Introducing Investment Ideas – $CBST : Superbug Kryptonite?

Dan and I were at a Stocktwits conference two weeks ago in San Diego and one of the presenters was going over some charts in the market over the past year. He got to a chart of solar companies and asked rhetoically “Who would have said that solar would be the biggest performing sector at the beginning of this year, no one.” I turned to Dan and I said, well, actually, we did. Here’s Enis talking about the Solar industry in April of this year with specific focus on SPWR when it was around 14 dollars:

Sounds to me like another “hot” industry where investors were just too early, but the long-term story is as attractive as ever.

SPWR is now $34. About a month after that post, Enis highlighted the solar ETF TAN, wanting to buy it in the low 20’s and said:

I mentioned my long-term bullishness on the solar sector overall in my CotD post last month, comparing fallen solar stocks to fallen internet stocks in the mid-2000′s. Putting aside the price action comparisons, the fundamentals are definitely improving for the sector, as solar costs rapidly move lower, Chinese capacity becomes more rational, and financing options expand across the world.

TAN is now close to $40. A couple months later I looked at Solar City (SCTY) when it was trading $40. It’s now $60. And then there’s the ultimate miss on a long term trade when we did this in TSLA:

Trade Update $TSLA – Taking Profits On This Move, Will Revisit Later

9:54 am EDT – April 12, 2013

Action: Sold the TSLA ($44.60) June 42 / 47 Call Spread at $2.10 for a $0.70 gain

Note the price at the time. My favorite part of that headline is “Will revisit later.” We never even got the chance. TSLA is now famously a $170 stock.

These were not the only examples, there have been many others. But my point is that since RiskReversal.com was focusing on short term trading, these longer term trend ideas were just brief thoughts from us and not trades ideas like the rest of the site focused on. We’ve recently decided to expand the offering on the site to start to include longer term vision ideas as it’s probably one of the most requested features we get from readers.

So let’s look at an interesting trend that we by no means are the first to discover. PBS’s Frontline program this week was titled Hunting the Nightmare Bacteria and it focused on the fact that we could possibly be entering a time of crisis as far as anti-biotic resistant superbugs that are causing untreatable infections. Here’s the teaser for the program:

Scary stuff. Here’s a link to the entire program if you want to watch more. And here’s a link to an interview with Dr. Arjun Srinivasan from the CDC going over how we got to this point. Another interesting aspect of this story, and the one that possibly provides an investment opportunity, is this interview with with Dr. Charles Knirsch of Pfizer. He talks about a number of things including the honest fact the Pfizer made a fairly conscious cost benefit decision that drugs for longer term diseases (think Lipitor) was more in their best interest (way more profitable) than focusing on anti-biotics that a patient may only takes for a few days. There’s also the fact that the FDA was behind the curve on this but is now coming around:

I think with some of the recent legislation that’s been passed, for instance the GAIN legislation, that the FDA is really focusing on being part of the solution and working in a broad way in coming up with guidance documents that will allow a greater certainty that if you do the following programs that that will lead to an approval.

Also interviewed was Dr. John Rex, the vice president of clinical research at AstraZeneca. Here he is discussing the pipeline for new anti-biotics:

To say that it’s drying up is perhaps to give it more credit for having stuff in it than I actually would. I think it’s worse than drying up.

I think it is terribly close to a drought. This is one of the great catastrophes of our age, that if we don’t have new antibiotics and have a vibrant, diverse pipeline soon, we’re going to be in trouble.

Like I said before, this is not breaking news. People focused on this area have been discussing this issue for years. But Frontline catching wind of the story and developing a 1 hour documentary on the subject that probably took months or up to a year to produce and broadcast is not a necessarily a contrary indicator on this subject, because alot of this has yet to play out. And one could make the argument that a program like Frontline may be the type of publicity needed to bring this problem to the wider public. And since we’re talking about investment ideas, we could be hearing more and more about the subject when it comes to bio-tech stocks.

So what stocks are in this space? After I watched the program I went hunting around online and quickly came across this Bloomberg article from 2011. (like I said, this is hardly breaking news):

Optimer Pharmaceuticals Inc. (OPTR)’s Dificid is on track to lead as many as five new antibiotics onto the market over the next three years as a surge in drug- resistant germs stokes the need for new medicines.

The biotechnology industry is starting to fill a critical public-health niche being mostly shunned by larger drugmakers. Since 2006, only three of 111 drugs cleared in the U.S. were antibiotics.

Other companies in final testing of drugs that may gain U.S. marketing approval by 2014 are: Trius Therapeutics Inc. (TSRX), based in San Diego; The Medicines Co., of Parsippany, New Jersey; Boston-based Paratek Pharmaceuticals Inc.; Cubist Pharmaceuticals Inc. (CBST), of Lexington, Massachusetts; and closely held Durata Therapeutics of Morristown, New Jersey.

What’s interesting is what has happened since that article. Cubist (CBST) has either merged with or bought alot of these other companies, TSRX and OPTR included. So here is this almost perfect vehicle to play this sector, in the form of CBST. One of the nastiest and worrying forms of these superbugs is MRSA – Methicillin-resistant Staphylococcus aureus. This is not only showing up in hospitals more and more but outside in places like gyms and even the NFL. From Wired a few days ago: 

News that a third player with the NFL’s Tampa Bay Buccaneers is battling Methicillin-resistant Staphylococcus Aureus (MRSA), a potentially deadly skin infection, generated national headlines, but it’s not an isolated case. High schools in Carmel, Ind., and Northville, Mich. reported MRSA outbreaks within the past month. The lesson for all high school, collegiate and professional locker rooms: follow the CDC’s recommendation to be more proactive in preventing an outbreak rather than simply cleaning up after one occurs.

The Centers for Disease Control and Prevention (CDC) in September released a report that paints a grim picture of the on-going war against these so-called “superbugs” – pathogens such as MRSA and C. difficile that are becoming increasingly resistant to traditional medicines and killing tens of thousands of people every year. The report, “Antibiotic Resistance Threats in the United States, 2013” states that more than two million people in the United States get infections that are resistant to antibiotics and at least 23,000 people die as a result.

Digging deeper into CBST’s financials, here is how the company describes its primary products in its own Quarterly Statement:

Cubist has two marketed products, CUBICIN and ENTEREG. We also co-promoted DIFICID in the United States, or U.S., under our co-promotion agreement with Optimer. In addition, Cubist has three drug candidates that have reached Phase 3 clinical trials and several pre-clinical programs, each being developed to address areas of significant medical needs.

CUBICIN is a once-daily, bactericidal, intravenous antibiotic with proven activity against methicillin-resistant Staphylococcus aureus, or MRSA. CUBICIN is approved in the U.S., the European Union, or EU, Japan and many other countries for the treatment of certain infections caused by Gram-positive bacteria, including treatment for certain bloodstream infections. ENTEREG is approved in the U.S. to accelerate upper and lower gastrointestinal recovery following partial large or small bowel resection surgery with primary anastomosis. ENTEREG is not approved for marketing outside of the U.S. DIFICID is approved in the U.S. for the treatment of Clostridium difficile-associated diarrhea, or CDAD.

So CUBICIN is the antibiotic targeting MRSA (and is about 85% of total current revenues).  The company also has a robust pipeline, with 3 drugs in Phase 3.  Therein lies the opportunity and the risk, as approval in Phase 3 would be a huge boon for the stock, and rejection would lead to investor disappointment.

While we are not medical experts speculating on the likelihood of Phase 3 approval, CUBICIN’s current success offers a sort of safety value for the company.  CBST’s earnings declined significantly in 2013 from 2012, but that was almost all due to increased R&D costs (primarily due to the costs of the three Phase 3 clinical trials):

The increase in research and development expenses for the three months ended June 30, 2013, as compared to the three months ended June 30, 2012, is due to: (i) an increase of $25.5 million in external expenses primarily related to Phase 3 clinical trial expenses for ceftolozane/tazobactam and bevenopran, as well as manufacturing process development expenses to support the clinical trials for ceftolozane/tazobactam; (ii) an increase of $15.6 million in milestone and upfront payments primarily related to the upfront fee to Hydra to amend our existing license and collaboration agreement; and (iii) an increase of $6.9 million in unallocated internal research and development expenses primarily due to additional headcount to support our clinical and pre-clinical programs.