The Health Care Short Sales That Never Fit

NEW YORK (TheStreet) -- I've spent far less time over the past 15 years celebrating my investment successes than analyzing my failures, even though I think I've been right more often than not. The goal of this rigorous self-evaluation is simple: Improve my process. This week's column will examine the valuation short, a classic error that can entrap even the most veteran investor in a quicksand-like morass. Let's take a look at a few of the mistakes I've made and then at a current example.

The Revolution: Biogen Idec (BIIB)

I remember when monoclonal antibodies, now-ubiquitous therapeutics that attach to cell surface proteins and function as either receptor blockers or helpful "red flags" for the immune system, were considered nearly impossible to develop. Johnson & Johnson's (JNJ) Orthoclone OKT3 (known chemically as muromonab) received FDA approval in 1986 for the prevention of acute transplant rejection, but the technology relied solely on mouse protein. The resulting risk of autoimmune rejection of the drug itself made long-term therapeutic use unlikely. Even Eli Lilly's (LLY) cardiovascular drug ReoPro, which reached the market in 1994 and used chimeric -- or fused human-mouse -- technology, was used short-term.

Then came Rituxan.

Long before the merger that created Biogen Idec, I found myself sitting face-to-face with Bill Rastetter, the CEO of Idec Pharmaceuticals. In preparation, I had extensively researched Rituxan, a chimeric anti-CD20 antibody for the treatment of non-Hodgkin's lymphoma (NHL), and the company's partnership with Genentech. My work suggested that although Rituxan would likely be a commercial success, Idec's deal with Genentech overwhelmingly favored the larger biotech.

Rastetter patiently listened as I noted that even if Rituxan sales reached $1 billion in the first few years post-launch, Idec's profits would be very limited. I also explained how analysts and investors seemed to be ignoring Idec's value relative to the company's near-term earnings potential.

Once I finished, Rastetter agreed that my analysis made sense and seemed factually accurate. He then told me I had missed a critical point. Rituxan was a revolutionary drug, he said, because it would be the first monoclonal antibody to be used chronically (studies eventually demonstrated that patients could be effectively retreated.) I distinctly remember his concluding comment: "Valuation won't matter for a long time."

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