Don’t Gamble on Sorrento Stock

Editor’s note: This article was edited from a previous version to highlight that the quote from Hindenburg Research is unverified.

For investors, there’s playing the lottery. And then there’s Sorrento Therapeutics (NASDAQ:SRNE). The unassuming biotech firm initially made headlines in May when it suggested it had a “cure” for coronavirus. SRNE stock initially spiked 140% before investors saw through the misstatement.

Stock market plummet sell shares on exchange with financial loss and money gone, representing stocks to sell

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The company then saw its second wave of interest in August after announcing plans for a rapid coronavirus test. As the product failed to materialize, Sorrento fell almost 50%.

But the pain isn’t over yet for Sorrento stock holders. That’s because Sorrento’s ill-fated foray into Covid-19 “cures” is emblematic of the company’s problems.

Rather than concentrate on creating marketable cancer treatments, management has instead focused on pumping up its share price to buy up questionable moonshots. Why? Its CEO has one of the most absurd compensation structures I’ve ever seen (page 36). Its “tranche” system gives leadership the incentive to shoot for the stars with little regard for investor losses.

So, while any of these moonshots may prove commercially viable one day, the company is gambling with other people’s money. Investors looking for a flutter might as well play the Powerball. You’ll have a far better shot at becoming a millionaire.

SRNE Stock: The Covid-19 Fiasco

Sorrento has a long history of puffery. Perhaps the best example comes from its attempts to profit from the coronavirus pandemic — in May, the company’s CEO made waves when he announced a “cure” for Covid-19.

“We want to emphasize that there is a cure. There is a solution that works 100%, “said Dr. Henry Ji, founder and CEO of Sorrento Therapeutics, to Fox News. “If we have the neutralizing antibody in your body, you don’t need social distancing. You can open a company without fear.”

Sorrento, actually, had not found the cure. Instead, the company had been running pre-clinical trials of coronavirus antibodies, an area where Regeneron (NASDAQ:REGN), AstraZeneca (NASDAQ:AZN), and other companies already had a long head start. (Regeneron, for instance, began clinical Phase 1/2/3 trials last June.)

Yet, investors understandably took Dr. Ji’s suggestions quite literally. The company is now facing at least two lawsuits for violating SEC Rule 10b-5 disclosures.

So Much for Learning From Mistakes

In July, Dr. Ji announced a $5 million licensing deal with Columbia University to develop a saliva-based Covid-19 test. Shares spiked to $18 as investors rushed in. And again, Sorrento disappointed.

“It’s a complete joke,” a senior administrator at Columbia supposedly said about the deal according to independent, unverified research by short-seller Hindenburg Research. “Why would we sell something for 5 million and royalties that has market potential? … This is nothing novel and the commercialization requirements will take time.”

And a joke it was. In August, rival Abbott Laboratories (NYSE:ABT) received FDA approval for its commercially viable rapid Covid-19 test. (Yale also received FDA approval for its saliva test). SRNE stock sank 65% over the following month.

Pumping Share Prices

Investors should quickly spot a pattern. In September, Sorrento once again announced an “agreement,” this time with the Mayo Clinic. In exchange for exclusive rights to Mayo’s ADNIC platform, “a potential breakthrough technology platform,” Sorrento would give the non-profit a $9.3 million upfront fee (mostly in shares) and $5.4 million in development costs.

Skeptical investors might wonder what’s going on? Why would the Mayo Clinic give away “breakthrough” technology for so little money? It smacks of the Columbia University testing-kit deal.

That’s because it is.

What’s Wrong With the Mayo Clinic Deal?

Readers would know by now that I always say this: know your investments.

And biotech is no different.

Here’s how antibody-based cancer treatments work: usually, cancerous cells grow because the human immune system fails to target them. So, researchers have developed lab-grown antibodies that 1) get injected into patients, 2) bind to cancer cells and 3) trigger the patient’s immune response to kill the tagged cells. There’s also a more advanced version, where the lab-grown antibodies are bound to a toxin that directly kills cancerous cells (known as ADC). It’s a simple process once you break it down, even if the research and production methods are highly complex.

Mayo Clinic is looking to create a new way to link antibodies (cancer-seekers) with toxins (cancer-killers) using nanoparticles, a method that “potentially addresses limitations of current ADC technology,” according to Sorrento.

So, What’s the Problem?

There are three critical problems with Sorrento’s plans. Firstly, the nanoparticles are expensive. Sorrento cites the cost of goods (COGS) as a reason why the new ADNIC technology could succeed, but I give that a diminishingly low chance. I imagine that’s also what researchers at the Mayo Clinic believed when licensing ADNIC out for the biotech equivalent of “peanuts.”

Secondly, the ADNIC platform doesn’t appear to work yet. There’s no mention of an effective test-case in the entire Sorrento press release. Presumably, the biotech firm plans to test its G-MAB antibody library against the ADNIC technology. But since none of their antibodies have yet shown efficacy with the old ADC technology, it’s the equivalent of throwing day-old spaghetti at the wall and hoping something sticks.

Most importantly, Sorrento’s $5.2 million pledge to the Mayo Clinic won’t even begin to cover ADNIC development (let alone the costs of a single drug). According to a review by the U.S. Department of Health & Human Services (HHS), drug companies spend $59.9 million in 2005 dollars (or $79.7 million today) in pre-clinical trials alone. And Phase 1/2/3 trials can then cost anywhere from $20 million to $67 million, according to the National Institutes of Health (NIH).

Could Sorrento stumble upon the next generation of cancer drugs? Of course. But an investor could also win the lottery by buying a ticket. And that’s not a sound investment strategy.

Sorrento’s Misaligned Incentives

Why would Sorrento management keep pouring money into tiny $5 million deals with so little chance of success? It’s a case of CEO pay at its worst.

In September, Sorrento released its annual proxy statement that outlined an absurd compensation structure for its Chairman/CEO, Dr. Ji. In exchange for reaching market capitalization “tranches,” Dr. Ji would receive up to 10% of all outstanding company shares.

Tesla (NASDAQ:TSLA) offered a similar compensation structure to CEO Elon Musk in 2018, but with two limitations:

  • Operational milestones. Tesla included revenue and adjusted EBITDA targets to the tranches, “designed to ensure that as Tesla’s market cap grows, the company is also executing well on both a top-line and bottom-line basis.”
  • Sole compensation. Elon Musk earns no salary or other stock options besides the tranche system.

On the other hand, Dr. Ji earned $8.1 million in 2019 from salary and options in addition to receiving his new “tranche” compensation. And the lack of operational milestones incentivizes management to push up share price with little regard for operational effectiveness.

No wonder they’re gambling with other people’s money.

What’s SRNE Stock Worth?

Investors will quickly realize that Sorrento has little value outside its only product, a lidocaine patch named ZTlido. The $21 million generated from ZTlido barely made a dent in Sorrento’s $182 million in R&D spend and $103 million in sales and general expenses. It’s preliminary third-quarter growth of 26% to $7.2 million is impressive … but it’s not enough.

And its cash position looks more like a failing retailer than a hot biotech startup. With just $24 million in the bank, the company barely has enough money for four months of R&D expenses. (It’s no surprise that Sorrento offered shares instead of cash for the $9.3 million upfront payment for ADNIC).

The median biotech company, on the other hand, carries 2.6 years of cash relative to R&D, according to Gurufocus, a financial data company. Similar sized companies to Sorrento hold an average of $440 million in liquidity.

So, why buy SRNE stock? Its shares could still surprise to the upside: make enough $5 million long-shot bets, and one might eventually pan out.

But will they? History says, “no.” No matter how good your corporate spin doctors are, remember this: your biotech investments are only worth the products they develop. And in Sorrento’s case, they’ve been spending more money enriching themselves and playing the biotech lottery than developing workable oncology drugs. Investors beware. Sorrento will keep gambling with your money if you give them a chance.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

Article printed from InvestorPlace Media,

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