A Biotech That Looks Ready to Drop

12/19/2007 12:00 am EST

Focus:

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts and ChangeWave Biotech Investor, says Celgene is vulnerable because it sells at a high multiple and growth is slowing.

I have disliked Celgene (NASDAQ: CELG) forever—but my distaste intensified when the stock broke in late October due to an earnings surprise. I follow the biotech sector very closely, so I was waiting for the firm's clinical trial results that came out last weekend to determine when would be the best time to initiate a short-side position.

Value money is flowing in, looking for a bargain, as the stock is down $25 from its 52-week highs. So, it's time for us to step in. CELG is now trading at around $50 and could slide to $25 in 12 to 18 months.

Celgene is a $20-billion market cap biotech selling for twice the valuation of other large biotechs, and it has slowing growth. Its major products are under siege from competitors and a potential generic threat.

Here are the details:

1. The company's hot new drug for multiple myeloma, Revlimid, is coming under pressure from competing Velcade from Millennium Pharmaceuticals, now in trial for this indication. Velcade has been approved for other indications and showed, according to some analysts (including moi), better results in treating the disease.

2. Celgene's half-billion-dollar drug, Thalomid, could face generic competition in a year or two. Barr Pharmaceuticals, a hyper-aggressive company that brought out the first great blockbuster generic of Prozac a few years ago, is pursuing this. The lawsuits are under way.

3. Celgene [virtually] admitted its pipeline was weak when it bought Pharmion last month for slightly less than $3 billion in cash.

4. The stock is selling for 50x current earnings—oops. Other biotech big caps sell for far less, including Biogen Idec, Gilead Sciences, and Genentech.

Analysts' earnings expectations are for $1.50 next year for a forward P/E of roughly 33x. No way: Genentech sells for 23x forward earnings and Gilead at 25x forward earnings, and they are far more secure in their markets (cancer and HIV) than Celgene.

CELG is at a critical support level of $50, in a manner eerily similar to Amgen. Those of you who were patient and stuck with Amgen are now sitting on a 100% profit—and the same thing can happen with Celgene.

The risk in this position is if the stock bounces off $50 and reflexively trades up toward $55 before reality sets in. To me, the risk is worth it, for when CELG cracks, it is a straight shot to $40 and below.

The biggest problem with this investment is that many investors agree with me, and therefore put premiums are very high. No matter; the potential reward outweighs the risks and still gives us some room to make a nice profit. So, let's give ourselves some time and buy the CELG July 45 Puts (LQHSI) under $4.70.

(Editor’s Note: Only the most risk-tolerant investors who can afford to live with large losses should engage in short selling.)

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