By Dr. George Huang
Kevin Tang is one lucky dude.
Tang, the activist manager of the health care hedge fund Tang Capital Partners, has an unusual strategy: liquidate underperforming biotech companies. Here's how it works...
The credit crisis – and the ensuing risk-aversion – has driven investors miles away from small biotechs. When sellers far outnumber buyers, a strange phenomenon happens. These stocks get pushed below the amount of cash the companies have in the bank (a condition called "negative enterprise value").
In theory, if you buy the stock at these depressed prices, you can generate instant, guaranteed returns by shutting the company down and returning the existing cash to shareholders. For Kevin Tang, it's not theory. He puts it into practice.
Recently, Maryland-based Vanda Pharmaceuticals became Tang's prime target. The company had developed the drug Fanapt for schizophrenia. But the FDA rejected it last July, demanding more clinical trials. Shares fell from a high of $29 in 2007 to less than $1 after the rejection. Still, Vanda persisted. It believed it could convince the FDA to approve Fanapt without any new trials.
I thought the Vanda management team was either crazy or brilliant. I figured their chances of success were less than 1 in 1,000. Apparently, so did Kevin Tang.
Tang knew Vanda's stock was worth much more than $1. In fact, the company was sitting on about $1.70 per share in cash after accounting for all its liabilities. So he moved in and scooped up almost 4 million shares (15% of the company) at less than $1. Then, he demanded management close shop and return the cash to shareholders. If the strategy succeeded, he would be sitting on a 70% return in less than a year. But, boy, he couldn't have been more wrong...
On May 6, the FDA did the unthinkable. It approved Fanapt for schizophrenia, dropping its request for new trials. The agency's miraculous change of heart was shocking and unprecedented. The next morning, Vanda's stock jumped 920% at the open. Yes, you are reading it right – a "10-bagger" in a single day.
Tang's original stake of roughly $4 million is worth more than $50 million today. (And yes, he immediately withdrew his proposal to liquidate the company.)
Tang's good fortune illustrates a strategy I've been telling my readers about for two years: Buying biotech stocks after an FDA rejection can be extremely lucrative. And if the company is trading below cash, you're going to limit your downside without giving up any upside.
Today, the market is full of these opportunities... A few months back, my FDA Report subscribers traded biotech player Indevus after the FDA rejected its testosterone injection. The stock dropped 70% in one day. Its market cap shrunk to $120 million... even with $60 million in cash plus a royalty stream worth $140 million.
So, at those prices, we owned Indevus for less than cash. We got its testosterone injection and pipeline for free. The probability of losing money was next to nothing. Sure enough, we weren't the only ones who noticed this incredible setup...
Eight months later, Endo Pharmaceuticals bought out Indevus at a 45% premium. My S and A FDA Report readers cashed out with a 70% gain.
If you're looking for one-day, 10-bagger opportunities, have a look at beaten-down biotech stocks trading for less than cash. You'll be surprised at how many are out there...
Good investing,
George Huang
