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Posted 10/25/2001
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Consider those biotech and pharmaceutical executives who, with full knowledge of the difficulty of threading their product through the FDA needle are courageous enough to buy shares in their own company.
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The Speculator
Follow the insiders to 10 top biotech stocks
Gains are almost an epidemic in the biotech world these days amid concern about bioterror. We've picked 10 with insider buying and recent losses for a first stab at profits.
By Victor Niederhoffer and Laurel Kenner
Certain insiders of beaten-down biotech companies have recently had the courage to buy their own stocks in the face of horrible market conditions, terrorist attacks and the near-impossibility of getting a product approved by regulators.
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We speculate, for reasons we'll give below, that the information possessed by these intrepid officers and directors is not averse to their companies. And while these enterprises aren't involved in developing vaccines or diagnostics that might protect against bio-terrorism, the entire biotech sector is likely to benefit from the attention created by the past month's anthrax attacks.
Ideas, after all, are contagious. The process by which information is spread can be likened to the way a disease infiltrates the population. First, an individual is infected. He spreads it to those he comes in contact with. The newly infected individuals either break out with the disease or show immunity to it. The disease is passed along or dies out. The process continues until every individual in the area has either been exposed, developed immunity or died.
Similarly, when a company has a product with potential, expectations about that potential can be communicated to other companies. Their stocks rise or show immunity, and the process continues until all the likely suspects have had their day in the sun.
Growth of such "memes," as scientist Richard Dawkins dubbed these mental viruses, has to start somewhere. Right now, as reports of anthrax exposures and infections increase, one company after another has been jumping through the hoop of investor enthusiasm, propelled by hopes that they may have a vaccine, an antidote, a cure or a test.
To name but a few examples, Bruker Daltonics (BDAL, news, msgs) was awarded an additional $250 million in market value, a 43% increase, after winning a $10 million contract with the Pentagon for mass spectrometers that identify contaminants. Cepheid (CPHD, news, msgs), which expects to start selling a suitcase-sized diagnostic machine in 2003, jumped as high as $8.19 from $1.50 after announcing it would make a prototype of the device available to the government and military. Vaccine makers Avant (AVNT, news, msgs), BioReliance (BREL, news, msgs), Corixa (CRXA, news, msgs) and Vical (VICL, news, msgs) rose between 26% and 128% after the attack -- even though vaccines have historically not been a good business to be in.
With one exception, none of the companies on our list has benefited yet from biodefense enthusiasm. But there is always the chance that the meme will be communicated to a related species -- in this case, biotech companies that aren't involved in diagnosing or treating something so imminent a threat as anthrax or smallpox, but simply something prosaic like heart trouble or cancer. Or, if we may say so, bowel health, as is the case with InKine Pharmaceutical (INKP, news, msgs).
On the face of things, our stocks seem to be unlikely picks, and InKine will serve as an example. The 42-month-old company buys up products that other companies lack the money or smarts to get through the Food and Drug Administration. InKine won its first approval in September 2000 for Visicol, a tablet that cleanses the bowels before colonoscopy. Visicol was approved after 27 months, which at the FDA is near the speed of light. Use soared and then fell off as technicians discovered that the micro-crystals used to bind the tablet caused a few minutes of delay in the procedure, enough to cost them one colonoscopy a day, or about $1,000 in revenue, Chairman Leonard Jacob told the UBS Warburg Global Life Sciences Conference in New York on Oct. 12. The company must now switch to new pill-making equipment and convince technicians to give the product another try.
But InKine is a perfect case in point. Four insiders bought almost 900,000 shares in September, and the purchases don't appear related to salary. They're not doing too well with the stock -- it's down from $9 to $1.34 in the past year.
What the insiders know
Three guys just won the Nobel Prize for writing about this kind of situation. George Akerlof, Michael Spence and Joseph Stiglitz won the prize this month for their pioneering work on the economics of information. This branch of the dismal science studies how much information people demand in determining what they will buy and sell. Among their areas of focus are situations of asymmetric information, where the buyer and seller have different degrees of information.
Akerlof used the example of the sale of a used car. The seller knows whether it's good or bad, and consequently the price drops because the buyer fears buying a lemon. Similarly, Stiglitz observed that a person buying insurance knows how sick or how likely he is to avoid calamity much better than the company selling policies. Stiglitz, like most economists, is much more concerned about how imperfect and asymmetric information can lead to violations of the competitive model, violations that can only, according to his lights, be fixed by government action to correct the asymmetry.
Indeed, he recently figured prominently in urging the government to expand its role in assuring security at airports. As for the virtues of competition and innovation that would be stifled by such interference, there is no consideration. In fact, if airlines were allowed to compete by offering additional security, we would gladly pay $15 extra to one that hired armed guards to fly on its planes.
Without extending the discussion of our deep philosophic disagreement with Stiglitz, we can point to another example where asymmetric information is highly likely. Before a product can be sold to treat a sickness, the FDA must approve it. Companies that have a product in the FDA pipeline, which is basically all companies in the drug and biotech field, have much information as to the likelihood of success. There are meetings, studies, letters. Consultants are hired, often those who will eventually opine on the product's effectiveness. In short, no matter how blind the double-blind study, the company has some knowledge as to whether tests are going well or badly.
Consider those biotech and pharmaceutical executives who, with full knowledge of the difficulty of threading their product through the FDA needle are courageous enough to buy shares in their own company. Are they doing so thinking that their product is likely to be rejected? We would hazard they are not. The information that is revealed by their insider purchases and sales contains, to us at least, as much of value as the advertisement that a car is for sale or an individual's inquiry about buying insurance.
The caveat is that such speculations are often incorrect. As Vic Hemmy, an 80-something Hawaiian reader who combines stock-picking acumen with surfing, observed: "Insiders are frequently afflicted with wishful thinking."
Further, except for a detailed study of the regulatory approval process involving more than a dozen books, numerous research papers and extensive calculations of our own, we are quite ignorant about the world of biotech.
Test-tube profits
What we needed was a test. We started with five years of data from the Washington Service, a firm that reports SEC filings on insider buying and selling. We chose a sample of 50 companies in the Russell 2000 Health Care Index with insider buying sometime in 1996 to 2000. The average change in the year after the buying was 44%. The Health Index rose 22% a year during the period.
Of the 50 companies considered, 53% showed a rise in the year after the purchase. Strangely, only one-third were up in the nine months before the purchase. Note that various Securities and Exchange Commission rules prohibit insiders from selling the stock they purchase within a year. The penalty is to disgorge the profits, so a one-year time horizon for following such purchases seems propitious.
The star was Amylin Pharmaceuticals (AMLN, news, msgs), which rose 832% after some timely buying near the end of 1998. However, and this highlights the risk of a strategy based on insider buying --- Amylin also held the booby prize, declining a spectacular 94% after ill-timed purchases in 1997.
Also notable were the 289% rise in Apria Healthcare Group (AHG, news, msgs) and the 81% decline in Avanir Pharmaeuticals (AVN, news, msgs) over the pertinent timeframes.
The variability of individual returns for the next year was some 168%. Taking into account the superior average performance we observed, the number of observations and the variability, we may say that these results are unlikely -- say 1 in 10 -- to have come through chance variations alone. But investors should consider the whole basket rather than just one or two, as the variability is great and many of these companies will doubtless fall by the wayside. We intend to buy these stocks ourselves as a basket.
There was a slight tendency for companies that were down the most in the nine months before the insider purchase to perform best in the following year, and for those that rose the most in the nine months to perform the worst. The correlation of –0.1 is somewhat unlikely to have occurred through chance variation alone.
Here, then, is our list of biotech companies with recent insider buying. We chose them from among the 103 companies in the Russell 2000 Health Care Index. We found 10 that had insider buying during the past three months, in addition to being at least one-third down in price this year.)
| Stock | YTD % Chg (Oct. 22) |
| Corvas (CVAS, news, msgs) | -53% |
| Dyax (DYAX, news, msgs) | -53% |
| Genelabs (GNLB, news, msgs) | -49% |
| Genzyme Transgenics (GZTC, news, msgs) | -68% |
| Guilford Pharmaceuticals (GLFD, news, msgs) | -35% |
| InKine Pharmaceutical (INKP, news, msgs) | -81% |
| Large Scale Biology (LSBC, news, msgs) | -57% |
| The Medicines (MDCO, news, msgs) | -68% |
| 3-Dimensional Pharmaceuticals (DDDP, news, msgs) | -51% |
| Triangle Pharmaceuticals (VIRS, news, msgs) | -14% |
We called each of the companies to inquire about the insider buying. Only two, InKine and Guilford, returned our call. Both attributed the buying to management's belief that their stock was undervalued. "These were historically unprecedented valuations, and we have a wealth of technology at Guilford," said Angie Rubin, spokeswoman for Guilford Pharmaceuticals, where seven officers and directors had bought a total of 52,890 shares on Sept. 19 and Sept. 20, the week the market reopened after the attack. "It wasn't a coordinated effort. It was a great buying opportunity."
With the FDA approving so few drugs, investing in biotech seems to us like a lottery. But you sort of like to buy the lotteries when you know that the top executives are buying
We are continuing our education in biotech. As most of you know much more about this subject than we do, we would like to hear from you. We answer all e-mail. If you are interested, write to us at dciocca@bloomberg.net, and we will send you a complete workout of our five-year study of the companies and results.
Neither Victor Niederhoffer nor Laurel Kenner owns any of the stocks mentioned in this column. Any similarities to real persons are merely coincidental.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.