Tuesday, April 28, 2009

A last hurrah for the rational markets hypothesis - Biota Holdings redux

You know we should all give this game away – at least when it comes to short term trading.  Rationality doesn’t work and I am not a good gut instinct trader.

I have posted on Biota (see here and here) – a stock very unlike my usual stock market picks.  I purchased it after it had risen 60 percent on swine flu.  It is clearly a big beneficiary of the flu as it is entitled to a 7% royalty on sales of Relenza – one of only two drugs that is likely to be effective against swine flu and one of two drugs that governments stockpile to deal with events like this.

I figured that if you believed the movement in Glaxo’s share price on the swine flu outbreak then you should believe that Biota would triple in Tuesday’s trading.  I also suggested that that was not going to happen.  The stock was up pennies.  However I observed that the relative movements was proof – if any more was needed – that markets are (at least medium term) irrational.  

Now there is a reason I was willing to speculate in Biota – which is that it simply is not that expensive.  I mentioned that Biota’s cash holdings were about AUD60 million.  Well I understated it.  It was 60 million before recent cash inflows.  

It is receiving a fairly big royalty payment on sales of Relenza before the swine flu outbreak.  Here was Biota’s last press release.  The company is not promotional – and there has not been a single release since the swine flu outbreak (if anything the CEO has talked down the stock).  

For Immediate Release
Melbourne, Australia — 23 April 2009

Relenza Royalty for March 2009 quarter $32.3 million
Biota Holdings Limited (ASX:BTA) today announced that it had received notification from GlaxoSmithKline (GSK) that Relenza sales were $462 million and indicative royalties were $32.3 million, for the three months ended 31 March 2009.

Indicative royalties for the nine months to 31 March 2009 total $36.1 million.

Biota CEO Peter Cook attributed the performance to recent significant orders for pandemic stockpiling from the UK and Japanese Governments.

After that cash inflow the cash holdings of Biota are closer to 100 million.

Now does anyone seriously believe that Swine Flu won’t cause a substantial increase in pandemic ordering of Relenza?  

I have no idea how big that that inflow will be – but five times the most recent quarter is hardly implausible.  (Though I am more than happy to say that it was just a guess...)

In that case Biota would have cash backing almost equal to its market cap.  And it could be bigger.  You would guess on a small possibility of very big Relenza ordering and massive and repeated stockpiling of the drug.

More to the point – the emergence of reports of psychological and resistance problems with Tamiflu will probably shift the market towards Relenza.  And Biota has a second generation flu product which should be out before Relenza runs out of patent.

Of course the dear stock market can price up the 93% of Relenza revenue for Glaxo by 6 billion and ignore the 7% owned by Biota.  In fact I frankly expect them to do so.  Rational markets don’t exist – and don’t consider this to be a stock tip because the insane relative movements can exist quite a long time and I figure the rise in market cap for Glaxo is probably wrong too.  But if you ever wanted a clear rational markets counter-example then this is it.


PS.  To me the strongest reason for buying the stock is that Biota is by far the cheapest financial protection against a very nasty global pandemic.  That ultimately is why I purchased it.  Though I admit - if the stock is super-strong I will take some profits...


Nick said...

You don't mention Avodart in your analysis.
I am not 100% on the timing of the various announcements and your calculation of the Swine Flu impact on GSK vs. Biota but perhaps this "mis-pricing" is rational after all.
(Fair disclosure: markets are quite clearly irrational, I just don't think this is evidence of that fact.)

Brendan said...

Funds don't buy Biota b/c it's too small, they can't buy enough of it to make it worth their while.

Nate said...

An interesting trade, though as cheap insurance against a global pandemic, I would guess that buying Biota stock would have limited efficacy. If the swine flu outbreak does reach global pandemic proportions, and if Relenza proves to be the most effective treatment, I would imagine that Glaxo/Biota would relinquish their royalty claims and the drug would be generically mass-produced. So there is probably a payout profile for Biota where their returns scale linearly up to a certain point and then plateau. (Hopefully that doesn't sound too callous.)

Anonymous said...

Novavax Keeps the Momentum, Shares Climb 24% on Day 2 of Swine Flu

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