Avanir Short-Sale Bets Rise to Record Before Oct. 30 FDA Ruling on Drug

Investors are making a record number of bets against Avanir Pharmaceuticals Inc. shares and pushing options prices to a four-year high before U.S. regulators rule on the drugmaker’s proposed neurological therapy by Oct. 30.

Avanir, based in Aliso Viejo, California, is seeking approval of the drug, AVP-923, to reduce bouts of involuntary laughing and crying among patients who have suffered brain injuries or have multiple sclerosis or Lou Gehrig’s disease, also known as amyotrophic lateral sclerosis.

Four analysts surveyed by Bloomberg have a buy rating on the shares and two issued notes this month predicting approval. A report, “Nine Reasons to Sell Avanir,” sent to investors Monday by Favus Institutional Research LLC, predicted the drug wouldn’t be approved by the Food and Drug Administration due to concerns over heart safety, said Elliot Favus, the firm’s co- founder.

“Our view is that there’s no dose of the drug that doesn’t cause a delay in electrical conduction of the heart and we think that’s a concern for the FDA,” Favus said in a telephone interview yesterday.

Avanir rose 10 cents, or 3.7 percent, to $2.81 at 4 p.m. New York time in Nasdaq Stock Market composite trading and has gained 54 percent in the past twelve months.

AVP-923 is a combination of quinidine, a generic drug that prevents heart arrhythmia, and dextromethorphan, a cough suppressant. The combination is thought to affect the neurotransmitter glutamate, Avanir has said.

Short Selling

More than 26 percent of the company stock available for trading, or float, were sold short as of Oct. 26, up from 11 percent two months ago and a 2010 low of 6.3 percent in January, according to data compiled by Bloomberg and Data Explorers, a New York-based research firm that tracks short sales. Implied volatility, the key gauge of option prices, for at-the-money Avanir contracts expiring in 30 days has doubled in the past six weeks to 357.49.

Short sellers profit from the decline in share prices by selling borrowed securities and later replacing them with shares bought at lower levels. Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will rise or fall.

Avanir presented results of a study at the American Academy of Neurology’s annual meeting in Toronto on April 13 showing that patients reported fewer episodes of involuntary laughing and crying after taking the medication. The uncontrolled displays of emotion are known as pseudobulbar affect.

FDA Concern

The FDA declined to approve the drug in 2006, citing concerns over heart rhythm safety, said Ritu Baral, an analyst for Cannacord Genuity in New York. The agency’s chief concern was whether quinidine caused QT prolongation, a change in electrical rhythm that can increase heart attack risk, she said.

The company then reformulated the drug with a lower dose of quinidine and conducted new studies, she said.

“We view all the safety data, including heart rhythm safety data, as clean,” Baral said in a telephone interview yesterday. “We don’t think FDA will delay approval.”

There is a 75 percent chance the FDA will clear the drug and that Avanir will begin marketing it in the first half of 2011, Baral said in a note yesterday to investors.

The options market is assigning an equal probability that the stock will plunge below $1 or soar above $7.50 because prices for November options to bet on moves to those levels are the same, said Ophir Gottlieb, head of client services at Livevol Inc., a San Francisco-based provider of options market analytics.

“The options market is implying it’s equally likely that the company triples in value or goes bankrupt,” Gottlieb said. “If the experts are guessing there will be a good result, the options market isn’t buying it.”

To contact the reporters on this story: Rob Waters in San Francisco at rwaters5@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net.

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Reg Gale at rgale5@bloomberg.net.

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