(XOMA) - Get Report

is supposed to be codeveloping a brilliant new psoriasis drug, but the biotech company's shares have slid 43% in the past two months. What gives?

Blame a lousy overall market, an abnormally sluggish biotech sector or profit-taking -- all this is putting pressure on Xoma, for sure. But investors shouldn't ignore the fact that the company's experimental psoriasis drug, dubbed Xanelim, is not living up to all the praise heaped upon it by Xoma executives and a cadre of bullish sell-side analysts.

In short, Xanelim has unresolved issues that have forced some institutional investors to step off Xoma's gas pedal. Xoma closed Wednesday at $10.05 per share, off its 52-week high of $17.75 reached in late June. That was right after the company released seemingly positive, but early, results from late-stage tests of the psoriasis drug.

Worked Overby Worry
Nagging concerns over
psoriasis drug have eroded Xoma's shares.

Emphasize the word "early." Xoma's recent fall is a cautionary tale for all biotech investors, not just Xoma shareholders wondering why their beloved stock is moving in the wrong direction. The big lesson: Biotech companies have a funny habit of accentuating a drug's positive results and paying less attention to legitimate concerns. Add bullish comments from sell-side analysts to the mix and you have a recipe for biotech hype that can catch investors flat-footed when the inevitable problems crop up.

Xoma still has a good shot at getting Xanelim approved by U.S. drug regulators -- no one is seriously disputing that assertion. But the company and partner



need to answer some tough questions about the drug before that happens. As long as those questions go unanswered, Xoma shares will likely remain under pressure.

Rebound and Safety Issues


has examined some of these Xanelim issues previously -- namely that many patients got better while taking Xanelim, but saw their psoriasis

roar back when they stopped taking the drug. Xoma and Genentech downplay the concerns over psoriasis rebound by insisting that patients would take the drug continuously for the rest of their lives. But tests to determine the long-term safety of Xanelim haven't been finished yet, which could

delay the drug's review by the Food and Drug Administration.

"We've lightened our

long position in Xoma because Xanelim still has issues that need to be resolved," says Alidad Mireskandari, fund manager with the


Orbitex Health and BioScience Fund, just one of several institutional investors taking a more conservative approach to Xoma these days. Also weighing on Mireskandari's decision is a rival psoriasis drug under development by



. That drug, Amevive, has already been sent to the FDA for approval.

Under their codevelopment deal, Xoma handled the early testing of Xanelim, while Genentech is responsible for the drug's late-stage development and regulatory review process. Xoma receives 25% of Xanelim profits if the drug is approved. But because Xoma has no other drugs on the market, the Berkeley-based biotech firm's stock is a purer proxy to gauge investor confidence in Xanelim.

Peter Davis, Xoma's chief financial officer, says he's aware of the concerns, but feels like they're overblown because the researchers working with Xanelim are not worried. And while not happy with the stock's performance over the past two months, he thinks it still fits within a general pattern that has seen Xoma rise on positive news and fall when the company goes silent for long stretches, like now.

"Our focus right now is on gathering the

Xanelim data for a BLA submission by the end of the year or early next year," he says, referring to Xanelim's approval application for the FDA.

But Genentech and Xoma continue to have nagging issues that pop up when data is presented on Xanelim. At a scientific meeting in late July, company executives released more late-stage test results for Xanelim, which seemed to bolster the company's bullish case for the drug. Buried in the press release was the seemingly inconsequential fact that two patients, one taking Xanelim and another on placebo, were hospitalized for severe psoriasis symptoms during the tests. No big deal, right?

Wrong. Later, responding to a question on an analyst conference call, Genentech executives admitted that the placebo patient who had been sent to the hospital was actually a patient who had been taking Xanelim successfully. He was taken off the drug and put on placebo to see if, and how fast, the psoriasis would come back. It seems clear that this patient suffered a severe psoriasis rebound -- bolstering concerns about the drug -- but investors wouldn't know this unless they paid attention to the conference call.

This discrepancy between the actual data and the explanation offered by Genentech and Xoma bothers biotech drug watchers like Dan Dubin, a dermatologist and president of


, an independent medical consultancy that evaluates the safety and efficacy of experimental drugs. Dubin has no position in Xoma, but his firm sells its advice to institutional investors.

Reflecting on this unresolved question of psoriasis rebound, Dubin says, "My biggest questions surrounding Xanelim are how, as a doctor, should I be taking patients off this drug if I need to; and just how safe is Xanelim for patients who are taking it long term?" If Dubin is asking these questions, rest assured: so is the FDA.

A Genentech spokeswoman confirms that the placebo patient was previously taking Xanelim before a psoriasis flare-up forced him to be hospitalized. But she defends the company's reporting of the event, stating that because the patient was taking a placebo at the time of his hospitalization, Genentech was correct in the way he was characterized.

Building a Bullish Story

The concerns of experienced buy-side biotech watchers like Mireskandari and Dubin go a long way toward explaining to investors why Xoma has suffered over the past two months. But you won't hear company executives acknowledging these concerns in their press releases, nor will you see much discussion aired in sell-side research reports.

U.S. Bancorp Piper Jaffray analyst Mark Augustine has been one of the most bullish Xoma supporters, rating the company a strong buy. On June 22 and 25, he published two research notes extolling the virtues of Xanelim, calling it the leader among several competing drugs all looking to grab market share for new psoriasis treatments.

Augustine could have been considered impartial because at the time, his firm had no banking relationship with Xoma. But the day after his June 25 research report -- a report in which he raised his 12-month price target from $23 per share to $26 per share -- Xoma announced the completion of a $43 million, follow-on stock offering of 3 million shares. Piper Jaffray -- Augustine's firm -- acted as Xoma's lead underwriter in the deal.

Augustine continues to publish very enthusiastic research on Xoma and its psoriasis drug -- two more reports were issued July 30 and 31 after the company released further test results. "We believe that Xanelim provides better rates of

efficacy than its competition and that these new data strengthen its lead position in the psoriasis derby," he wrote.

But neither report includes an airing of any of the growing concerns about the drug and both blow off Xoma's stock weakness as "overdone." Even more surprising, the reports don't disclose his firm's new banking relationship with the company.

Piper Jaffray spokeswoman Erin Freeman defends Augustine, stating that the analyst had no prior knowledge, or influence, over Xoma's decision to choose the bank as its underwriter. In fact, Piper Jaffray's trading department wasn't even contacted by Xoma about participating in the stock offering until after Augustine's report was published, she adds. As for the lack of subsequent disclosure in Augustine's reports, Freeman blames it on an administrative oversight, one that was corrected a week later.

To be fair, Augustine is not the only analyst who deserves scrutiny over coverage of Xoma. In fact, analysts from nearly every major investment bank have issued positive research on Xoma and its new drug.

And as mentioned before, Xanelim still stands a good chance of gaining approval from the FDA, which should bode well for Xoma shareholders in the long term.

But how do investors reconcile the positive news flowing from Xoma and sell-side analysts with the cold, hard fact that Xoma's shares have dropped 43% over the past two months? Sure, the broader

American Stock Exchange Biotech Index

is down about 15%, and some Xoma shareholders clearly sold shares to lock in some quick profits.

But the unanswered questions about Xanelim's safety remain a significant anchor dragging down Xoma shares. Biotech investing is a very tricky game, and investors need to learn that a new drug's development is never as easy or problem-free as companies want them to believe.

At this point, Xoma investors are learning this lesson the hard way.