainties regarding the Roclatan Phase 3 trial.

Analyst Elemer Piros noted that Aerie enrolled patients with the mean intraocular pressure of 23.7 mm of mercury, as opposed to the belief held by some that the enrolled patients had only mild glaucoma. The analyst also noted that Rhopressa, one of the ingredients of Roclatan, showed equal efficacy as that of the standard of care, namely latanoprost.

Cantor also noted that Roclatan caused mild redness in 50 percent of the patients, while prostaglandins, including latanoprost, was associated with hyperemia in 47-69 percent of the patients. Only 18 percent of the Roclatan had consistent redness.

The firm noted that the results of a pre-marketing survey revealed 72 percent stated they would adopt Roclatan moderately. The same respondents also stated they would prescribe Rhopressa to 20 percent of its patients two years after the launch in the US. The firm estimates peak sales of the 2 drugs to be at $1.3 billion."

We mentioned the $1.3 billion in peak annual sales in the top section. If this drives a $50 target on AERI prior to any response from the FDA with respect to the NDAs, imagine the target Cantor should have on SUPN with even higher peak sales potential and about a third of that already in the market! But oh wait, SUPN is a profitable company with no need to go to the market for financing and its convertible debt is nearly extinguished. Therefore no firm has an incentive to put out a biased, super-bullish target on the stock to try to sell shares as a well-compensated bookrunner.

Let's take a look at the first weak comment from Mr. Piros. "Aerie enrolled patients with the mean intraocular pressure of 23.7 mm of mercury, as opposed to the belief held by some that the enrolled patients had only mild glaucoma".

This is what says about eye pressure and the risk for glaucoma:

"Normal intraocular pressures average between 12-22 mm Hg. The “mm Hg” refers to millimeters of mercury, which is a scale for recording the eye pressure.

Eye pressure can vary hourly, daily and weekly. Many factors can affect the up and down changes in a person's intraocular pressure. These daily changes are normal.

Usually, the higher the pressure, the more risk to the optic nerve. Some optic nerves develop glaucoma even at low pressures (this is called normal-tension glaucoma) so it is important to have the optic nerve examined no matter what the pressure may be."


"Eye pressure is measured in millimeters of mercury (mm Hg). Normal eye pressure ranges from 12-22 mm Hg, and eye pressure of greater than 22 mm Hg is considered higher than normal. When the IOP is higher than normal but the person does not show signs of glaucoma, this is referred to as ocular hypertension.

High eye pressure alone does not cause glaucoma. However, it is a significant risk factor. Individuals diagnosed with high eye pressure should have regular comprehensive eye examinations by an eyecare professional to check for signs of the onset of glaucoma."

Feuerstein's article doesn't deny that AERI enrolled patients with a mean intraocular pressure of 23.7 mm of mercury. AERI's original trial designs included patients of up to 36mmHg. So there can be no denial that AERI is focusing on patients that are just above the normal range. The company freely admits this and justifies this trial design by stating that 75% of U.S. glaucoma patients have pressures less than 25mmHg on page 12 of the investor day presentation: says that "High eye pressure alone does not cause glaucoma. However, it is a significant risk factor" and "the higher the pressure, the more risk to the optic nerve". So while it is not the only cause, people with extremely high eyes pressures are at the greatest risk of developing glaucoma. Now whether the term "mild glaucoma" was the correct one from Feuerstein (there could be cases of normal tension glaucoma that are severe), what he meant was pretty clear. Roclatan and Rhopressa are useless for the people who are at the greatest risk of developing glaucoma due to very high eye pressure. It might not necessarily be mild glaucoma, but AERI's drugs are only good for a mild version of a symptom - eye pressure that is just slightly over the normal range.

Mr. Piros could have stated that rather than the severity of the glaucoma itself being mild, that AERI focuses on the symptom of glaucoma - eye pressure - that is on the lower end of the high range and could therefore be considered a "mild" symptom, That would have portrayed a fully honest scenario, one that AERI freely admits to, without completely discounting the word "mild". That is the type of comment that investors should expect from an analyst who is supposedly trying to present a fair and balanced view.

Mr. Piros also stated that: "Rhopressa, one of the ingredients of Roclatan, showed equal efficacy as that of the standard of care, namely latanoprost". This is absolutely false....well, unless you want to define efficacy in a way that also shows Roclatan is no better than latanoprost and plays right into what Mr. Feuerstein says in his article.

Let's have a look at Roclatan Phase 3 data, which is available on page 43 of the investor day presentation:

You could do the calculations yourself, but AERI actually does it for you. Roclatan is superior to latanoprost by 1.3-2.5 mmHg and superior to Rhopressa by 1.8-3.0 mmHg. Does that not mean that latanoprost is superior to Rhopressa by 0.5 mmHg? Is the analyst caught in a complete lie that not even AERI itself will back up?

Well, maybe not, but that's not good news for AERI longs. Recall that normal intraocular pressures average between 12-22 mmHg. All three drugs take the pressure down well into the normal range with the highest being 19.0 at 8AM of day 43 when using Rhopressa. If you want to define this as efficacy, then yes, the analyst is telling the truth. All three drugs score 100% efficacy in this instance. But this is exactly what Mr. Feuerstein states in his article:

"After 90 days, the average intraocular pressure of Roclatan-treated patients with mild glaucoma decreased from 23.7 to 15.6 mmHg. [Recall, "normal" intraocular pressure is 12 to 22 mmHg.]

The patients treated with latanoprost alone saw their intraocular pressure fall from 23.5 to 17.1 mmHg after 90 days.

Roclatan was numerically superior to latanoprost and Rhopressa alone, but FDA is likely to ask if an intraocular pressure difference of just 1.5 mmHg after 90 days is clinically meaningful, especially when all the patients complete the study with intraocular pressures in the normal range.

Note, too, that latanoprost was superior to Rhopressa in lowering average intraocular pressure at all time points measured in the study."

So if Mr. Piros wants to state that Rhopressa showed equal efficacy as latanoprost, then he must admit that Mr. Feuerstein's argument also stands. But of course that's not the case. AERI is banking on the FDA believing that the 1.5 mmHg superiority after 90 days (15.6 versus 17.1 for latanoprost) is enough of a benefit to approve the drug for those patients with less than 25 mmHg of pressure. This is based on one comment we see of page 13 of the investor presentation:

"Every 1 mmHg reduction lowers risk of visual field loss by 10%"

An article from 2005 by Gregg Heatley, MD suggests that this relationship is not linear. A basis point drop in mmHg when pressure is already low may have minimal impact, although that is dependent on each individual patient and he didn't specify an exact number which he considers to be "low". However, a 2014 article by Christopher W. Lievens, OD, MS, FAAO did seem to support the idea that lower pressure leads to less progression of the disease, even if pressure scores of less than 18 mmHg had minimal visual field defects:

"However, an analysis of the data did reveal some very important points regarding IOP management in unstable glaucoma patients. Eyes in which 100% of visits over a 6-year period had an IOP <18 mmHg also had a visual field defect score (from baseline) close to 0. This was in stark contrast to those eyes in which only 50% of visits had an IOP <18 mmHg and visual fields continued to worsen. Furthermore, the lower the IOP, the more reduced the progression. Those with 15 mmHg IOP showed half the progression of those with 18 mmHg, and those with 13 mmHg showed half the progression of 15 mmHg. The results indicated that lower IOP resulted in patients who were far better managed.2 So, with unstable glaucoma patients, low IOP is an excellent goal."

So will the FDA approve Roclatan based on the 1.5 mmHg improvement over latanoprost? It's not a slam dunk but it remains a possibility, safety issues notwithstanding. But an analyst who doesn't provide a fair context to the story and slaps a $50 price target on the stock while his firm is the stock's bookrunner is not someone we can trust to be unbiased.

Finally, Cantor's analyst downplays the side effects for half of the patients who took Roclatan as "mild redness". The safety profile is found on page 62 of the investor day presentation:

What we find alarming about that safety profile is that out of 238 patients for Roclatan, there were a total of 241 adverse incidents! While the analyst downplays Conjunctival Hyperemia as "mild redness", let's see what an unbiased source has to say about the symptoms of Conjunctival Hyperemia:

"Apart from the characteristic redness, these are the most common symptoms associated with conjunctival hyperemia:

  • Pain in the eye
  • Blurry vision or loss of vision
  • Increased sensitivity to light (photophobia)
  • Systemic symptoms (swollen lymph nodes, fever, nausea and vomiting) are encountered in acute cases (suggestive of infection)
  • Discharge from the eye
    • Green, purulent in case of bacterial infection
    • Watery discharge if the main cause is an allergy (associated with tearing and nasal congestion)
  • Facial rash might also be present in case of infection or allergies
  • Tenderness upon palpation of the eyes or the eye might feel hard to the touch (closed eyelids)
  • Significant differences in the pressure of the eyes (glaucoma in one eye)
  • Sensation of having something in the eye (patients describe this sensation as ‘sand’ or ‘dust’ in the eyes)
  • Severe throbbing sensation (acute glaucoma)
  • White infiltrate under the corneal epithelium (infection)
  • Inflammation of the eyelids margins (blepharitis)
  • Dry eye, with reduced production of tears
  • Diffuse or limited inflammation of the sclera."

14 different symptoms that cause pain or discomfort or impact the person's vision. What we find particularly shameful is the analyst's willingness to call out Adam Feuerstein on his use of the word "mild" but is willing to downplay the major side effect in half the cases of people who took Roclatan as "mild redness" when it is clearly much worse than that when referencing a source not related to AERI.

We hope that our readers have found this information valuable. We are short AERI and long SUPN. It would not surprise us if these two stocks switch prices within the next few months.

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