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The Health Care Short Sales That Never Fit

He was right. Idec shares continued to defy gravity as Rituxan sales grew. I eventually gave up on the short and covered my losses.

The lesson: Make sure to focus on the right metrics. The market never focused on the weakness I had identified, so the investment thesis didn't pan out. A company like Idec, with an exciting new drug and impressive sales ramp, can "grow into" a reasonable valuation over time.

The Bait and Switch: Celgene (CELG - Get Report)

Thalidomide first received FDA approval for the treatment of erythema nodosum leprosum, a rare complication of leprosy, in 1998. Investors paid little attention. (Not surprisingly, there aren't a lot of lepers in the U.S. these days.) Yet over the next few years, a few single-arm trials suggested that the drug might have an impact on multiple myeloma, at the time a rapidly fatal hematologic cancer. As data from these physician-led studies were presented at medical conferences -- and aggressively publicized by Celgene -- "off label" use started to grow. (Physicians can prescribe an FDA approved drug for any disease.)

Wall Street took notice and Celgene's stock began to gain traction.

Having never conducted formal dose ranging studies, Celgene didn't understand how to dose thalidomide in multiple myeloma. In an effort to increase the drug's efficacy and the lifetime value of each patient, the company encouraged experimentation with higher thalidomide doses. At one point, some multiple myeloma patients were receiving a gram or more of thalidomide, more than ten times the current standard dose of 100 mg. At such high doses, thalidomide causes severe somnolence and peripheral neuropathy. The result was zombie-like patients who couldn’t feel their toes.

Celgene's valuation clearly overvalued thalidomide's prospects, yet some investors believed company scientists could engineer a better version of the drug with fewer side effects. These efforts yielded Revlimid, which received FDA approval for the treatment of multiple myeloma in mid-2006. Bullish investors had waited, more-or-less patiently, for eight years with little evidence that the molecule once encoded CC-5013 would become the company's $3.5 billion flagship brand.

The lesson: Beware the potentially exciting follow-on pipeline asset. Unless you know the "hope" asset will fail, bullish biotech investors can be astonishingly patient. Revlimid's transformation from chemist's dream to clinical reality gave Celgene a smooth upward trajectory unmarred by commercial challenges. I covered my short.

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