Dermira Acne Drug Failure: What Biotech Binary Means

(Bloomberg Gadfly) -- The word "binary" brings to mind a coin flip. But in biotech, the coin is often weighted unfavorably. 

The latest example is Dermira Inc., which announced Monday that its heavily hyped acne drug had failed two final-stage trials. The drug flopped so thoroughly the company is giving up on it altogether. 

This is a reminder that the downside of biotech binaries is often bigger than any potential upside. And despite what many sell-side analysts suggest, the downside is in many cases the likelier outcome. 

Biotech investments are often uniquely binary, with companies depending heavily on the success of one drug or one clinical trial. Analysts don't always have incentives to make negative or even ambiguous calls in these cases. It can anger the targets, putting access at risk. And it is not exactly a boon to the banking business when these companies look to tap equity markets for funding.

For binary stocks such as Dermira, such pressures often lead to overoptimistic predictions of a trial's likelihood of success, premature stoking of an M&A premium and high price targets.

Eight of nine analysts tracked by Bloomberg had "buy" ratings on the stock on Friday, and their average price target suggested Dermira's shares were undervalued by more than 35 percent. By Monday, shares were down 62 percent from Friday's close.  

Wall Street's optimism wasn't completely unfounded; Dermira's drug succeeded in two earlier-stage trials. But, as is often the case, analyst views arguably weren't fully risk-adjusted.

Developing new drugs for acne is especially difficult, as illustrated by recent failures or mixed results from Novan Inc., Foamix Pharmaceuticals Ltd., and Xenon Pharmaceuticals Inc. Jumping from a mid-stage trial with roughly 500 people to a final-stage trial with 1,500 is always a big risk. And Dermira made some changes to the final-stage trial, including a lower concentration of the active ingredient, that may have introduced more risk.

Analysts also sometimes soft-pedal the potential impact of failure as they predict success. Mizuho analyst Irina Koffler suggested before Monday's data release that a failure could send shares down to $17, with the company's other programs providing a floor. After Monday's news, Dermira shares hovered around $9.44. 

Dermira has $551 million in the bank and drugs for excessive sweating and eczema in its pipeline. But it is now a much less appealing investment. Its other programs are tougher to trust after the complete failure of its acne medicine, and none of them offer the near-term upside of that drug. 

Investors that want to focus more on the reward than the risk of binary biotech investments get plenty of encouragement. Dermira reveals the danger of being swayed by it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Max Nisen is a Bloomberg Gadfly columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

To contact the author of this story: Max Nisen in New York at mnisen@bloomberg.net.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net.

©2018 Bloomberg L.P.