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Looking to Play HGSI's Huge Move Higher? Consider Convertibles

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With the stock itself, the risk/reward is less skewed to your benefit.

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Leerink Swann has been the loudest supporter of Human Genome Sciences (HGSI). The boutique is now saying the biggest impediment to HGSI becoming the next big-cap biotech -- presumably a la Amgen (AMGN), Celgene (CELG), and Gilead (GILD), to name a few companies with market caps over $20 billion -- is a takeover of the company. The research firm believes big potential acquirers have yet to discover the true value of HGSI's lupus treatment, pipeline, and tax-loss carry-forwards.

If Leerink Swan is right, the 30-fold gain in HGSI from the lows of several months ago could be just the beginning.

Now, the firm could be wrong. Even analysts sometimes are. And there's no getting around the fact that, yes, the stock is 30 times higher than it was in the spring.

If you've read my column in the past, you probably sense a convertible comment coming (CCC). And you're right.

Human Genome has 2 convertibles outstanding. I prefer the 2.25% bonds due in 2012.

If Leerink Swann is really right, these bonds -- currently trading around 114 -- could be worth several times that when they mature.

But if they're wrong, the worst you'll do -- assuming the company isn't bankrupt at that point, (and given the company's prospects and recent equity issuance, bankruptcy seems very remote) -- is lose 14 points of principal, or a little over 10%. Plus, you'll clip a little coupon for a few years, cutting your modest loss nearly in half.

With the stock, on the other hand, the risk/reward is less skewed to your benefit.

So if you're looking at jumping on board in HGSI, take a long look at the convertibles.
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Position in HGSI.

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