Short squeezes can deliver enormous returns for investors in the blink of an eye. Several so-called "meme stocks" generated jaw-dropping gains for investors earlier this year due to this phenomenon.
The mechanics of a short squeeze are fairly straightforward. Short-sellers, or investors betting against an equity, are essentially forced to cover their position in response to an uptick in investors buying the stock. The net result, more often than not, is a brief, parabolic-like move higher in the stock in question.
Last month, short-sellers seemingly took advantage of the widespread weakness across the biopharma space. As a result, scores of biopharma equities sport sizable short positions as a percentage of the outstanding shares. The Alzheimer's specialist Cortexyme (NASDAQ:CRTX) and the commercial-stage biotech Heron Therapeutics (NASDAQ:HRTX) were two of the most heavily shorted pharma stocks at last count. These two drugmakers, however, could prove to be terrible stocks to bet against. Here's why.
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Cortexyme: Alzheimer's drugs are too risky to short
Cortexyme, a small-molecule drug developer, became a huge target for short-sellers after its experimental Alzheimer's disease treatment atuzaginstat flopped in a late-stage trial toward the end of October. In fact, the biotech's shares were the most heavily shorted equity among biopharmas at last count, a little over two weeks ago. Short-sellers are clearly betting that atuzaginstat is basically dead on arrival. That rather dire take might not be the case, however.
During a recent conference call, Cortexyme management said that the drug does appear to show a worthwhile clinical benefit for Alzheimer's patients who also tested positive for the gum-disease bacteria Porphyromonas gingivalis. While this analysis is far from definitive, it may help the company identify the correct patient population to evaluate atuzaginstat in, via another late-stage trial. Cortexyme intends to do just that. Almost immediately after the drug disappointed in this all-comer study, management announced plans to target a more-focused group of patients in another pivotal study.
Why is Cortexyme an outstanding short-squeeze candidate? Even as a drug exclusively for Alzheimer's disease patients with an active P. gingivalis infection, it should still generate mega-blockbuster sales (greater than $5 billion). That's a massive revenue stream for a company with a $420 million market cap at present. Cortexyme plans to provide an update to investors on this upcoming clinical trial in the first quarter of 2022. This update could very well spark a short squeeze in the biotech's stock.
Heron Therapeutics: Down but not out
Heron Therapeutics has been a top short-seller target for well over a year now. As a result, the biotech's stock is currently one of the most heavily shorted within its immediate peer group. Bears have bet against this small-cap pharma stock for two clear reasons. First, Heron's chemotherapy-induced nausea and vomiting franchise has underwhelmed from a commercial standpoint.
Second, the biotech's highly anticipated acute pain medication Zynrelef didn't get the type of broad label from the Food and Drug Administration (FDA) that would have allowed it to become a major growth driver right off the bat. Heron is working with the FDA to expand Zynrelef's label, but this process will take a while to work through.
The good news is that Zynrelef still holds the potential to rake in upward of $500 million in sales by the middle of the decade. That's a nice chunk of change for a biotech with a sub-$1 billion market cap.
Why might Heron be gearing up for a noteworthy short squeeze? It is expected to announce important commercial and regulatory updates for Zynrelef before the end of February 2022. If the drug's commercial launch continues to show promise and its label-expansion plans remain on track, the stock should reverse course. The biotech's shares, after all, are currently trading at under 3 times 2023 sales, which is a dirt cheap valuation for a commercial-stage biotech.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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