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A Fatal Mistake for Biotech TradersBy Dr. George HuangFriday, March 5, 2010 On February 18, Fidelity blew $26 million on one trade.
Its loss will be our chance to make anywhere from 30% to 75% from here. Before we get to that, though, let me show you what happened to Fidelity...
Before February 18, the mutual fund giant owned about $40 million of stock in XenoPort, a small biotech with its lead drug up for FDA approval.
As I highlighted in January, if XenoPort's drug for restless leg syndrome garnered approval, shares could have soared 20%-30% in one day. But as I also noted, a rejection could have slashed 50%-70% off its market cap in an instant.
Thus, from a risk-vs.-reward perspective, owning XenoPort stock before the FDA decision was a terrible idea. That's almost always true. I've told you several times trading biotech stocks ahead of FDA decisions is a sucker's game. The government agency's opaque workings and political bickering make it impossible to consistently predict which way it will rule.
But I guess Fidelity managers don't read Growth Stock Wire.
Rather than hedging or exiting the position, Fidelity, like most of the dumb money holding XenoPort shares, believed in its own expertise.
XenoPort's drug is a longer-lasting version of Pfizer's blockbuster epilepsy treatment Neurontin. And institutional investors viewed its approval as inevitable. Wall Street analysts projected XenoPort shares would go from $20 to as high as $47 after the news.
They were wrong.
Due to a small increase in pancreatic cancer risk in rats, the FDA rejected XenoPort's drug. It's a stupid ruling. Neurontin has been on the market for over 15 years. And the pancreatic cancer risk in rats has been well documented with no corresponding effect in humans. But regardless, the rejection did just what we expected: XenoPort shares collapsed 65% the next day.
Now, we've got a low-risk trade in our hands. The company has about $5 in cash and no debt. At $7.50 per share, we are paying only about $2.50 for the restless-leg drug and the rest of its pipeline. If the company can get an independent panel to endorse the drug, a strategy successfully used by other biotechs to gain approval for controversial products, shares will likely soar above $13.
Further, the company has many other promising products ready for partnering. Any Big Pharma partnership could mean a 30% gain from here. Essentially, we are risking $2.50 for the next few months to make $5 or more. That's a much better risk-reward profile.
Scooping up quality biotechs AFTER an FDA rejection is a low-risk way to generate monster profits. Our 10-year backstudy showed 50% annual returns are possible with this strategy. I think we could see that much or more with XenoPort.
Good investing,
George Huang
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