Don’t Be Scared by Biotech’s Double Down

03/16/2012 4:03 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Although MoneyShow’s Jim Jubak jumped the gun by a few days in recommending this promising stock, he writes the pullback is now an even better opportunity for new buyers.

Can’t say I like being on this end of the news for OncoGenex (OGXI) today.

The company announced this morning that it will sell more than 4.1 million shares of stock at $12 a share to raise approximately $47 million in capital. The offering is expected to close on March 21.

The stock closed yesterday at $17.43—quite a bit above the $12 price of the offering—and on the news is down 20.5% to $13.86 as of 2 p.m. ET.

The drop is understandable. Current investors will face serious dilution to their stake, as the company’s count of shares outstanding rises from 13.9 million.

And I’d sure like to have bought an initial position in this stock today, rather than at the $15.71 price on March 14 when I recommended this stock for my Jubak’s Picks portfolio.) That position is down 12% from my purchase price.

But although I believe the drop is understandable, I think it’s, well, wrong. Or at least short-sighted.

OncoGenex is doing what management that sees a need to raise capital down the road is supposed to do. It’s taking advantage of a spike in the price of its stock to raise capital at a good price.

Biotech companies raise capital for two reasons—one bad and one good. The bad reason is that the company is in danger of running out of money, because its research is running behind schedule, or the existing research direction has turned out to be a dead end and the company is facing a total reboot.

Often in this scenario, a company will clearly have gone through a period of hoarding cash by cutting costs in an effort to get to a place in its research where it can show progress sufficient to go back to the market to raise more capital.

The good reason is that the company’s research is proceeding on or ahead of schedule. Biotech research gets more expensive as it moves out of the lab and into the regulatory and marketing phases. Clinical trials big enough to convince the US Food & Drug Administration to approve a drug are expensive—especially, as in this case, when a new drug has to prove that it produces a better outcome than existing drugs.

Moving from trials to marketing is even more expensive. OncoGenex’s partner Teva Pharmaceutical Industries (TEVA) will pick up the tab for a lot of that effort, because it will do most of the marketing for OGX-011 after trials are completed in 2013 and the drug wins approval.

But besides the $60 million upfront payment, and the $370 million in potential milestone payments (and royalties on sales) that OncoGenex got in its deal with Teva, the company retained the right to co-promote the eventual drug in Canada and the United States.

It looks to me like OncoGenex wants to build a drug company, not just a lab. And the announced offer, painful as it may be at the moment, fits with that scenario.

(You might ask, and I do, why the company raised money today, instead of waiting for 2013. My guess is that this is a reaction to the incredible volatility of the last year. The lesson from that is take the money when the taking is good.)

Biotech stocks are volatile, and this kind of event comes with the turf, I’m afraid. The short story is that if you liked the stock at $15.71 on March 14, you should like it even more at $13.86 today.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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