Health

Max Nisen is a Bloomberg Gadfly columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

Biotech stocks are in many ways a perfect environment for short-sellers.

These are frequently small companies with volatile stocks. Biotechs often have little or no revenue. The majority of their worth is tied up in experimental medicines. That makes clinical trial results a binary event that can explode a stock. But these kind of bets can go wrong, even when a short-seller is right.

Short
Biotech is often one of the most heavily shorted sectors on the market
Source: Bloomberg

Predicting the result of a clinical trial is always difficult -- companies wouldn't spend millions to run them if someone didn't believe very strongly that they will succeed. Trials aren't always clear cut failures or successes. It's hard to know how a stock will move even when results look negative; a lot depends on what else a company has going on and current market sentiment. And a successful short investment is also about timing, which is extra difficult in biotech. Trial results frequently come out months or years later than expected. 

Take the example of Kerrisdale Capital, a small hedge fund that has made a number of short investments in biotechs coupled with detailed research reports outlining its reasoning. It's had a heady run of correct calls. But investors attempting to tag along on their own might have had a bumpy road. 

Kerrisdale criticized Sage Therapeutics Inc. last year for relying on a tiny and flawed study to justify a late stage test of its lead medicine in a seizure disorder. The firm was right. The trial flopped and Sage shares plunged 13.7 percent in September. But the stock was still elevated from when Kerrisdale published its report; investors cared more about a different trial of the drug in post-partum depression. Anyone who remained short in the hope that the final stage depression trial would fail as well --  9 percent of the company's float was short as of October 31 --  got a very unpleasant surprise on November 9 when that trial succeeded. 

Burned By Sage
A failed trial for Sage's lead medicine was rapidly followed by a success
Source: Bloomberg

Bavarian Nordic A/S is another example of the difficulties of turning correctness into profit. The company has been studying its prostate cancer vaccine for more than a decade, and Kerrisdale highlighted what it called misleading data in an earlier trial and predicted final stage failure in 2015. But earlier this year, investors seized on the news that the trial's results were delayed as a sign that patients were living longer and success was more likely. That made staying short an expensive proposition. The trial ultimately flopped in September 2017, giving Kerrisdale two correct calls in a week. But it's not likely that everyone who was right from the start benefited.  

Nordic Skiing
It was a long ride to rightness on Bavarian Nordic's cancer drug
Source: Bloomberg

Other Kerrisdale efforts like its call on Zafgen Inc. have been more straightforward successes, and plenty of others do well betting against individual biotechs. But going short is always tricky, and biotech adds a bunch of extra wrinkles. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Max Nisen in New York at mnisen@bloomberg.net

To contact the editor responsible for this story:
Daniel Moss at dmoss@bloomberg.net