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<DAILY TROUBLE>
Friday, June 11, 1999
Hollis-Eden Pharmaceuticals
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Phone: 619-587-9333
Website: www.holliseden.com
Price (6/10/99): $10 1/4
HOW DID IT FIND TROUBLE?
"We may have found a cure for AIDS."
So said Professor Wimpie duPlooy, a researcher at the Medical University of South Africa (Medunsa), who added that the reportedly inexpensive drug in question could be on the market by year-end.
The quote appeared in a story for the South African Press Association posted March 11 to Dayinvestor.com. The day traders there connected the fact that Medunsa was working on the drug HE2000 for the Irish-based Colthurst Ltd. And Hollis-Eden had licensed the rights to the drug.
In no time, Hollis-Eden shares scurried from the low teens to the low $20s. This was a return to Eden for the company's shareholders. The stock topped $25 per share in January after the company announced that it had raised $25 million in two private placements, including a $13 million deal led by noted healthcare investor Rick Beleson of Capital Research and Management.
However, the stock plunged on March 1 following word that the Food and Drug Administration (FDA) had greenlighted a Phase I/II clinical trial for HE2000 as a possible treatment for HIV, the retrovirus believed to cause AIDS. Investors who had bought on the rumor were selling on the news. Or, perhaps some were put off by the concurrent resignation of Hollis-Eden's President and Vice Chairman Terren Peizer.
Such is the world of biotech investing, where stocks lurch this way and that between tangible milestones like financing deals, nods from the FDA, and reports on clinical trials. After this second trip to the garden, though, speculators ate from the tree of biotech investing knowledge and discovered they were naked and vulnerable.
Hollis-Eden said it had not yet seen, much less analyzed, the data from the South African trial, which reportedly showed HIV "viral loads" dropping to undetectable levels in all but one of a small group of test subjects, while CD4 white blood cells depleted by the illness were "restored." But the company did say it would present animal data March 24 at the International Conference on Antiviral Research.
In that study, six macaque primates were infected with a supposedly recombinant form of SIV/HIV known as SHIV-229. All were in declining health when half were given HE2000. By the study's end, the three given the drug had survived the infection for an average of 384 days while the three not given HE2000 died after an average of 193 days following infection.
Yet, the gap between "cure for AIDS" and these promising results soon sank in, and the stock fell.
BUSINESS DESCRIPTION
Based in San Diego, California, Hollis-Eden is a development-stage biopharmaceutical company working on treatments that may be useful for a spectrum of infectious diseases and immune system disorders.
The company's lead compound is HE2000. Related to DHEA, a steroid marketed over-the-counter in recent years as a wonder drug, HE2000 is believed to work by inhibiting the energy-producing enzymes and proteins required by a human host cell to replicate the virus. In a sense, it starves the virus.
The company thinks this method of action might avoid the production of drug-resistant virus, which is believed to be a major reason other AIDS drugs eventually fail. Early versions of HE2000 reportedly showed limited side effects, another major problem with the protease inhibitors and nucleoside analog reverse transcriptase drugs that currently represent the standard of care.
The company is also working on other technology platforms, including an immune modulator called Reversionex that may also be used to treat AIDS. AIDS is a major killer internationally, affecting over 33 million people, according to the World Health Organization. More than half the patients taking the expensive AIDS drug cocktails fail therapy within a few years.
Like the other active agents Hollis-Eden is testing, HE2000 has been licensed from Irish researcher Patrick Prendergast and his Colthurst Ltd.
Peizer, the former president, was once a senior member of Drexel Burnham Lambert's junk bond department under Michael Milken. Hollis-Eden accelerated the vesting of 300,000 of his stock options on his departure. The FY98 proxy indicates that, at year-end, Peizer had 400,000 exercisable options plus 2 million unvested options. The proxy says some 1.2 million of these options were due to become exercisable by the end of April.
Insiders own 5.4 million common share equivalents, or 41% of a fully diluted count of 13.2 million. Chairman/CEO Richard Hollis owns most of this stake (3.3 million shares, or 29.3%).
The company came public through the back door in March 1997 by merging with an OTC Bulletin Board shell company, Initial Acquisition Corp., which then changed its name to Hollis-Eden.
FINANCIAL FACTS
Income Statement
12-month sales: None
12-month income: ($12.6 million)
12-month EPS: ($1.44)
Profit Margin: N/A
Market Cap: $113.4 million
Balance Sheet
Cash: $52.9 million
Current Assets: $53.3 million
Current Liabilities: $0.5 million
Long-term Debt: None
Ratios
Price-to-earnings: N/A
Price-to-sales: N/A
HOW COULD YOU HAVE SEEN IT COMING?
The January financing deal was a good one -- about 1.37 million shares sold at an average price of $18.28, or just slightly below market value. To get the deal done, Hollis-Eden issued a modest 90,000 warrants that exercise at $18.25.
Yet, the company had agreed to a much less attractive deal in May 1998 when it raised $20.6 million. It issued 1.33 million shares of common stock, including 0.19 million which had an adjustable feature; 4,000 shares of Series A convertible preferred (valued at $4 million) that converted to common stock at a fixed conversion price of $20.30 per common share for the first seven months (so, about 197,000 shares) but floated thereafter; and warrants to buy 1.44 million shares at $17 per share.
Hollis-Eden issued 0.35 million shares last January to cover converting the preferred stock into common stock and issuing additional shares related to the adjustable feature. So overall, it issued 1.78 million shares as a result of the May 1998 placement, valuing its stock at $11.55 per share, or substantially below last May's trading range of $14 to $18 per share. And that doesn't count the warrants.
Lots of numbers, but biotech investors should get used to it since the business involves spending money for years before seeing a potential payoff. The terms of such financing deals tell you a lot about the relative strength of a company's drug portfolio. Last summer's swoon into the single digits, for example, was a somewhat predictable reaction to the May financing.
The January financing, though, suggested Hollis-Eden was looking more impressive. So how could you have foreseen the latest dip?
Simple, the word "cure." It's a word people love to hear. It makes speculators and novice investors want to throw money at a stock. But, it's also a word that is almost always used rashly. In nearly every instance, you will make money shorting a stock that's shot up because of a supposed cure. This is especially true of AIDS, which has proven a daunting challenge for scientists.
Also, the circumstances surrounding the stock's March jump were ludicrous. The reported results came from a small, early stage clinical trial. These results were not yet published in a peer-reviewed journal; they weren't even being presented at an international conference. They represented merely an anecdote told by a doctor no one had ever heard of.
WHERE TO FROM HERE?
Short-sellers love companies that have gone public through a reverse merger with an OTC Bulletin Board company and that have used discounted convertible financing. Add all this to a development-stage biotech that can periodically make hype-worthy headlines ("Cure for AIDS"), and you have a combination that short-sellers will likely return to again and again, given the chance.
However, Hollis-Eden's board does include Thomas Merigan, a highly qualified mainstream AIDS researcher at Stanford University. And its clinical trials are proceeding.
On May 6, the company announced it had begun a Phase I/II trial in South Africa, testing HE2000 in 36 HIV patients who have never taken other anti-HIV drugs. The study will check for safety, tolerance, and antiviral activity. It will also test whether resistant viruses emerge. HE2000 will be given in a five-day dose. Positive results from that trial could lead to a Phase III trial early next year.
While the FDA will expedite the review of AIDS drugs, Hollis-Eden will need to amass a wealth of patient data before the FDA will even think about HE2000. So, the company doesn't expect to generate revenues "for the foreseeable future."
Hollis-Eden says it now has money to fund itself through 2001. Although the company reported a nasty $8.4 million loss last quarter, some $7 million of that came from a non-cash charge (for Peizer's options and for issuing 500,000 warrants to a financial consultant). The actual cash burn was just $1.15 million, with R&D amounting to only $0.76 million.
There's plenty of evidence, as well, that immune system modulators of various stripes (some of them quite strange, like a chemical used in photography) may be safer, better drugs for treating AIDS than the highly toxic anti-retroviral therapies that dominate Western medicine. However, studying a drug's very short-term effects on surrogate markers like "viral load" or CD4 counts tells you almost nothing about the drug's effectiveness. Many ineffective drugs can produce the results on humans thus far reported for HE2000. And, for many reasons, animal models for AIDS are completely suspect.
Like most biotechs, Hollis-Eden is a speculation for those with the expertise to seriously evaluate the science. Even then, it would only look interesting, in my view, if it traded down close to its cash on-hand. Others would do well to avoid it, unless they wish to fill the pockets of short-sellers, who have shorted nearly a quarter of the float.
-- Louis Corrigan
([email protected])
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