Avoiding the Next Telik
Sitting on data is a good sign it will be bad
The debacle in Telik (TELK) caught too many people on the wrong side of that trade.
While I know some true believers, most of the biotech pros I know were either avoiding the name or were short. Few had solid fundamental reasons – the mechanism of action for the drug is attractive and reasonable, the company (with a glaring exception we'll get to in a moment) was apparently well run, and the potential markets were legitimate.
So why were so many biotech pros short or avoiding it?
If you're new to Minyanville or my columns, I strongly suggest taking a trip back through the introductory series I wrote in 2004. It will help those who are not expert biotech investors get a feel for how the sector works.
Most pertinent to the Telik discussion is the fact biotechnology companies are a strange breed. There is no way to value a dev-stage biotech company – at least in traditional terms – that does not expect revenues for years and effectively has no sales. Their market cap floats along largely based upon psychology until certain binary events occur – usually centered around the release of clinical data, regulatory approval, or partnerships with larger companies.
Biotech managers know this as well. They also know they constantly have to raise money. They are keenly aware raising money at higher stock prices is better than raising money at lower stock prices. Higher prices also mean a better quality of investor – more mutual funds than hedge funds. The main "tool" biotech executives have to raise their stock price is good data.
Therefore, a biotech management team has every reason to release good data as quickly as possible. Their stock price goes up and all the good things that come from higher stock prices are enjoyed sooner rather than later.
At Telik, management started telling people they "might" hold clinical trial data without releasing it back in 2005. At the JP Morgan Healthcare conference in January 2006, they told people at the breakout session the first two trials were already mature, but that they'd be holding those data until the third trial matured.
This is nonsense. There is no reason to hold good data. Experienced biotech investors immediately knew something was fishy. In fact, one of the hedgies in the room was on his cell phone to his trader immediately after the session wrapped, telling him to "short as much Telik as you can."
If a management team has data in hand, and does not release it in a timely fashion, the safe interpretation in terms of avoiding big portfolio losses is to assume the data are bad.
Management tried to hide behind the idea the trials were blinded to them. And while that may technically have been true, they are constantly meeting with their investigators – the docs that run the trials. It's perfectly apparent, in most cases, whether a drug is working really well or not.
In some ways, whether they knew the data were bad is immaterial. Management teams have a legal duty to shareholders to release material information in a timely fashion. And while the SEC cannot seem to get its head around what this means for biotech companies, clinical trial data is clearly material to these dev-stage biotech companies. Any honest management team knows this and will refuse to sit on data for any appreciable length of time. I've been able to avoid many big blowups in the biotech space simply by avoiding management teams whose first inclination is to withhold key information. Sloppy investor relations usually predicts sloppy organizational execution in other areas.
As with any rule, there are some exceptions. Sometimes management teams have to withhold portions of the data in order to present it at scientific conferences. Other times, management will hold data a week or two so the release happens outside of a market holiday week for better impact. These are limited exceptions, however, none of which justify Telik's decision to hold clinical data for almost a year.
The best defense against blowups in biotech is a diversified portfolio. You have to own a number of these stocks to cushion blows like Telik delivered. But diversification doesn't free you from the requirement of knowing how the sector works. Since only one in ten of these companies succeed, a healthy dose of skepticism and distrust is a good thing. When a management team does something fishy like hold data for an extended period, at least mark the stock down as something you want to hold puts against.
Biotech is an exciting and lucrative sector if you know what you're doing or can access good research from a trustworthy source that knows what they are doing. The rewards are significant as long as you combine good research with some common sense to avoid the landmines.
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