In the volatile biotechnology sector, it is common for a company’s stock price to soar when news breaks that the company has received approval from the FDA to launch a new drug. For most of these companies, however, FDA approval is just the first step on a long journey, and history teaches us that, in the majority of cases, the journey will end in commercial failure rather than success.
Of course, it’s easy to get swept up in the wave of optimism that accompanies a major event like FDA approval, even for supposedly circumspect financial advisors. Thus, investors should be leery of recommendations to invest in biotech stocks that are riding high off the back of such news. If faced with such a recommendation, investors would be well served to remember the cautionary tale of Vivus, Inc.
I. Vivus, Inc.
In April 2012, Vivus was a “hot stock.” The company had just obtained FDA approval for two new drugs: the obesity drug Qsymia and an erectile dysfunction medication called Stendra. Investors, many of whom were acting on the advice of their brokers, flocked to Vevus, eager to reap the rewards of its new wonder drugs.
Unfortunately, many of the stock brokers who steered their clients towards Vevus overlooked or disregarded the company’s shortcomings and a host of impediments to its success. As a result, many investors failed to appreciate just how risky their investments were. They soon found out, however, as Vevus’s stock price plummeted more than 90% in the next three years. Here’s what transpired:
Even as the FDA was approving Qsymia, analysts were already expressing concern about Vevus’s ability to successfully bring the drug to market without the backing of a pharmaceutical heavyweight to assist with marketing and commercialization. That concern was fueled, in part, by Vevus’s prior failure to capitalize on a highly-publicized FDA approval. Analysts were also predicting that Vevus would have to contend with “severe pricing and competition headwinds” as similarly situated drug companies were expected to vie with Vevus for market share in the medical weight-loss sector. To compound the foregoing concerns, the FDA’s approval was conditioned upon a study of Qsymia being undertaken to investigate links between the drug and major adverse cardiac events such as heart attack and stroke. This left many, including many in the medical community, with lingering doubts about the safety of Qsymia.
Many of the concerns that were being voiced about Qysmia in Spring 2012 proved to be well founded. The storm clouds gathered almost immediately as sluggish initial sales precipitated a dramatic decline in the stock price (60% in less than a year). The inauspicious start was attributed, in part, to deficiencies in marketing and distribution, highlighted by the company’s failure to get Qsymia approved by health insurers, as well as its failure to expand its sales channels beyond mail-order pharmacies. Things got worse in 2013 when European regulators refused to approve Qsymia based on concerns about the potential cardiac dangers of the drug. By 2014, with a proxy war raging and new and more-visible competitors to Qsymia beginning to emerge, short sellers began flocking to Vevus en masse, driving the stock price down to new lows.
By the time Stendra was approved by the FDA in 2012, Viagra and Cialis had been household names in the U.S. for over a decade. Backed by pharmaceutical giants Pfizer and Eli Lily, these drugs had consistently swept aside the challenge of would-be competitors, including a product launched by the European pharmaceutical giant Bayer. There was little evidence to suggest that Stendra would prosper where other more heavily-marketed alternatives to Viagra and Cialis had failed.
Vevus was able to generate some buzz around Stendra in 2013 by announcing it had received approval to advertise the drug as a faster-acting alternative to Viagra and Cialis, but the enthusiasm was short-lived due to disappointing sales numbers. Subsequent licensing and commercialization deals offered new hope to investors, but each endeavor has ended in failure.
II. Biotech Investing and Suitability
The story of Vivus is not an anomaly. More biotech companies fail than don’t, which is precisely why investing in biotechnology companies is considered “a very risky endeavor.” Stephen D. Simpson CFA, A Biotech Sector Primer (updated 2018): accord Financing the Biotech Industry: Can the Risks Be Reduced? 4 B.U. J. Sci. & Tech. L. 1, 8-12 (1998) (“Biotechnology is a very high risk business ….”).
Not surprisingly, securities regulators have taken the view that investment strategies that involve overweighting the biotech sector are unsuitable for investors who do not have the willingness and ability to pursue “aggressive growth” or “speculation.” See ,e.g., NASD Dep’t of Enforcement v Hennion & Walsh, Inc. et al, Disciplinary Proceeding No. C9B040013 (Jan 10, 2005) (“it should have been obvious to Hennion that speculative trading, resulting in concentrated positions in biotechnology stocks, was not suitable for an elderly widow with limited financial resources.”).
A popular study guide for FINRA license exams echoes the regulators’ views, stating in pertinent part as follows:
On the opposite end of the spectrum from liquidity, we would find speculation as an investment objective. . . . . Speculation involves going for higher rewards but taking higher risks. Investments in “growth stocks,” “technology/biotech stocks,” and “cyclical stocks” are generally speculative because the “investor” is often putting his hard-earned money into a company and perhaps an entire industry that has not even come close to proving itself yet.
. . .
Risk tolerance can be referred to in different ways. Risk-averse, conservative and low risk tolerance all mean the same thing – dude doesn’t like to party. High risk tolerance, aggressive, and speculative also go together, more or less. If somebody’s risk averse, keep him out of things like “biotech, emerging markets, small cap, or aggressive growth funds.”
Robert Walker, Pass the 6: A Training Guide for the FINRA Series 6 Exam (4th Ed. 2011).
Even biotech enthusiasts have urged restraint when it comes to investing in the volatile biotech sector:
In scanning the available literature, I’ve found very few specific recommendations to suggest how much of an investor’s total portfolio should be placed in the biotech sector. According to Michael Dauchot of the Dresdener RCM Biotech Fund, no more than 10 percent of a portfolio should be devoted to biotech because of the sector’s volatility. His partner, Dr. Faraz Naqvi suggests no more than 5 percent.
George Wolf, The Biotech Investor’s Bible (2001).
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