U.S. biotech stocks may fall further as short interest rises

By David Randall

NEW YORK (Reuters) – A 4 percent decline in biotechnology stocks on Wednesday sent the Nasdaq Composite Index <.IXIC> to its largest one-day loss in nearly a year, and some investors are betting that the once-hot sector has further to fall.

Short interest has risen in a number of biotech names perceived as vulnerable to a selloff after a rally that has sent the Nasdaq Biotechnology Index <.NBI> up 42 percent over the last year even after this week’s declines.

Overall, a screen of about 1,650 mid-cap U.S. companies shows biotech stocks, on average, have a short interest ratio of about 11.6 percent, compared with the average mid-cap name’s 6.4 percent in short interest, according to Starmine, a Thomson Reuters company. This suggests a greater number of bets on these stocks falling than the rest of the market.

That is occurring as other fund managers boost their bets on the high-flying names. Fund managers now have an average of 4.1 percent of their portfolios in biotechnology companies, nearly double the level of three years ago, according to Lipper data.

“We think that investor sentiment is a bit overdone,” said John Fraunces, a co-portfolio manager of the Turner Medical Sciences Long/Short fund <TMSCX.O>, whose fund is in the top 1 percent among long-short funds tracked by Morningstar over the last three years.

“The problem is that investors are giving people the benefit of the doubt and instantly giving a company billions in market value when there still need to be more studies to determine whether or not a drug is therapeutically effective,” said Fraunces, who is looking for more opportunities to “short” stocks, or bet that the price will fall.

Some of the names attracting short bets are recent entrants to the stock market. There have been 88 initial public offerings of biotechnology companies over the last 12 months, which have gained, on average, 59.6 percent – the most of any sector, according to data from Renaissance Capital. Early-stage biotech companies rarely post any revenue, and tend to be money-losers.

Many recent IPOs have only a small percentage of their outstanding shares trading, with some still restricted due to lock-up provisions. But the shares out in the public market are being frequently lent for short bets.

One is cancer-therapy company Kite Pharma Inc <KITE.O>, whose shares are up 322 percent since the company went public on June 19. About 2.7 million shares – or about 70 percent of what is available for short bets – has been lent out for shorting, according to Markit, which tracks short interest lending programs.

Andrew Morey, portfolio manager of the Aston Small Growth Fund, said the shares of companies that have come to market in the last year have largely looked overstretched.

Around 1-1/2 years ago, he bought shares of a gene therapy company, whose name he would not divulge, shortly after its initial public offering, but quickly and sold it after shares rapidly doubled.

“That’s when we started to say that some of these gains don’t look appropriate,” he said.

Some shares that were initial winners have seen their fortunes dimmed and yet short-sellers remain prominent. Castlight Health <CSLT.N>, which went public in March 2014, saw its shares rocket in its first day and has since lost nearly 80 percent of its value.

But short bets remain. More than 88 percent of the shares available for short bets are being borrowed for that purpose, according to Markit data.

(Editing by Matthew Lewis)