Biotech Values

[DewDiligence]

Re: DNA:

>> …you must have some gut feeling that the DNA correction is coming soon, or you wouldn't be shorting now. <<

I really don’t –I think a correction can come at almost any time. I have held some short positions for as long as two years.

Here are a few of the scenarios in which DNA’s stock might plunge:

1. A problem with Avastin’s toxicity, resulting in an FDA warning letter to oncologists. (An FDA recall is extremely unlikely, but not beyond the realm of possibility. #msg-2484393 )

2. Refusal by CMS to reimburse for Avastin in whole or in part because of Avastin’s sky-high price.

3. Modest sales uptake of Avastin compared to the lofty expectations.

4. Any difficulties or delays in the European Avastin filing by Roche.

5. Failure by DNA to get its supplemental BLA for Vacaville manufacturing of Avastin approved in a timely manner. (Without Vacaville, Avastin production would be quite limited.)

6. Failure to meet the primary statistical endpoint in the Avastin+FOLFOX trial in second-line colorectal cancer. At its CC last week, DNA warned that this trial may be “underpowered” to show statistical significance. (Because FOLFOX has become the preferred chemo cocktail in colorectal cancer, Avastin’s sales will be adversely affected to a substantial degree if this trial comes up short.)

7. Poor or mediocre Avastin data in other cancer indications such as lung, breast, pancreatic, and renal. Avastin has yet to show compelling data in these indications and the dose being used in these indications is 10mg/kg (double the dose used in colorectal cancer), which increases the likelihood of safety problems.

8. Issues pertaining to any of DNA’s other drugs, such as Tarceva (which is nearing the end of its phase-3 trial in third-line NSCLC).

9. Last but not least, a general market correction. Given its humongous valuation and its 200%+ rise during the past 10 months, DNA would almost certainly be hit hard in any downturn in broad indexes.

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Given the manifold ways in which a DNA correction might occur, how the heck can anyone hope to call the timing?

>> Don't you have to pay margin loan interest for the duration of your short? <<

No! Shorting is a form of selling, so it can’t increase your margin debt. In fact, some brokers are willing to pay you interest on the proceeds of short sales because these proceeds generate free cash for the broker until the short position is covered. (You may have to be a good customer to get this perq.)

>> What kind of valuation metrics would you use for DNA. PE?, PEG?, market cap to revenues? And what companies would you compare it with? Amgen? Just wondering where your $80 target came from. <<

I think PEG is silly; among the various other metrics, you can take your pick: DNA is overpriced according to any reasonable valuation model I can come up with. This would be true even if Avastin were to become to biggest-selling cancer drug in history in a matter of months.

My $80 figure represents the point at which I would find the risks and potential rewards to balance if nothing much changed in the fundamentals. In practice, it is almost certain that something will change (as in items 1-9 above) and I’ll have to reassess the situation in light of the new circumstances. Regards, Dew