Description

I am recommending a short position in Novavax (NVAX.) NVAX is a clinical stage pharmaceutical company focused on developing vaccines for infectious diseases using a novel platform. Much like many of my favorite shorts, NVAX is a zero revenue company that has been lifted to a market cap far in excess of its intrinsic value thanks to a short-term phenomenon. In this case, the search for exposure to companies that will benefit from the H1N1 (swine flu) pandemic has caused a massive run in NVAX’s stock price that is sure to come unwound as the pandemic passes.

Traditional vaccines (for flu or any other sort of virus) are manufactured via a lengthy and inefficient process utilizing chicken eggs. While the process is proven to be safe and effective, it is also very slow, and this is part of the reason for the current shortage of H1N1 vaccine in the U.S. There’s more on this process in this NPR article.

NVAX is attempting to develop an entirely new type of vaccine technology that utilizes a Virus Like Particle (VLP.) Whereas traditional vaccines use small amounts of actual virus to create a serum that allows the body to build up antibodies against the foreign agent, VLPs seek to replicate the structure of the virus without utilizing the virus itself. In theory, using VLPs to create vaccines is attractive because it can be done very quickly (does not require a 6 month attenuation and replication process), does not involve the use of a live virus, and uses disposable bioreactors that mean much lower upfront cost to develop a vaccine.

In reality, it’s a lot more difficult than NVAX is making it sound. The company is attempting to use an insect-based structure known as the baculovirus. Again, this works in theory, but our discussions with infectious disease specialists indicate it is much more difficult to practice in real life. HIV researchers stopped using the baculovirus in their search for an HIV vaccine several years ago, due to the complexity of the task. When you consider that the economics of producing influenza vaccines are generally quite poor, and that an HIV vaccine would theoretically be a gold mine, does it make sense that you would pursue a technology for influenza that has been abandoned as too expensive and difficult for HIV?

In the last 6 months, NVAX has engaged in two of my favorite activities in a zero-revenue-but-hoping-for-respectability short: egregious press releases and insider sales.  Take their September 1, 2009 press release (linked here.)  The jargon-laced release would make Phil Mulacek proud, but one infectious disease expert we spoke to referred to as the most “muddled” press release he had ever read. The release clearly leads the reader to believe that the VLP performed as well as an egg based vaccine, yet this Phase IIA trial was not even designed to test efficacy – its only purpose was to show tolerability at different doses. The release also lacks key pieces of information such as how the study was blinded (if at all) and why the egg-based population was so small. The company refuses to share this information and has not submitted any of their trial data for proper peer review – they’d prefer you simply take their word for it via the press release.  Another favorite tactic is invoking the name of a respected company in a press release (think EEE and Bechtel; IOC and Merrill Lynch.) They don’t come any bigger than NVAX’s newest “partner,” the General Electric Corporation. In this press release, the company touts their relationship with GE Healthcare, who is selling them disposable bioreactors for a trial in Mexico. The company would like for you to infer that this H1N1 trial in Mexico will lead to somebody (anybody) from the FDA to the WHO taking notice of their vaccine. Based on our experience with the FDA, the odds that they will accept the results of an on-the-fly trial in Mexico are exactly zero.

Okay, so they are a little promotional, what small company doesn’t have to be to get noticed and get funded? And get funded they did, selling 12.5MM million shares at 88c (15% of the company) to an Indian firm (Cadila Pharmaceuticals) in March 2009. Good timing on Cadila’s part, as the investment came just before H1N1 initially broke out in April last spring. The stock proceeded to increased nearly 8 fold in the ensuring 6 months, but CEO Rahul Singhvi proceeded to cash out of all of his primary shares as well as a portion of his 150K tranche of options with a 74c strike price at ~$3 per share in July 2009. The options did not expire until 2015. To be fair, Singhvi maintains option exposure of ~600K shares at a weighted average price in the $3 range. Various other officers sold stock in early July as well, but in my experience, CEO sales are the most telling sign of management confidence and opinion about the stock price. Management has continued to raise cash throughout the year via an ATM facility established in early 2008 with Wm. Smith & Co. The company sold $8MM worth of stock in Q309 alone. There is nothing particularly wrong with having an ATM in place, but I do find it very curious that during the Q309 earnings call, the CFO did not bother to mention the additional share issuance during his comments, and in fact in took until 4^th (and final) analyst allowed on to the call to get this information.

The company typically burns $6MM to $8MM of cash per quarter, and currently has $34MM in cash and equivalents on the balance sheet. I fully expect further equity raises and ATM transactions in coming quarters as liquidity runs low. The company is nowhere near generating any sort of vaccine-related revenue. Even if their H1N1 vaccine were to be proven effective, which my research indicates is highly unlikely; they will not get any produced prior to the end of the H1N1 pandemic. By the 2010 flu season, the H1N1 vaccine will simply be rolled into the normal seasonal flu vaccine and the hype surrounding the potential for a quick rollout of a pandemic will have subsided. There is always the chance the stock will spike on swine flu fears/headlines over the next 4 months, but these events should provide an excellent opportunity to add to a short that will ultimately trade <$1.

Catalyst

- Further equity raises

- Swine flu fears subside

- Negative trial results