Using Insider Activity to Navigate Small-Cap Biotech Stocks

Create profile for David Miller Small biotech stocks present a unique investment opportunity, with the potential for a very strong upside. Developing the next big drug or technology can create strong returns or result in high acquisition premiums. Increasingly, large pharmaceutical companies are acquiring these smaller companies, looking to capitalize on the next big drug opportunity rather than spending on internal R&D. Investing in this industry, though, brings a unique set of challenges. Traditional assessment is muddled by several factors: complicated products and regulatory landscape, limited to no revenue during the clinical trial process and financial models that are typically based on sales assumptions far in the future. But yet, it is an industry worth embracing. To get smart on these potential investments, looking to the people running the company can provide the best insight (aside from granular comprehension of the subject matter) as to whether or not a particular company is a good investment. The idea is that corporate insiders know best about the direction of the company they are working for. So, if insiders start buying in an unusual manner, there may be some positive developments on the horizon, such as a successful clinical trial or potential M&A talk. Take for example, OPKO Health, Inc (OPK) and OvaScience (OVAS). In both cases, strong insider buying activity forecasted a rally in stock prices. This activity, when assessed with factors such as expertise of the management team (including track record of selling their companies to larger pharmaceutical companies) and number of positive developments regarding their products, can be a strong indicator for investment and can help you better navigate the landscape. A deeper analysis into each company reveals the opportunity signaled by strong insider activity: OPK Insiders have been strong buyers of OPK, which is involved in the discovery, development and commercialization of pharmaceutical products, vaccines and diagnostic products. In 2014, the stock experienced significant purchases made by top management: CEO Phillip Frost, MD purchased over $50 million, CTO & Vice Chairman Jane Hsiao PhD purchased over 30,000 shares and Director John Paganelli purchased 10,000 shares. This insider activity was substantiated by the caliber of the leadership team. CEO Frost is an industry veteran who famously sold his company IVAX to Teva Pharmaceuticals for $7.4 billion in 2006. These insiders have made regular purchase throughout the year. In mid-November, OPK presented a positive update on the phase III study for a potentially big product, Rayaldee. And just this week, OPK announced that Pfizer has licensed rights to its long-acting human growth hormone, hGH-CTP, for $295MM upfront and $275MM in regulatory milestones and potential gross profit split. Over the past five weeks, the stock has rallied over 12% compared to the S&P 500 Index being down slightly. OVAS OVAS is a life sciences company focused on the discovery, development and commercialization of new treatments for infertility that are both cheaper and more effective. Corporate insiders started buying the stock in March of 2013. Since then, CEO Michelle Dipp, Chief Scientific Officer Arthur Tzianabos, Chief Commercial Officer Christopher Bleck, and five directors have collectively purchased almost $2 million worth of stock. In 2014 alone, CEO Dipp purchased over $1 million worth of stock, including when the stock was trading in the low $7's. In recent weeks, updates on the successful launch of AUGMENT, OVA's core IVF treatment, has contributed to the stock's price rally, which is currently trading around $46 a share. But it's the future of the stock price that tells the real story of potential. In recent days, the stock has rallied due to significant advances from OvaPrime and OvaTure, two treatments that are still in development phases. Continued updates on success for either product could lead to a continued rally. Additionally, the company is in a good position for potential acquisition, as their CEO Dipp previously sold Sirtris, her former employer, to GSK for $720 million. These are just two examples of small-cap biotech companies primed for growth, with significant insider activity pointing to a potential rise in price per share. While investing in biotech, particularly small-cap, can seem complicated and daunting, looking to insiders can present a significant advantage to navigating the space successfully. David Miller is senior portfolio manager at Catalyst Funds.