by Hilary Kramer | September 11, 2013 8:37 am
Last Tuesday, Cytokinetics (CYTK) was one of the market’s worst losers, down close to 27% in what amounts to a bitter disagreement between investors and management over whether the company’s new heart failure drug actually works.
Data from a Phase II study showed the drug did not improve shortness of breath in hospitalized patients, but patients who received the highest dose did breathe easier and showed other improvements. Another Phase II trial is underway, and after those results come in early next year, Cytokinetics and partner Amgen will decide whether to move to Phase III, the final stage before applying for FDA approval.
CYTK CEO Robert Blum insists that the right intravenous dose of omecamtiv mecarbil delivered “pleasing” primary results in the trial. Some of the smartest biopharma experts on Wall Street back him and his cardiologists up, arguing that the goal was to establish safe dosage, not effectiveness, and besides, reducing a key heart failure risk factor twice as often as a placebo is not exactly evidence of failure.
Analysts from Terence Flynn at Goldman Sachs on down were never looking for a clinical breakthrough from this trial in the first place. They never factored the drug into their price targets on CYTK, which still average a lofty $22.50, more than 150% above current prices. And based on management’s optimism about pushing toward Phase III, they note that the long-term upside here is alive and well.
But as the flood of sell orders demonstrates, the fast money is evidently convinced it knows better and that this drug is dead. If you dig into the data and think last week’s move was overstated, the upshot is that CYTK is now trading where it was back in June even though its drug portfolio is two months closer to a final FDA decision.
In any event, CYTK has the potential to bounce in coming weeks as Wall Street beats the drum and everyone else realizes they may have overreacted. The stock is up 14% off the bottom, and there are a couple of potential plays here.
Buy the Stock: High-conviction investors could simply buy the stock and hang on, and traders can get exposure to a bounce without putting much cash at risk by buying call options—which have, if anything, been discounted to outright distress levels.
Buy Options: Last week, before the trial results were announced, the CYTK September $10 calls (expiring September 21) were going for $2 a share. That same option is now selling for $0.15, as the stock would have to move to $10 in the next 10 days for it to have any value.
Given the huge open interest, these ultra-low contract prices will probably have to go up to give counter parties an incentive to write. And, CYTK bulls have a rare opportunity to capture almost all of the upside at an extremely low marginal cost.
The CYTK September $10 call looks especially interesting because CYTK tracked the 50-day moving average fairly closely before breaking down on the “bad” news. With the 50 MDA now hanging a full 38% above current price action, any attempt to regain that historical support level has a lot of room to move – and leaves the stock open to a test back up to $11.59 as the panic unwinds.
Buying a $10 call at $0.15 would cost $15 per 100-share contract. If CYTK recovers most of the ground it lost, that contract is in the money. By that point, of course, demand for these options would logically rebound and a trader should be able to sell them back at a higher premium. And on the flipside, if these shares fail to reach the strike price, only $15 per contract was at stake in the first place.
If you think CYTK has been oversold but is unlikely to recover so much ground in just the next 10 days, the September $7.50 calls are already in the money. With the calls trading at $1.30, the stock only needs to be above $8.80 for the trade to be in the black, or $0.10 above Tuesday’s close.
That’s not a bad bet if you’re on the side of the cardiologists and the analysts. Speaking of those analysts, here’s one bit of trivia if you think Wall Street has been unrealistically bullish on CYTK. Although this company has struggled for years to earn a profit, its actual losses have almost always come in below consensus. The fundamentals here are reliably better than what the market expects, so when analyst after analyst says the news flow isn’t bad enough to dent the model, they may be right on target.
Remember, the consensus price target here is way up at $22.50. As battered as CYTK looks now, it’s unrealistic to expect shares to surge close to 200% to that level in the next few weeks. But the likely direction here still looks more bullish than bearish.
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