By Michael Brush and John Tabacco Jr.
Flu season is just around the corner – so it’s no surprise the “swine flu” stocks have had a nice move up.
Some of them, however, aren’t destined to stay aloft. Shares of the vaccine play Novavax (NVAX) have recently been subject to some of the highest demand by shorts at Locatestock.com. Plus an insider is selling significant amounts. That spells Double Trouble for this swine flu play.
Here’s a look at six reasons why Novavax could see significant declines from here.
Reason # 1: Novavax carries a rich valuation
Novavax currently brings in about as much cash as an experienced New York City police officer who puts in overtime. In the first quarter, the company showed just $29,000 in revenue. Yet investors are willing to value this miniscule revenue stream at $475 million (market cap minus net cash).
We’re sure New York cops would like to think they are worth that much, but it seems pretty rich for a stock like this. Throw in expenses, and the company is bleeding $8.5 million a quarter – and it will continue to do so for years. The company trades for over eight times book value, or 2.6 times the typical book value of a successful biotech company.
Reason # 2: Novavax won’t see any pay off for years
Yes, we know investors aren’t really paying up for the current revenue of Novavax, but rather the potential of its “virus-like particle” (VLP) technology. Indeed VLP may have value, as recent studies seem to show.
In VLP the company makes particles that look like viruses to the body, and thus set off an immune response. Recent studies in humans show that it works, apparently with minimal side effects. (We won’t see the full results till next spring.) The big advantages are that VLP will be faster and cheaper than the current method of using eggs to produce vaccines.
Despite all the hoopla surrounding swine flu, however, the cold fact remains that any actual revenue from VLP technology is still far, far off.
Reason # 3: Analysts are slashing their ratings
The payoff is so far away that Wall Street analysts recently slashed their ratings on this stock. Analysts think that right now any benefits from VLP are completely priced in to the stock. This is why the two analysts covering Novavax cut their ratings to “hold” in early September with the stock trading around $6.
When even the Wall Street analysts are neutral on a stock, it is not a good sign.
True, in early September the company announced that Phase II tests showed its VLP-based vaccines created “robust immune responses” in humans against swine flu (H1N1), the seasonal flu, and two other kinds of flu.
But Novavax still must do much more testing, get approvals and then set up production. The process is so time consuming, Oppenheimer & Co. analyst Brian Abrahams doesn’t expect significant revenue until 2012. This is the company’s view, as well.
Reason # 4: Expect Big Dilution Ahead
At the end of the second quarter Novavax had $31.2 million in cash. It also racked up $8.5 million in expenses for the quarter. So at current rates, the company will run out of money in less than a year.
Some of the inevitable shortfall could be made up in payments from joint venture partners. But those agreements dilute future earnings. And even with those payments, it looks like Novavax will have to raise more capital down the road, which will dilute the value of its stock.
Reason # 5: Insiders are selling.
In July, five insiders including chief Rahul Singhvi sold $1.4 million worth of stock. Combined with the high demand at Locatestock.com to short Novavax, this spells double trouble.
Reason # 6: Bulls have to stretch to make their case
Novavax bulls apparently need to stretch to generate buzz around the stock. This isn’t a great sign. If they had an airtight case, they wouldn’t need to do this.
A recent bullish commentary on Novavax began with the line: “Forget what analysts in the pockets of big hedge funds say, to quote the Wall Street Journal directly, “Novavax is a winner.”
Check the Wall Street Journal and indeed those are the exact words in the headline. However, the article was just a routine market summary of big gainers, and the Journal’s use of the word “winner” referred to the fact that Novavax stock was up 10% one day. It was not a reference to the product potential at the company.
Risks to betting against Novavax
We still haven’t seen that swine flu is any more deadly than the regular flu, which kills about 36,000 people a year in the U.S. However, when more people regrettably die from swine flu in the coming weeks, there’s a chance we could see a global panic. Or swine flu could actually turn out to be much more lethal than the regular seasonal flu.
Novavax is in discussions with several countries looking for quick ways to make swine flu vaccine. A swine flu panic could speed up those negotiations. So even though under the standard approval timeline Novavax is not slated to have a product on the market until 2012, “these are not standard times," observes Novavax chief Singhvi in a recent press interview.
At the time of publication, Michael Brush and John Tabacco Jr. had no positions in any stocks mentioned in this column. Michael Brush is a regular columnist for MSN Money (http://articles.moneycentral.msn.com/Commentary/ByAuthor/MichaelBrush.aspx). John Tabacco Jr. is the CEO and Founder of LocateStock.com. John is recognized as an expert in the area of Securities Lending and Global Equity Finance, and is a regular contributor on Fox Business News and CNBC.
What is Double Trouble?
Stocks in high demand at Locatestock.com by investors looking to go short regularly perform badly. The high demand is a sign that shorts have unusually strong conviction that a stock is overpriced.
Stocks where insiders are selling significant amounts often underperform, as well.
Put these two negatives together, and you have a stock facing Double Trouble. At Double Trouble, we regularly present companies that face both headwinds, and examine why their stocks may decline.