Seattle Genetics: A Cancer Niche Too Small

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SEATTLE (TheStreet) –Let’s examine the short thesis on Seattle Genetics(SGEN), which also perfectly illustrates an important point about short selling, generally.

Last August, Seattle Genetics received FDA approval for Adcetris — an anti-CD30 monoclonal antibody linked to the anti-cancer drug monomethyl auristatin E (MMAE) — for the treatment of relapsed or refractory Hodgkin’s lymphoma (HL) and systemic anaplastic large cell lymphoma (sALCL). Adcetris is a good treatment option for patients within the labeled indication and management deserves applause for getting the drug to market.

Unfortunately, there’s a problem: Adcetris sales estimates are too high. HL and sALCL are rare cancers with extremely effective initial therapeutic options, leaving few patients for the Seattle Genetics to treat. Usually, when a drug misses Wall Street estimates, the stock price of the company selling the drug falls. I believe Adcetris sales will fall short of Wall Street estimates, causing Seattle Genetics’ stock price to tumble as well.

Before I dig deeper into Seattle Genetics, I want to focus on that shadowy coalition with nefarious intentions which secretly controls global markets — otherwise known as the shorts. [Insert sarcastic sneer here.]

For the unfamiliar, short selling — or “shorting” — is a way to bet that a company (or nearly any other asset) is overvalued. An investor borrows and sells shares, promising to “return” those shares at a later date (the details are more complex, but that’s the gist.) If the share price declines, the investor covers (buys and returns the borrowed shares) and pockets the difference for a profit.

Missteps can be costly; a short has a maximum profit of 100% (an asset’s value can only decline to zero), but unlimited downside. Unlike a long position, a short that moves in the wrong direction also becomes larger, thereby compounding the pain. As yet another perk, short sellers are often ostracized for daring to question management’s vision.

To be clear, those who illegally manipulate stock prices in either direction — whether at a hedge fund, bank, mutual fund, or elsewhere — should be caught and punished. Rather than focus on this tiny subgroup of criminals, doe-eyed optimists blame the shorts for nearly any unwanted outcome. Sadly, this practice isn’t new. In the 17th century, the Netherlands banned short selling when an investor’s bet against the Dutch East India Company went awry. Regulation would have been the better answer. Napoleon Bonaparte linked shorting with treason, banned the practice, and imprisoned offenders. A few years ago, prominent U.S. politicians lambasted short sellers for causing the financial crisis. (Global overleverage, mispriced assets, and governmental policies that encouraged bad decisions were legitimate targets apparently too nebulous.)

This long-standing demonization of short selling ignores reality. Even quality assets like the cancer drug Adcetris can be undervalued, fairly valued, or overvalued at any given point in time. Admiring Seattle Genetics’ regulatory accomplishment shouldn’t require loving the stock too, however.

Some executives obsessively assail short sellers publicly, which is often a red flag indicating shorts sellers are onto something. The best management teams don’t worry about shorts. They focus on their business with the confidence and understanding that in today’s extremely liquid markets, even massive short positions have little impact on a company’s long-term prospects. Over time, fundamentals are what make or break a stock. In fact, CEOs should actively seek to meet with the shorts; convince a skeptic and you’ve created a new shareholder.

I’ve had my say in defense of short selling. I also realize that most people’s negative view of short selling isn’t going to change. Shorts are, and likely always will be, vilified unfairly. I do feel a little better with that off my chest.

Back to Seattle Genetics and Adcetris: Every year, 8,800 Americans develop and 1,300 die from Hodgkin’s lymphoma (HL), according the National Cancer Institute’s Surveillance, Epidemiology and End Results (SEER) database. HL is very sensitive to traditional chemotherapy, so front-line treatment produces objective responses (tumor shrinkage) in roughly 80-90% of patients; most patients do not require further therapy for years, if ever. Patients that relapse usually receive high-dose chemotherapy combined with autologous stem cell transplant (ASCT), a procedure that replaces unhealthy cells with healthy ones. This combination yields durable responses in many patients, with three-year progression free survival rates of 50-60%.

Adcetris employs a neat drug-delivery technology to kill cancer. The antibody portion of Adcetris attaches to receptors found on the cancer cell. Once attached, Adcetris’ toxic drug payload is cleaved off inside the tumor cell where it can maximize efficacy and limit toxicity.

In relapsed HL, the Adcetris data are encouraging and clearly warranted FDA accelerated approval. Nearly a third of Adcetris-treated HL patients experienced a complete response (CR) and another 40% had partial tumor shrinkage (a partial response, or PR). Results in sALCL were even better: 59% of patients had a CR and 27% qualified as a PR. Seattle Genetics must still prove Adcetris’ clinical benefit in a confirmatory Phase III trial, which the company will start later this year.

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