Monday, September 12, 2011

The Dangers of Betting on a "Sure Thing", and A Tale of Two Stocks

In the classic comic strip Bloom County, in the wake of the 1987 stock market crash, a young boy tries to help his stricken father accept the reality of his portfolio wipe out by revealing, “As of October 1, our broker says our net worth is about six dollars. Now…for instance…how might this bit of news affect our plans to buy a new boat this summer?” The shell-shocked father replies, “My God, we’re going to have to settle for the more fuel-efficient 260h.p. 350 MAGS in that baby.” I was sitting in an undergraduate economics class on “Black Monday” (October 19, 1987) when I heard that the Dow Jones average plunged 23% that day. As a financially naïve liberal arts major, I barely knew what the Dow Jones was, so I expressed astonishment that people were financially wiped out as a result. I recall thinking, “Wait a minute, the drop was bad but still only could people be wiped out?” I soon learned that there are indeed easy ways for people to lose their life savings (or worse) in the stock market, and sadly over the years I have personally observed this happen to some very good people. Equally as frightening, I myself have been sorely tempted on a number of occasions to pursue the same actions that led to their pain. As such, I’d like to discuss some common pitfalls that carry tremendous risk of causing one to go flat broke. Additionally, I’ll share with you “A Tale of Two Stocks,” which will help demonstrate how ordinarily rational folk like you and me can easily fall into such a predicament.

Nice Basket…Where Are My Eggs?
Invest all your money in one stock? Given that every reputable personal finance professional in the modern world sternly preaches the necessity of portfolio diversification, surely no one is goofy enough to do something so outrageous, right? But then during the boom-boom ‘90’s, the super successful fund manager Peter Lynch comes out with a few best-selling investment guides suggesting that, for us non-professionals, “investing in what you know” is the way to go. The idea is, since us commoners may not have the time, tools, or training to research stocks and analyze mind-numbing financial reports like the pros, we should target buying stock in, say, the new shoe store that we notice has a constant long line of customers snaking out of it. Alas, being the unwashed commoner heathen that we are, some of us take this principle to a level beyond Mr. Lynch’s intent: if investing in a small basket of stocks that we know well is a recipe for success, surely investing in one stock that we know amazingly well is the path to investment nirvana! With seed planted, some are now at least open to the idea of putting all eggs into a single basket. Per my observation, people fall in love with stocks all the time (case in point: myself). Over time, the longer we hold a certain stock, the more we feel we know and understand its nuances. Often as a result, the deeper our affection for said stock and the more we want of it, for it to be closer to us, to press it gently and lovingly into our bosoms and enjoy its warm caresses until we cry out in a sweaty feverish….sorry, where was I? Ironically, it’s when the share price of our beloved stock drops significantly (either with the general falling market or due to company-specific hiccups) that we are at increased risk of concentrating too much of our portfolio (i.e. all of it) into this single stock. For who can resist a big sale on something we know and love to be a virtual sure thing? And if the price continues to fall, this just indicates an increasingly compelling buying opportunity, so we’ll simply continue to buy more shares so long as we have remaining funds. To wit, consider the following scenario: let’s suppose that you’ve been investing in a very stable company for a number of years, and you feel you know the company quite well. Over the most recent several years, the company has focused heavily on world-class innovation and enhancing its industry leadership position. Revenues and profits have been growing by leaps and bounds, and the stock price had risen accordingly. This is no fly-by-night company, as Fortune Magazine has chosen it as “America’s Most innovative Company”, as well as one of the “100 Best Companies to Work For in America.” As a result, the company has been scoring the best and brightest MBA’s and PhDs from the country’s top schools to join its employee ranks, which currently numbers over 20,000. However, for no apparent reason other than market fluctuation, the stock price has actually fallen about 30% from its high only a few months ago. In response, the company’s well-respected management team has come out and publicly declared its belief that the market greatly undervalues the company. Would this stock seem a screaming buy? Actually, the company I just described is Enron, circa the first half of 2001. Yes, this is an extreme example, but my point is that no matter how “sure” a sure thing may appear, anything is possible. To put all your eggs into the “surest” of baskets could be quite risky.

Lose Your Margin-ity
Using margin has been one of the most common causes of investor anguish. “Margin” is purchasing stocks or other securities by borrowing money from your stock broker (so when someone says, “I bought shares of X stock on margin”, it means he bought at least a portion of those shares with borrowed money). Why would someone do this? Well, if one felt confident that a given stock was going higher, he can significantly enhance his gains by borrowing money to buy more shares, a dynamic known as “leverage”.

Let’s suppose you strongly believe that Doodah Inc.’s stock, currently trading at $10 a share, is going higher… but you only have $5,000. Ergo, you can buy 500 shares of this stock (note: let’s leave transaction/trading costs out of the equation for simplicity). However, if you can borrow another $5,000 to buy another 500 shares, that would give you a 1000 share stake. If Doodah Inc. stock goes from $10 to $12 a share, you would have gained $1,000 (or a 20% return) if you only used your own money. But if you margined as described, you would have gained $2,000 (or 40% return, less interest on the margin loan). Sounds groovy, right? Alas, like love or a spicy burrito, leverage is a two-way street, for if your margined Doodah Inc. shares fall $2 (to $8), your loss also magnifies to $2,000.

Now that we get the basic concept, let’s explore how margin can enhance the risk of losing all your money. Sometimes folks get so high on a stock that they not only put all their eggs into one basket, they borrow more eggs to put. Again, if you go “all in” on margin and the stock goes up, the world is exceedingly wonderful. If the stock stays flat, you’re disappointed but only out a small amount of interest paid on the margin loan. If the stock goes down a bit, you’ll want to Ozzy the head off a bat but you’ll survive. But what if the stock tanks? What if it loses, say, over 50% of its value in short order, which is not an unusual occurrence especially in the high-risk, high-reward world of tech or biotech stocks?

To demonstrate, let’s increase the stakes. Suppose you have $100K in your account, in essence your life savings. Doodah Inc., a company you’ve been following for quite some time, specializes in penile implant technology and has recently received FDA approval for its first revolutionary device, TriPod-X. In addition to spending many hours of painstaking due diligence, you note that (a) your investment-savvy friends who drive Ferraris are all recommending it; (b) Jim Cramer just drooled on his red bull squeeze toy over it (and beaming to viewers, “I’m not only bullish on the stock, I’m also a happy customer!”), and (c) it’s currently trading at $10 a share, down from $20 just a few months ago when the general stock market was booming. Surely, this is a once-in-a-lifetime opportunity. In fact, based on your conservative revenue and profit projections, you’re so confident the stock is headed to $50 within the next year or two (maybe even within the next month or two if the non-savvy investment community at large wake up), not only will you go “all in”, you’re planning to margin to the hilt. After all, why settle for a $400K profit when you can have a $900,000 profit (almost) and be a millionaire? So you buy 10,000 shares with your $100K, borrow $100K from your stock broker to buy another 10,000 on margin, then sit and wait with your largess of 20,000 shares. Then one fine morning, you wake up and turn on CNBC to find that the FDA has just pulled TriPod-X from the market. It seems that 20% of patients implanted with TriPod-X had their penises fall off approximately twelve months after implantation (the label only suggested 2%). Because of this, Doodah Inc.’s stock (ticker symbol “DIC”) immediately falls to $3 a share. So here’s the situation you’re in: you are holding stock worth $60,000 (20,000 shares x $3), but you owe your stock broker the $100,000 you borrowed, not counting interest. So not only have you lost all of the money you started out with, you are now $40,000 in the hole.

But wait, you say. You’re still confident that everything will eventually work out, so you’ll continue to hold your 20,000 shares, happily pay the margin interest, and wait for shares to go back up. Unfortunately, it’s not that simple. On margin accounts, brokers generally require that your margin loan cannot be greater than 50% of your stock investment (sometimes the percentage is even lower, depending on how volatile the underlying stock is). So in the example above, the loan is for $100K, so your total stock holdings must be worth at least $200K (that is, the $100K loan is 50% of your $200K portfolio value). If the value of the total stock holdings in your account falls below the required threshold, you will get a “margin call”. A margin call is when the broker contacts you and forces you to either (a) add more money or securities into your account to bring the total account value back to twice the margin loan, or (b) sell some shares already in the account to reach that ratio. In our example, it means you would have to (a) add $140K in cash and/or securities into your account to bring the total account value back to $200K, or (b) sell ALL of your remaining shares and also cough up the $40K you owe. If you don’t respond to the margin call, the stock broker will automatically sell your holdings at whatever the market price is at the time. In other words, unless you can provide the substantial infusion required, you don’t have the option of staying the course and holding on even if you believe the stock will turn around.

But again, you say hold the phone: a stock falling 70% overnight? That’s a dire and unlikely scenario, isn’t it? First, as you will later see in the “Tale of Two Stocks” section, such scenarios are not as unlikely as you’d think. But let’s explore what would happen if the drop was more reasonable: let’s suppose the stock price per our example falls from $10 to $7, or a 30% drop (a fairly common phenomenon if you look at the daily “biggest % losers” section in the Yahoo-Finance website). In our scenario, your total stock holdings would now be worth $140,000 (20,000 x $7), and your loss at the moment – at least on paper – is $60,000. Furthermore, you’ll get a margin call from your broker to add $60,000 to your account, or do some selling to pay off part of the margin loan. Assuming you have no additional outside funds to add to the account, you’ll thus need to sell $60,000 worth of stock, or roughly 8572 shares at $7/share, to pay down the loan and reach the required margin threshold. Doing this would leave you with an outstanding loan of $40,000 and a total account value of $80,000 (approximately 11,428 shares at $7/share), which meets the 50% margin criteria. So assuming no further stock movements, your loss under this “more reasonable” scenario would be 60% of all your money. While you won’t be broke, you’ll be in considerable pain.

You Have the Option to Go Broke
Another way one can use leverage to achieve potentially greater gains on a “sure thing” stock is to buy options rather than buying simple shares of the stock. One can open an account that allows options trading with pretty much all the well-known brokerage (Schwab, E-trade, Scottrade, etc.). There are basically two types of options: “calls”, which are bets that the underlying stock will go up, or “puts”, which are bets that the stock will go down. For this discussion, we’ll stick to the scenario of the bullish investor buying “calls.” When one buys a call option, he is buying the right to purchase a certain stock at a given price within a certain time frame. So if I possess the option to buy a stock at $1 and the stock goes to $10, I may exercise my option by paying $1 for the stock, then immediately selling the stock on the open market for $10, thus profiting $9. There are many complicated nuances to options trading, but a couple of basic nuances to understand are: (a) the longer the time period underlying the option’s purchase right, the more expensive the option will cost; and (b) the more volatile the underlying stock, the more expensive the option will cost. Intuitively, these nuances make sense: an option that gives you the right to buy a stock at a given price over the next 12 months should be more valuable than one that only gives you that right over the next month. Also, given that your chances and potential size of profit are greater if the underlying stock tends to fluctuate greatly (i.e. there’s greater chance the stock will fluctuate greatly to the upside) an option on a stock that’s more volatile (i.e. its stock price tends to move up and down significantly and often) costs more than one for a stock whose price historically is more stable. Smaller companies generally tend to be more volatile than bigger more established companies, so options for smaller (riskier) companies tend to cost more.

So how does an enthusiastic investor “leverage” with options? Again, let’s suppose you have $100,000 to invest in Doodah Inc., whose current stock price is $10 a share. Suppose it costs $1 to buy one option that gives you the right to buy one share of Doodah Inc. at $10 per share between now and 12 months from today. So, with your $100,000, you can either buy 10,000 shares of Doodah Inc. common stock or 100,000 options at $1 per option. Let’s now suppose a year later, Doodah Inc. shares have increased to $20 a share. If you had simply bought common stock, you would have a profit of $100,000, which would be pretty nifty. However, if you had purchased 100,000 shares of options, your profit would be a whopping $1,900,000 (100,000 shares x $20 per share, less the $100,000 you originally paid for the options), or 19 times the profit versus simply buying common shares. If the stock had gone up even more, your relative profit multiplies accordingly.

Beautiful, yes? Alas, just as in the case of buying stock on margin, there’s significant potential downside to buying options. Again, the world is Louis Armstrong wonderful if the stock goes up. But if the stock does not go up (i.e. goes down or stays flat), your options may become worthless and you lose all of your investment (NOTE: in real life, if you buy an option that expires in one year, you don’t have to wait one year before you cash in: you can sell your option any time between your purchase date and the option expiration date at the option’s market price; the market price of the option will go up and down in correspondence to the underlying stock’s price. Additionally, all else equal, the option price will decrease the closer it gets to the expiration date, since there’s less time opportunity remaining for the stock price to move. But for simple demonstration purposes, our example assumes the option buyer keeps the option for the full 12 month term, i.e. until expiration). Let’s suppose instead of going up, Doodah Inc. shares go down over the next year to $8 a share. If you bought regular shares of stock, your holdings would be worth $80,000. Yes, you’re kicking yourself because you’ve lost the equivalent of a new Hyundai Elantra, but you still have $80,000 of your original $100,000 investment. But if you bought options with your whole bankroll? You’ve lost everything. Why? Because the option is only worth something if the underlying stock price is above the option’s strike price, i.e. $10 in our example, i.e. what good is the “right” to buy a stock at $10 a share when I can buy it at $8 in the open market? But actually, the story is scarier: even if the stock remains flat at $10 a share at the end of the 12 months, you still lose your entire investment. In fact, in order to make any profit, you need the stock to at least increase to over $11 a share at the end of the year, because you need to at least cover your original $100,000 outlay. In summary: relative to buying regular shares or buying shares on margin, buying options will give you the biggest payout if the stock goes up materially. However, it also gives you the biggest risk of losing every cent of your investment. To be sure, options can be and are used as a legitimate and prudent financial planning tool by investors, such as to provide a hedge against a very big stock position (i.e. insurance against major losses if the stock were to fall drastically). We are talking here about using options strictly as a leverage tool to soup up one’s stock bet.

Now at this point, many of you may be saying, “Yeah, but I would never do anything as extreme as those risky things being described.” Let me say that I would not be writing this piece if I did not personally observe very good and normally prudent folks get immensely hurt by falling into the above-mentioned traps. I must also admit that I myself have on more than a few occasions been sorely tempted to dive into similar traps, and it was only through a great degree of willpower (and larger degree of wimpy-ness) that I avoided doing so. Until you’ve encountered a stock situation that is so “sure thing” compelling, then, as wise Darth Vader once said, “you don’t know the power of the dark side.” In my investment career, I’ve encountered two such stocks.

A Tale of Two Stocks – Part One: Elan Pharmaceuticals
Elan Pharmaceuticals is an Irish-based company that currently co-markets (with partner Biogen-Idec) Tysabri, one of the leading drugs for multiple sclerosis. Elan also is and has been a recognized pioneer in the field of Alzheimer’s disease research, and together with partners Pfizer and Johnson & Johnson has a promising potential Alzheimer’s treatment in late stage clinical development called bapineuzumab. As an employee of a small biotech named Athena Neurosciences, I became aware of Elan when it purchased Athena in 1996, and I suddenly found myself transformed magically into an Elan employee. Elan is also known for its very vocal and proactive small investors, many of whom were (are) absolutely sure that Elan was a special jewel destined for greatness, primarily on the back of its Alzheimer’s program. At the time of the Elan/Athena merger in 1996, ELN stock was trading at about $15 a share. Over the next several years (I departed in 2000), Elan seemed to execute flawlessly: its drug delivery products were cash cows and selling well; promising drug candidates (including its lead Alzheimer’s product at the time, a vaccine known as AN1792) were moving crisply through the development process; additional exciting small companies were being bought that would bolster pipeline and sales force; and each passing year saw its revenues increased significantly. By June 2001, the stock hit an all-time high of $65 a share (and I was happy as a clam with all the shares I still held). Then in February of 2002, Elan halted its Phase 2 trial on Alzheimer’s vaccine AN1792 due to safety issues (6% of patients developing meningoencephalitis). At about the same time, another storm hit in the form of Enron, Worldcom, Global Crossing, and their ilk that were being pummeled due to accounting shenanigans. Elan had always been known for its aggressive accounting methods. The SEC in fact had previously investigated the company’s accounting, which resulted in a small fine but by and large no changes. However, Enron was publicized to have used an off-balance sheet financing vehicle known as Special Purpose Entities (or SPE’s) as part of its shenanigans. So when a news article came out saying, “Hey guess what Elan Pharmaceuticals also uses? SPE’s!” investors bailed. The SEC then announced another formal investigation into Elan’s books. As a result of all these hoopla, the stock began falling dramatically. But Elan now had an even bigger problem on its hands: Elan had billions of dollars in debt on its books, including $2 billion that was due in less than 2 years. In the debt agreements, Elan had the right to pay the debt in either cash or stock. Now when the stock was at $50-60 a share, the debt was no big issue since Elan could issue 40 million or so shares (a humble amount relative to its total shares outstanding of over 300 million) to cover the debt. But with the falling stock price, and given that Elan did not have enough cash on hand to pay, this would mean Elan would have to issue MORE shares at the lowered price per share to cover the debt. But having to issue more shares means further dilution for shareholders, and the anticipation of this dilution resulted in the stock price fell even more. But stock price falling even more means still further potential dilution….and so on and so on. This became known as the “death spiral.” At the bottom of the spiral on October 1, 2002, Elan closed at $1.05 per share. After Elan’s CEO and COO were pushed out, Elan embarked on an effort to sell some of its many assets to raise money. It turned out that Elan had many attractive assets, and most sold at better than expected prices, including $750 million from King Pharmaceuticals for muscle relaxant Skelaxin and insomnia drug Sonata. In all, Elan was able to raise the necessary money to pay off the pending debt, and the company was out of immediate danger. Soon thereafter, good things started to happen again. Multiple sclerosis drug Tysabri was in the middle of Phase 3 trials, and although the trials were supposed to last two years, there was an interim peek at the data after year one. The peek showed that Tysabri worked so well, the FDA actually encouraged Elan and partner Biogen to file for early approval based on the 1-year data (they would still have to complete the 2-year study). Not being fools, the companies did just that, and the FDA granted priority review status to Tysabri (“priority review” means the FDA commits to completing its review in 6 months rather than the typical 12 months). In November 2004, the FDA approved Tysabri, and multiple sclerosis patients and Elan investors rejoiced. On the strength of Tysabri’s promise, Elan shares closed at $29 on January 12, 2005. Things were moving along smoothly for several months until, on Monday February 28, 2005 (a day Elan investors would come to label as its very own version of “Black Monday”), Elan and Biogen made a surprise announcement that Tysabri was being immediately withdrawn from market. Two patients in one of the clinical trials had contracted a very rare and often fatal infection known as progressive multifocal leukoencephalopathy, or PML. A few weeks later, a third case of PML was discovered in a former Tysabri trial patient. In response, Elan’s share price fell to as low as $3.00 (on March 31, 2005). In the weeks that followed, fear and misinformation ruled the day. On June 2, 2005, the Boston Globe trumpeted the headline, “A fourth death may be tied to Biogen’s MS drug.” It later turned out that not only was the patient in question not dead, she didn’t have PML. Her doctor, upon hearing media reports that the patient was deceased, was quoted as saying that the subject was “alive and out shopping.” The companies began a comprehensive review and analysis of all Tysabri patients and by March of 2006, an FDA advisory panel meeting was held to determine the possibility of Tysabri returning to market. Because so many MS patients applied to speak on behalf of Tysabri’s return, a second day was added to the meeting. In the end, after hearing the testimony and reviewing all relevant safety and efficacy data, the FDA advisory committee unanimously recommended that Tysabri be returned to market. Three months later on June 5, 2006, the companies announced that the FDA followed the recommendation of the advisory committee and approved Tysabri’s return to market. At the end of that trading day, Elan’s stock closed at $16.52 per share.

Over the next couple of years, Elan’s shares steadily climbed on the strength of Tysabri and the progress of the Alzheimer’s program, in particular the Phase 2 study of bapineuzumab, a “passive immunization” treatment that targets beta amyloid peptide in the brain. On June 17, 2008, Elan and partner Wyeth (later bought by Pfizer) issued a press release announcing “encouraging top-line results from Phase 2 Clinical Trial of Bapineuzumab for Alzheimer’s Disease.” In essence, the press release revealed although the primary endpoints (i.e. primary goals) of the trial were not met, enough good and promising signs were observed for the companies to pursue expensive Phase 3 trials. The market seemed to like the message. The stock closed at $30 that day (Tuesday), and by the end of Friday that week the stock closed at $32.95. Then came July 29, 2008, when the companies presented the aforementioned data in detail at the International Conference on Alzheimer’s (or ICAD). Elan investors were very optimistic about this presentation, and were convinced that after hearing the Phase 2 data in detail the market would finally fully recognize the promise of the program. However, although the presentation by and large was simply the same data given in the previous press release, the market apparently decided it didn’t like what it heard. The stock had closed at $33.75 on July 29, and the presentation occurred after the market closed. Immediately after the presentation, the stock began plummeting in after hours. The next day on July 30, the stock opened trading at $21.74 and, by the end of the day, closed at $19.63, or almost a 42% drop from the previous day’s close. Then, before already shell-shocked Elan investors had a chance to take a breath, two days later on Friday, August 1, Elan and Biogen announced that two more cases of PML were confirmed in Tysabri patients in Europe. By the end of Friday, the Elan’s stock fell to $9.93 per share. Elan investors would later name this week “WTF Week”, i.e. “What the F*** Week” (hint: rhymes with “truck”, as in we just got hit by one). In the subsequent three years, although no earthshattering developments have occurred, Elan’s shares have fluctuated from as low as $4.33 (August 30, 2010) to its current price of roughly $10 a share.

Elan investors await the next big catalyst, which will likely be bapineuzumab Phase 3 data results some time in 2012 (despite the reaction to the ICAD Phase 2 data presentation, the partners did feel the bapineuzumab data was compelling enough to move to Phase 3 trials). As for Tysabri, additional PML cases have, as expected, become a fact of life (as of August 2011, a total of 150 PML cases worldwide have been reported). However, on the positive side: Tysabri’s benefits appear to outweigh the risks for many patients; the number of PML cases are still by and large consistent with the drug label’s specified risk of approximately 1 PML case in 1000 patients; contracting PML is no longer seen as a “death sentence” due to early steps of mitigation (of the 150 PML cases, 29 have died); and there is high hopes that a newly released screening procedure will be able to effectively pre-screen patients for risk of PML. Whether or not and to what degree bapineuzumab and Tysabri achieve success will be the most material drivers of Elan’s share price going forward.

A Tale of Two Stocks – Part Two: Dendreon
Dendreon is a Seattle-based biotech whose lead product, Provenge, is approved as a treatment for prostate cancer. Considered an exciting and new form of cancer therapy, Provenge is an “autologous cellular immunotherapy” that works by removing a patient’s own white blood cells, exposing these cells to a protein that stimulates and directs them against prostate cancer, then re-injecting them into the body. Like Elan, Dendreon also had (has) a very vocal and activism-prone group of investors who felt they’d stumbled onto the next great pharma at its budding stages. After many years of development, the company on November 13, 2006 announced that it had completed its BLA submission to the FDA for approval to market Provenge for prostate cancer. At the end of that trading day, the stock closed at $5.25 per share. Subsequently, the FDA announced it had granted Provenge priority review (i.e. 6-month review rather than the typical 12-month), and set the FDA advisory committee meeting for March 29, 2007. Between November 13, 2006 and leading up to the scheduled meeting, the stock hovered around the $4 – 5 mark, closing at $5.22 on March 29, 2007 right before the meeting. Typically in such meetings, a panel of independent experts made up of doctors and scientists is asked to review available data then each panelist gives his/her respective opinion regarding whether the evidence shows a drug candidate is safe and effective. Although the FDA is not required to follow the recommendation of the panels, they do over 95 percent of the time. At the end of Provenge’s panel meeting, the 17 panelists voted unanimously that the drug was safe, and 13 of the 17 panelists concluded that there was substantial evidence of efficacy. In effect, the panel was recommending Provenge’s approval. The next day, Provenge’s shares opened trading at $17.92 a share before closing the day at $12.93. Over the next five weeks, the stock traded as high as over $25 intraday before closing at $17.74 on May 8, 2007. Then on Wednesday, May 9, 2007 (“Black Wednesday” to long-term Dendreon investors), Dendreon announced that, contrary to the FDA advisory committee’s recommendation, the FDA decided not to approve Provenge. Instead, the FDA gave a “complete response letter,” which declared that Provenge was approvable assuming Dendreon provided additional efficacy data, presumably from an additional Phase 3 trial. This of course meant, at the very least, a multi-year delay to possible approval as well as millions of dollars in additional clinical trial expenses. By the end of Black Wednesday, the stock plummeted from the previous day’s $17.74 to a close of $6.33.

In the aftermath, Dendreon reached agreement with the FDA to alter its ongoing Phase 3 “IMPACT” (short for “Immunotherapy for Prostate AdenoCarcinoma Treatment”) trial so that, if the trials results are positive, it would satisfy the FDA’s demand for additional efficacy data. As the trial progressed, Dendreon’s share price languished in the single digits, closing as low as $2.61 (March 6, 2009) as pessimism became the prevailing sentiment. As the time approached for the IMPACT trial data to be released, the stock recovered a bit, closing at $7.30 on April 13, 2009. Finally on April 14, 2009, the company announced that the pivotal IMPACT trial was a success, having met the primary trial endpoint of improving overall survival in patients versus placebo. As a result, the stock rocketed and closed at $16.99 that day.

Then, a couple of weeks later, something very strange occurred. On April 28, 209, Dendreon was scheduled to officially present IMPACT data results at the American Urological Association annual meeting in Chicago. On that day, the stock opened at $22.32 and subsequently climbed to as high as $25 over the next few hours. The IMPACT presentation was scheduled for after close of market. Then, at approximately 12:30 Chicago time, Dendreon’s stock price began to sink - actually more like dive-bomb. The stock fell from $24 to about $7.50 within the course of 75 seconds. Dendreon investors who happened to be watching the stock ticker were understandably panicked: what is happening? What just blew up? Was Provenge just found to cause deadly incurable anal warts? Did the Hootie and the Blowfish break up? For investors, it was scary and confusing, and for some who either sold in the panic or were sold out due to “stop losses” (i.e. standing instructions with their stock brokers to automatically sell their shares if the price fell below a pre-specified threshold) - expensive. Although the stock recovered somewhat, it still closed the day at $11.81, well below the previous day’s close. As it turned out, there was no underlying bad news. Whether the episode was due to some crazy blip in some exchange computer, or the result of a massive “naked short selling attack” as some investors speculate, Dendreon’s presentation went without a hitch and the stock went back to over $22 the next day (note to newbies: a “short sell” refers to a bet that the stock price will fall, in which you borrow shares of stock from your broker, immediately sell them at current market price, then hope to buy back cheaper shares after the price drops so you can return the borrowed shares and pocket the difference; “naked short selling” is a method allegedly used by unscrupulous folks/ hedge funds/etc. [clothed or unclothed], in which they illegaly sell millions of shares that don’t really exist to drive a stock’s price down).

Over the next year, increasing optimism over Provenge’s future drove shares higher. When the company finally announced on April 29, 2010 that the FDA approved Provenge, the stock ended the day at $50.18. Over the next 15 months or so, share price fluctuated in the $30’s and $40’s. But with a potential blockbuster drug approved, manufacturing capacity successfully increasing to meet projected demand, and sales expected to significantly and inevitably ramp up, it appeared that shareholders could finally take a restful breath. Even as a crappy stock market dragged Dendreon shares to a closing price of $35.84 on August 3, 2011, shareholders were not too concerned as they eagerly awaited the Q2 earnings report scheduled to be released that day after market close, a report that would shed some much anticipated light on how fast Provenge was being sold. Alas, to shareholders’ horror, Dendreon revealed that not only did it miss its Provenge revenue forecast for the quarter, and not only will it not meet its forecast for the remainder of the year, but they were unable to provide any new lowered forecast guidance at all. According to the company, the problem was due to reimbursement concerns of prescribing doctors’ offices: because of Provenge’s high $93,000 price tag, doctors were reluctant to prescribe the drug until they were certain of reimbursement. Apparently, the company was not aware of this issue until very recent days, and it was unable (or unwilling) to estimate how long it will take to alleviate those reimbursement concerns. Stock analysts, many of whom had “buys” on the stock, responded by immediately downgrading Dendreon shares and theorizing that the real reason behind Provenge’s slow sales was lack of patient demand. Whatever the reason, the stock once again plummeted, closing at $11.69 the next trading day. As of this writing in September 2011, Dendreon stock is hovering in the $10-11 range.

Aside from marveling at their respective stomach-churning roller-coaster rides that would make Indiana Jones queasy, what’s my point in reviewing these tales of Elan and Dendreon? The point is that, in hindsight, one can see multiple occasions in which shareholders would have felt the stocks were screaming “sure thing” buys, and if they succumbed to that confidence with extreme leverage they would have lost all or most of their money. For instance, Elan investors’ confidence was sky-high leading up to the 2008 ICAD meeting. The same could be said for many Dendreon investors when the stock seemed cheap immediately prior to the 2011 Q2 earnings call. The market’s gnarly reaction to Elan’s ICAD presentation and the subsequent revelation of new PML cases later that week were completely unexpected, as was Dendreon’s big earnings miss and Provenge sales fiasco. Furthermore, recall that under an “all-in” margin scenario, you may very well lose your whole pie if a stock falls over 50%. If you take note above of how many times “sure thing” stocks Elan and Dendreon did just that over the years, it should give you ample perspective and pause. It’s possible that, in the future, Elan and Dendreon may still both turn out to be the shiny jewels that die-hard investors expected over the years. Alas for those who massively leveraged and lost their investment powder, they won’t participate in any potential turnaround reward. For others who still have all or most of their Elan/Dendreon holdings because they were fortunate enough to avoid leverage, they will live with the memories of being curled up in the fetal position on more than one occasion, and with regret over not putting their funds into something that would have proven more rewarding over the years, like a boring bank CD. But at least they have the option of still holding their shares for a potential payoff, for better or worse. So the next time an investment feels like an absolute “sure thing” and you (or your spouse, buddy, etc.) feel the great temptation to go “all in” or heavily leverage with margin or options, remember the tales of Elan and Dendreon and their investors who paid a Herculean price for similar confidence and temptation.


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