The Case for Shorting Elan Into Upcoming Alzheimer's Trial Results

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NEW YORK ( TheStreet) -- Past truly is prologue. In mid-2008, I was short Elan and getting crushed. My thesis was that Phase II data for the company's lead drug candidate, a monoclonal antibody called bapineuzumab for the treatment of Alzheimer's disease, would disappoint.

There were a select few who shared my view, but most investors invoked two oft-heard justifications for healthcare bullishness: "If the drug works, it will be huge"; and "Management wouldn't be so confident if the data weren't good." Part of what makes it so hard to be a successful short seller is that you must swim against the tide of popular opinion. Shorting Elan in mid-2008 felt like swimming against the tide with sharks in the water and a cut on my leg bleeding badly.

Anyone who has had a large short position move quickly in the wrong direction knows how I felt -- frustrated and scared. I had based my Elan short on a strongly-held belief that the amyloid beta hypothesis -- which posits that accumulation of a sticky protein in the brain cause the memory loss and deteriorating mental function that are hallmarks of Alzheimer's -- was wrong.

Elan's bapineuzumab -- "bapi" for short -- was engineered to facilitate removal of amyloid beta from the brain. If my thesis were correct, bapi wouldn't meaningfully improve patients' cognitive abilities. Failure of bapi's Phase II study would cause Elan's stock price to collapse.

In both public and private meetings during the spring of 2008, Elan executives expressed confidence that the Phase II results would confirm bapi as the first disease-modifying Alzheimer's drug. Bullish Wall Street analysts lapped up management's confidence and forecast bapi sales of $20 billion or more. Elan shares soared; my short position sank.

In July 2008, the Phase II data were finally unveiled at an Alzheimer's research conference widely attended by scientists and investors. The large meeting hall was packed. I sat anxiously in the front row; bullish Elan investors in the room exuded self-assured optimism.

When the bapi data were projected on a large screen, even I was surprised. The results were wildly inconsistent, with no clear efficacy trend. Bapi obviously didn't work. Elan's stock price plummeted, turning my struggling short position into a big winner.

Bapi's development did not end in the summer of 2008, in large part because the stakes are so high. Alzheimer's disease affects 11 million people in the U.S. and Europe. Current treatments, like Pfizer's ( PFE) Aricept and Forest Labs' ( FRX) Namenda, have only a modest, short-term impact on symptoms yet still generate billions of dollars in sales. Any drug that can stop or reverse the course of Alzheimer's would truly be a multi-billion-dollar blockbuster.

Despite what looked like unequivocally negative results to me and many others, Elan and partner Wyeth (now Pfizer) squinted hard at the Phase II data and excavated slightly more favorable trends post hoc from a lower-risk subgroup of patients without a gene called ApoE4. Based on this retrospective data mining, the companies pursued Phase III studies. (In late 2009, Johnson & Johnson ( JNJ) joined the effort). These hugely expensive trials, which enrolled 4,100 patients worldwide and easily cost $500 million, should yield data by the middle of this year.

Investors are yet again betting -- albeit more hesitantly this time -- on bapi and the amyloid beta hypothesis. Elan shares have surged 30% since November and the company's market capitalization hovers around $8.5 billion. Even some neutral-rated analysts have assigned bapi a risk-adjusted valuation of more than $2 billion, with a tantalizing upside of nearly $22 billion.

Elan bulls were wrong in the summer of 2008 and they're still wrong today. Critical red flags from the graveyard of amyloid beta-clearing drugs are still being ignored.

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