While the NYSE ARCA Biotech Index (BTK INDEX) is up almost 39% year-to-date and up 8% since late August, short interest in the U.S. Biotech Sector increased by $1.2 billion over the last week and $2.4 billion over the last month. Total short interest is now $34.9 billion in the U.S. and $39.0 billion worldwide. Both long and short investors are active in the sector as seen in the activity in the two largest biotech ETF’s. The iShs Nasdaq Biotech ETF (IBB US) and the Spider S&P Biotech ETF (XBI US) have a combined $13.9 billion AUM with $3.7 billion of short interest.
Recent M&A activity has brought immunotherapy cancer treatment stocks into the forefront for both long and short investors. Kite Pharma (KITE US) is up 28% since Gilead Sciences (GILD US) recent merger announcement and similar cancer treatment stocks such as Juno Therapeutics (JUNO US) and Bluebird Bio (BLUE US) are up 39% and 28% respectively, since the announcement. The prospect of additional M&A activity has thrown the sector into hyper-rally mode.
Besides the search for the next biotech M&A brass ring there are fundamental reasons for the sector’s rally over the past year and a half. Continued product innovation, such as Novartis’ CAR-T cancer treatment, and increased demand from an aging population has turbocharged revenue growth. Changes in the FDA approval process and relaxation of regulatory hurdles are shortening the pipeline timeline and are making even orphan disease treatments a profitable endeavor.
While the creation of new genus’s of drug therapy will drive biotech profitability in the future, the growth of generics and biosimilars will offset some that firm-wide growth momentum. In addition to this cheaper price competition on existing profitable product lines these drugs and treatments are experiencing usage plateaus. Continued growth at historical breakneck levels of these mainstay drugs is proving to be unsustainable. With demand for some of these mature drugs and therapies stable at best, and supply increasing, prices and margins will deflate significantly. As a final “con”, the biotech sector is still operating under the dark cloud of several pricing scandals which, if repeated, may force the legislature or FDA to enact some version of pharmaceutical price controls.
The Biotech Sector is already expensive relative to the S&P 500 with a P.E. of 40, over twice as large as the broader market. Long shareholders must decide if this extended rally will continue and short sellers must decide if a reversal is imminent.
Shorts have not done well since this rally started on February 11, 2016. The top 5 short “winners” are up $798 million in profits while the top 5 “losers” are down $4.3 billion in losses.
Even in the face of a steady rally this year, short sellers continue to build their exposure via outright equity shorts or sector ETF’s. Financing costs and recall risk are minimal as there is sufficient borrow supply in virtually all the securities in this sector, with only two stocks in the top 25 most shorted stocks having stock borrow financing rates over 1% fee (Juno @ 1.28% and Opko @ 2.16%). At $34.9 billion the Biotech Sector is the most shorted sub-industry in the U.S., $10 billion larger than the Internet Software & Services Industry and $12 billion larger than the Semiconductor Industry. If shorts start covering their positions because the rally continues and losses are mounting, there will be an additional tailwind helping move biotech prices even higher.
Biotech investors must decide whether to listen to the Siren’s songs and short a possibly overheated sector and risk crashing in the rocky shores as the rally continues, or listen to Circe, fill their ears with beeswax, and hold onto their long positions and let their profits run.
Want deeper insight into the above analysis? Contact:
Managing Director Predictive Analytics, S3 Partners
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