Last Wednesday, two pain specialists that were top subscribers of Insys Therapeutics’ (NASDAQ: INSY) leading prescription therapy Subsys were arrested, as part of a year-long operation by the DEA. Charges filed against the two practitioners include the illegal prescription of prescription drugs and conspiracy to commit health care fraud.
Subsys, a sublingual spray version of fentanyl (an opiate) and used to treat cancer pain, makes up about 98% of Insys’ revenues, and the news represents the culmination of many disturbing reports over the past year about a small group of doctors who were doing a whole lot of Subsys subscribing.
We wanted to highlight the stock’s reaction to this news as a way of highlighting a key feature of stocks, and offer a lesson that investors can take away and apply to other situations in the future.
A Review of Subsys Inquiries
News of an arrest and questionable practices is not coming out of left field. It was more than a year ago that Bronte Capital posted an article highlighting concern over the drug itself, and the compensation model Insys puts forth to the health care providers that subscribe it.
The New York Times followed up on this story in December of last year by taking a deep look into the incentive payments Insys was sending out to its top Subsys prescribers. In addition, subpoenas were filed by U.S. Attorneys in both California and Massachusetts related to Insys’ practice.
As we know, the abuse of opioids in America has become epidemic, so many areas of government enforcement are focused on attacking this problem from all angles. Subsys is a product for only extreme pain sufferers, and its ability to be addictive make it a target for increased scrutiny from the get-go.
Investors Come in With an Eye for Stock Drop
As the initial news story came together last May, INSY shares dropped precipitously – roughly 50% in a matter of weeks. In addition to many investors deciding to leave the name, news of a possible scandal also brought in a wave of short sellers. These investors look to borrow shares to sell, hoping to see the price fall whereby they can “cover” their position by buying the stock back for a profit.
Indeed, short sellers have not only arrived at Insys, they have stuck around for the past year. In fact, INSY is one of the most shorted stocks in the all of the NASDAQ – in excess of 55% of the total float (outstanding shares freely available to trade) is held as a short position, over a year after the initial “short thesis” was put in place. There were a few months last fall where the short ratio was nearly 70%, which is a nearly unheard of percentage of the total share float.
If the bad news were to make its way up to the C-suite at INSY, sales of Subsys could be all but shut down by the government if management was shown to be complicit in illegal subscription writing. Any interesting cannabis-based compounds the company was pursuing would be delayed, if not flushed down the proverbial toilet.
On the other hand, if it turns out that this is a sad but not unique case of a few bad apples, Insys would be able to move forward and put the story behind them. In addition, all those people who sold the stock short would have to covert their positions for big losses, which would truly propel the stock higher.
Efficient Market Theory in Action
There is a longstanding theory about the way stock markets function, and the nickel version goes like this: At any moment in time, the stock market has assimilated all the possible information about a company that there is to know – good and bad. So if you read a story about something related to a stock you own, that news is no longer “tradeable.” If the news was good, the stock’s already going to be up. If the news is bad, there isn’t time for you to get out of the stock before others see the same story.
Some people subscribe to this theory more than others, but most veterans will tell you this is true more often than not. So with all the questions surrounding Insys in the past year, let’s take a look at how the stock performed through this news cycle, and see if there’s anything we can glean about efficient markets.
Let’s start by assuming that the initial 50% plunge last year was almost entirely based on the Subsys Rx news; after all, the NASDAQ and any pharmaceutical/biotech index were in the midst of a big uptrend last summer. Since the initial drop, INSY shares have more than doubled, with the rally continuing into 2015 and the stock hitting fresh all-time highs. Subsys sales rose 74% in the last quarter ending March 31, to $70.8 million, supporting this share price appreciation. And after taking an initial 5% hit when the news of the arrests broke last week, shares quickly recovered within 48 hours – a strong sign that the market has decided “we have assimilated this already, and we think it’s no big deal.”
Total institutional ownership in INSY is just north of 40% – a fairly low percentage for a NASDAQ-listed security. However, looking at the 10 largest institutional holders individually, we can see that only one decreased their holdings in the first quarter of this year, and that holder (Janus Capital Mgt) still owns over $95 million worth of INSY shares. The point here is that these are some of the largest money managers on the planet, and there’s no chance that they’re not aware of the news surrounding Subsys.
What the market seems to be clearly telling us is that it’s looking past the Subsys news, and it sees increased value in the company despite a potential time bomb should Insys management be indicted by the government.
The Cannabis Angle is Coming into Focus – Slowly
The company’s pipeline includes cannabinoid compounds, most noteworthy being a Phase I efficacy trial begun in April with a high-CBD formulation for pediatric epilepsy. But the lead candidate (the one closest to a commercial release) is Dronabinol, a generic version of Marinol (THC) capsules.
Insys initially had their application rejected by the FDA, and had to scramble back home to update their application. In the most recent conference call to investors, CEO Michael Babich said they would be re-submitting to the FDA in the “very near-term,” but their initial stumbles should give investors pause when deciding how fast this product could hit the market in the U.S.
Rather than take this analysis as a bullish or bearish argument for INSY shares, consider the lesson when reading good and bad news. If “new news” that is good doesn’t push a stock higher, then investors have already discounted that story. The same thing works in reverse – if new bad news doesn’t punish a stock more than it already has, then chances are the story has been put to bed by investors. This doesn’t mean that the stock is definitely headed higher ad infinitum, but at least the future performance will be based on new catalysts – not old story hangovers.
For investors with an eye on cannabis medical breakthroughs, this is the ideal prescription.