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Aquinox: A case study in why it's so hard to pick biopharma stocks Add to ...

Every so often, small-cap biotech and pharmaceuticals stocks, particularly the newly public ones, get caught in a downdraft that pulls down everyone.

Vancouver-based Aquinox Pharmaceuticals Inc. discovered this: It gained 30 per cent in its first several days of trading after its March initial public offering, then shed nearly half its value over the next six weeks. The shares, still trading below their initial offering price of $11, might even be considered cheap.

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And yet a look at the prospects for Aquinox, including the lengthy timeline before the company actually books revenue, illustrates just how difficult it can be for the individual investor to pick stocks in the biopharma space. Winners are the cure for what ails the portfolio; the losers’ performances are downright sickening.

Aquinox is developing an anti-inflammatory drug called AQX-1125. The company’s scientific founders, based at the University of British Columbia, discovered inositol-5’-phosphatase 1, or “SHIP1,” a regulator of a cellular signalling pathway in immune cells. AQX-1125 activates SHIP1 and can reduce inflammation. Possible uses are to treat chronic obstructive pulmonary disease and bladder pain syndrome/interstitial cystitis, which affect millions of people. Pfizer and Johnson & Johnson own a significant amount in the company, and each bought shares in the IPO (although not enough to prevent dilution of their stakes).

This sounds wonderful. I have no idea if the drugs will work, however. This is why the company is in the midst of what are called Phase II clinical trials for each of the potential uses. The company is recruiting patients, should complete enrolment in the studies in the middle of this year, and have trial data late this year and early next year in the two studies, says Biren Amin, an analyst at Jefferies. Assuming positive data in this trial, and in the subsequent Phase III trial, he says, AQX-1125 could get U.S. approval in 2018 for both uses and reach peak revenue of $1.5-billion (U.S.) in 2028.

This is, it should be noted, a long time away. It’s also not atypical of the long-term forecasting necessary to place a current value on revenue-free companies only part of the way through the drug-approval process. (Aquinox trades, by the way, at one of the cheapest price-to-book-value levels of all North American biotech and pharmaceutical companies. If that matters.)

Mr. Amin’s $17 price target is based on that 2028 sales forecast, discounted by 75 per cent to account for the risk inherent in the process. Drugs can fail a trial, or the U.S. Food and Drug Administration could delay or reject approval of a treatment.

His “upside scenarios” include positive outcomes in both Phase II trials (price target $40); in just one of the Phase III trials ($30-$31) and in both Phase III trials ($81). Awesome. His “downside scenario” is AQX-1125 flunking both Phase II trials and a price target of $4 to $5. That would not be as good.

For now, the shares are flying mostly under the radar. The three sell-side analysts who cover the company all work for the underwriters who took Aquinox public in March. Some consider this a negative. Others consider it a positive, such as a Seeking Alpha blogger who said in March “AQXP’s underwriters … will try to reverse the recent downward trend in the price of shares through a release of positive research reports at the expiration of the quiet period.” (I don’t think he was supposed to say that out loud.)

In all likelihood, only new analyst reports will make Aquinox shares break from the pack in the coming months. Then, investors can steel themselves for the trial data at year-end, with the prospect of big gains or a share-crushing disappointment – there’s really no middle ground.

That kind of do-or-die performance seems to make Aquinox, and most of its peers, not particularly suitable for individual investors, unless they have an outsized appetite for risk.

After all, while Aquinox could end up being wildly lucrative for those who take a flyer on the shares today, it’s easy to see how you’d be sick with worry waiting for the results.

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