Which Pharma Stock Should You Short?

Affymax AFFY is a small-cap biopharmaceutical company that focuses on various hostile diseases. It is trying to break into the mature pharmaceutical space, and it seems that investors are looking for tangible results before validating Affymax as a reasonable contender in the biopharma industry.

One of the things that investors need to consider when making a risky play in small-cap companies is the company's operational ability. Does Affymax appear to be operating steadily? Over the last five quarters, Affymax's sales have been extremely volatile. In the second quarter in 2010, sales were $54 million. It dropped to $17 million the next quarter, and has reached $14 million in the latest quarter. Expenses have been quite volatile as well, to the point where the company has experienced a loss over the last four quarters. This last quarter, the company's EPS was -$0.35. Simply by looking at the income statement, it appears that Affymax's operations are overly volatile. This sort of behavior is not unique to small-cap pharmaceuticals. As many smaller life sciences companies operate, they are continuously trying to come up with the next big product to sustain themselves. Only large companies like Pfizer PFE and Merck MRK are able to sustain themselves and garner steady revenues and steady costs.

Investors also need to consider Affymax's cash situation. Ultimately, cash is king and dictates what a company can do on a day to day basis. Unfortunately for the company and its shareholders, it appears that the cash flow from operations is very volatile. Over the last five quarters, the company's operational cash has been negative. In Q2 2010, the company lost $10 million in operational cash. In the most recent quarter, Affymax lost $48 million. The primary reason comes down to net income but also to working capital. Working capital negatively affects cash when current assets increased. Receivables or inventories may be the culprit, but in either case, investors need to be aware that this is going on.

Affymax has not pursued much in terms of capital expenditures in the last couple quarters. In 2010, it made various diversified investments, but that sort of activity has not been present throughout 2011. Another warning sign for investors is that Affymax has been ramping up equity issuances in 2011. In each of the first two quarters, Affymax issued $54 million in common stock. The only time shareholders want to dilute their stakes in the company is if it needs capital fast. This appears to be the case with Affymax, and may not be the most positive sign for shareholders.

Affymax's balance sheet shows a contraction as well. As expected, cash and short-term equivalents declined by $30 million in the last quarter. Property, plant, and equipment have been stagnant as well. the liabilities side looks fairly positive, as many current liabilities have declined significantly. Deferred revenues along with accrued liabilities declined by over $10 million. The company also wiped out deferred tax liabilities, and appears to have paid off its short-term debt.

Investors have to consider one last thing in the financial statements. Retained earnings, which is a direct measure of the value added to shareholders, has been declining quarter over quarter. The last five quarters have been negative, but it appears that the downtrend is the only consistent trend in Affymax's books. Retained earnings continuously declines by a bit over $10 million each quarter, and is currently at -$411 million. Based on paid-in capital, Affymax is attempting to cope with the negativity by aggressively issuing equity.

Correlating with the negative numbers on Affymax's books, its growth prospects are less than stellar. It has negative EPS growth, negative margins, and a negative return on equity. Competitors are all positive in these aspects. Affymax, however, does have a much higher revenue growth number: 36.4% versus 16.4% for the average competitor. It also has virtually no debt on its books, and appears to be undervalued based on price/book value and price/sales.

Investors have to consider everything about a company's financials. Whether it is looking at the books are considering the numbers, Affymax appears to be a speculative play at best. It does not seem to have any semblance of stable growth in the near future. Especially considering the negative news coming out regarding European debt. Investors may considering playing Affymax's earnings announcement, but things do not look particularly positive in the medium to long-term.

Affymax is currently trading at about $5.18, down about 22.3% for the year.