Tuesday, April 28, 2009

Can the stock market count?

The title is a rhetorical because I have been long enough in the market gain to know that the stock market does not come close to counting accurately.  The rational expectations hypothesis is just nonsense. 

That said I have a single highly topical example.  

I purchased Biota Holdings yesterday.  Biota is a one-product company – a biotech with a line in influenza drugs.  It is also a small cap company listed in Australia.

Biota invented Relenza – one of two drugs that are effective against swine flu – and one of two drugs stockpiled by governments in anticipation of an event like this influenza outbreak.

More precisely Biota is entitled to a royalty of 7 percent of Relenza sales.  Glaxo funded Biota’s development and much research and as a result Relenza is essentially a Glaxo drug.  (Incidentally Gilead is to Roche as Biota is to Glaxo.  Gilead developed Tamiflu.)

Glaxo’s stock price went up by 7.5 percent in a sharply down market on the news of swine flu.  It was quite specifically a swine flu reaction in that pretty well only the companies that would benefit from swine flu (Glaxo, Roche, Gilead etc) went up.  

7.5 percent on Glaxo’s huge market cap is a lot.  Indeed as Glaxo’s market cap at the end of the day was USD79.8 billion the rise in Glaxo’s market cap of about USD6 billion.

Now Biota is entitled to 7% of the sales of Relenza – without any expenses – just a pure royalty – so whilst it is entitled to 7% of the sales – at a minimum it should be entitled to say 8% of the economics.

Now if Glaxo’s market cap rose by USD6 billion then Biota’s market cap should rise by 8% of USD6 billion or USD480 million.  USD480 million is AUD676 million.  

I do not expect it to happen.  Biota’s market cap at close of business yesterday (and after a 80% rise) was AUD276 million.  

If the market could count then Biota would approximately triple today on the open.

I doubt it will happen because (a) the market can’t count and (b) fund managers would rather speculate a lot on Glaxo for small gains than a little on Biota for big gains because.  Well frankly nobody was ever sacked for buying Glaxo/IBM.  

The effect of swine flu is hard to calculate.  But the stock market effect of swine flu on Glaxo is highly visible and it should be reflected in Biota’s share price.  But even when things are easy to calculate (as this post demonstrates) the market does not price consistently.  At least one of the Biota/Glaxo stock price moves is demonstrably wrong.

When things are hard to calculate – eg losses in the financial system – is it any surprise that the market is entirely schizoid?


Post script... the extent to which the stock market can not count is indicated by the fact that Biota opened a penny down albeit still above my midday yesterday purchase.

Now I do not think the move in Glaxo was necessarily rational... but one of the Biota or Glaxo moves is clearly wrong.


John Hempton said...

I am of course understating it here - because 92 percent of the economics (Glaxo) is worth 6 billion so 8% of the economics (Biota) is worth 521 million USD.

That is 731 million AUD.

And Biota had some pre-existing value - so the stock - if the market were consistent - would be closer to a 4 bagger today.

Now of course it will not happen...


Anonymous said...

In fairness, I thought that I should direct you to this article which, among many other things, tells of 2 incidents in which Sheila Bair seems to have acted wisely.


Greg said...

John, with news from WHO coming out since friday with 1000 more confirmed cases and 2 more deaths in the US you might see your play in Bioata playing out nicely with a possible sharp up swing coming your way on Monday.

Best of Luck!


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