This commentary originally appeared on Real Money Pro at 10 a.m. ET on Friday, April 8. Click here to learn about this dynamic market information service for active traders.
I talked some two weeks ago about how small-cap biotech Relypsa (RLYP) was insanely low-priced given its fundamentals, and the stock soared nearly 70% yesterday on reports that the company is seriously considering selling itself.
RLYP is one of my favorite biopharma stocks, as well as one of 15 small-cap stocks names in my "Biotech Forum" portfolio. The main reason why is that its drug Veltassa is the first treatment approved in decades to treat the disease hyperkalemia. That's a market that many analysts believe is worth some $2 billion in annual sales.
Veltassa has had a solid rollout and good acceptance from the health-care community, which made Relypsa one of the most undervalued stocks in my universe. The company's market capitalization had fallen below $600 million as RLYP got caught by the hugely negative sentiment that had recently swept the biotech sector into its largest and deepest bear market since the 2008 financial crisis.
Relypsa was also under pressure because management had said earlier this year that it might have to raise additional capital to support continuing trials and expansion of the firm's potential blockbuster drug. But as I noted at the time, RLYP didn't have do this immediately, as had more than $250 million in net cash on hand.
I also said that one way Relypsa could solve its problems was to simply accept a buyout offer from a big player with a large, established sales force. That's what rival ZS Pharma did in November when it agreed to sell itself to giant AstraZeneca (AZN) for $2.7 billion -- a huge premium to that stock's price at the time.
Relypsa faced intense buyout speculation following ZS Pharma's merger deal, as Veltassa had already received regulatory approval while ZS Pharma's rival hyperkalemia drug had not. But the speculation died as the biotech sector continued its plunge into darkness, although interest in the firm was bound to return once the sun came back out for the industry. That's exactly what happened yesterday.
But even with Relypsa's big rally, the stock still sells for only around $25 a share and sports a market capitalization just north of $1 billion. In my view, that means RLYP remains significantly undervalued given Veltassa's potential and how much cash Relypsa has on hand.
Even with a discount to what was paid for ZS Pharma, I believe RLYP's share are worth at least in the low $40s in a buyout scenario. And if an acquirer doesn't emerge, the company should manage to soldier on just fine as a stand-alone entity.
That's why I plan to hold on to the vast majority of my Relypsa stake despite yesterday's big rally. But this brings up something I haven't had to articulate in quite some time -- my "Jensen Rules."
These relate to culling some profits when you enjoy a big rally in a small biotech stock that you hold. Let's say you bought 1,000 shares of a small biotech that has gone up big time. The "Jensen Rules" state that:
- You should sell 100 shares after a 50% run-up.
- If the stock doubles, cash out of another 200 shares.
- Finally, if you're lucky enough to get a triple, unload an additional 200 shares.
Follow the above rules and you'll have a guaranteed gain even if the stock subsequently falls to zero. That's because you'll have sold half of your original stake but kept the other half riding on the "house's money."
This method allows you to take some gains and redeploy them into other opportunities. But it also ensures that you don't completely cash out of what might ultimately turn out to be the next biotech "juggernaut."
The Bottom Line
After more than six months of being beaten like a rented mule, I'm sure investors will have no problem dealing with some gains on their biotech positions. Hopefully, Relypsa will be just one of many small biotechs to rally this quarter and throughout the rest of 2016.