A Fatal Mistake for Biotech Traders

A Fatal Mistake for Biotech Traders
By Dr. George Huang
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.

Half-Wit Bureaucrats Serve Up a No-Brainer Biotech Trade

February's Best Bargain Stocks

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

P.S. Pay attention to biotech Amylin over the next couple weeks. The company is expecting approval for the once-weekly diabetes drug, Byetta LAR. The decision date is March 12.

If approved, LAR will be a mega-blockbuster, with worldwide peak sales surpassing $2 billion. But a rejection could result in a 20%-40% beating for the company. I expect the drug will eventually win approval, so any temporary setback may be a way to profit from the diabetes breakthrough at bargain prices.

Doug Casey: European Union is going to implode soon
"The EU was really a stupid idea to begin with."

JP Morgan: Terrible news is coming this month
Why you shouldn't be worried...

Forget China, invest in this incredible emerging market
One of legendary investor Mark Mobius' top picks...

•	Natural gas down 4% yesterday... fund UNG hits a 52-week low
•	Soft drink behemoth PepsiCo hits new high... up 8% in four weeks.
•	Fresh high for entertainment giant Walt Disney.
•	Discount retailers Target, Dollar Tree, and Family Dollar reach highs.

	Last	Change	52-Wk
S&P 500	1122.97	+1.82%	+57.53%
Oil (USO)	39.15	-0.63%	+41.80%
Gold (GLD)	110.86	-0.69%	+24.58%
Silver (SLV)	16.79	-0.18%	+31.38%
U.S. Dollar	80.53	+0.00%	-8.93%
Euro	1.36	+0.00%	+7.40%
VIX	18.77	-6.62%	-60.53%
HUI	421.42	-1.62%	+54.87%
10-Year Yield	3.61%	-0.01	0.71

Advertisement

Company	Sym	Industry
PepsiCo	PEP	soft drinks
Jones Lang	JLL	property mgmt
Dover	DOV	machinery
DeVry	DV	for profit ed
El Paso	EP	pipelines
Brit Am Tobacco	BTI	cigarettes
Shire	SHPGY	pharma
Goodrich	GR	defense
Family Dollar	FDO	discount stores
BJ Services	BJS	oil services
McCormick	MKC	packaged foods
Edwards	EW	medical devices
Walt Disney	DIS	entertainment
BCE	BCE	telecom
Newfield	NFX	oil & gas drilling
ConAgra Foods	CAG	packaged foods
Millipore	MIL	medical devices
Shaw Group	SHAW	construction
Petsmart	PETM	pet stores
Lubrizol	LZ	chemicals
Berkshire	BRK-A	insurance
Dendreon	DNDN	biotech
Target	TGT	discount stores
TELUS	TU	wireless
Concho	CXO	oil & gas drilling
Toronto-Dom	TD	bank
Boeing	BA	defense
Limited	LTD	clothing stores
VeriSign	VRSN	software
Cooper	CBE	conglomerate
Icahn Ent	IEP	holding co
Rockwell Collins	COL	defense
Dollar Tree	DLTR	discount stores
ONEOK	OKE	utilities

Company	Sym	Industry
No lows of note

Make the Bankers Pay
March 4, 2010

Why I'm Still Bearish on Copper
March 3, 2010

The Government's Next Scapegoat
March 2, 2010

My Plan for Trading Gold Stocks
March 1, 2010

Weekend Edition: A World Gone Crazy for Government Debt
February 27, 2010