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A Pair of Perfect Short Sales

By Rob Fannon, editor Phase 1 Investor
Friday, December 12, 2008

Biotech wants a government bailout, too.
Funding risky biotechs with zero revenue is not high on investors' to-do list this holiday season, and biotech financing is at a 10-year low. This year saw one tiny stem-cell outfit hold an initial public offering (IPO) for a measly $6 million. That's down from 28 IPOs for $1.7 billion last year. Overall, public and private biotech funding is down more than 55%, year-over-year.
With no new funding, more than 35% of publicly traded biotechs will run out of cash in less than six months.
The bankruptcies are already taking shape...
Georgia-based Atherogenics defaulted on $300 million in debt in September. The company closed shop shortly after. At one time, Atherogenics laid claim to one of the best cardiovascular drugs under development. It fetched a collaboration deal with AstraZeneca worth a possible $1 billion in future payments. But when the drug failed, those milestones evaporated, and the company suffocated under its own debt.
MicroIslet, a micro-cap San Diego biotech, filed for bankruptcy shortly after. It had burned through all its capital, couldn't pay its debt obligations, and was unable to raise money for more trials for its diabetes drug. Florida-based Accentia Biopharmaceuticals and Orchestra Therapeutics, a California biotech, suffered the same fate.
Now biotech has turned to Congress – everyone's favorite sugar daddy – for help.
On Wednesday, biotech executives marched on Washington seeking a lifeline. Their proposal calls for a temporary change to the accounting and tax code. The change would trigger immediate cash infusions for cash-strapped companies. In exchange for government handouts today, the companies will pledge to forgo future tax credits.
I'm as big a biotech advocate as they come. Yet I have an entirely different proposal for Congress: Let them die.
First, this proposed bailout is a terrible deal for taxpayers. The government will only "break even" on the trade if each and every suffering biotech reaches profitability and starts paying corporate tax.
But drug development is a high-risk venture. On average, just one in 10,000 drug candidates ever makes it to pharmacy shelves. That's why only 10%-15% biotechs are profitable today. More than 70% of biotechs will never reach profitability. Failures are part of the game.
Second, the biotech industry needs pruning. The U.S. alone has 370 publicly traded biotechs. If undeserving biotechs get the boot, investors will allocate funds to well-run companies with realistic products.
In the meantime, companies with drugs lacking meaningful data will not find a partner. And with share prices so low, they won't be able to raise cash by diluting existing shareholders. A crushing debt load and high cash burn are hallmarks of the biotech bankruptcies to come.
Now, biotech investors have the chance to short some of the industries weakest members... Here are two names to start your research: MannKind Corporation (MNKD) and XOMA (XOMA).
Berkeley-based XOMA focuses on antibody-based drugs. It has a portfolio of partnered drugs as well as proprietary drugs in development. But it burns at least $1 million per month, and only has $10 million in unrestricted cash in reserve.
XOMA is desperately seeking Big Pharma partners to keep its lights on. But because its proprietary drugs are early in development and aimed at competitive markets, I don't think a buyout is coming.
MannKind recently produced positive results from its inhaled insulin diabetes drug. Unfortunately, no Big Pharma company is interested in inhaled insulin after Pfizer lost $3 billion trying to launch a similar product. Drugmakers have no appetite for a high-risk partnership.
Even before advertising or marketing costs, MannKind would have to spend north of $100 million to bring its drug to market. The company has about $95 million in the bank, but it also carries more than $110 million in debt.
I guess there's one possible remaining partner for both MannKind and XOMA – the U.S. government. But it's more likely the government will let the biotech bill die... just like the crippled biotechs should.
Good investing,

Market Notes
Yen continues to climb against the dollar... CurrencyShares Japanese Yen hits all-time high.
Gold royalty company Royal Gold hits new high... up 67% from March lows.
Cocoa soars 22% in the last month to $2,745 a ton... highest price since 1989.
Southwest Airlines cuts back flights, drops to 10-year low.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%

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