$XBI remains an EXTREMELY challenging space these days with the sector trading down 100-200bps or more very often with no real news. This type of sector move is actually not that bad as it is just driven by fund flow / capital allocation – as in these are driven by non-fundamental factors.
However, there is one type of news that often crushes biotech stocks and I try to avoid buying this type of dips – and that is DEPARTURE OF KEY EXECUTIVES.
Obviously every situation is different, but insider departure is generally negative. It is particularly negative if a Chief Medical Officer leaves in a pre-revenue / development stage biotech company.
This morning, we all saw Zymeworks ($ZYME) announce their Chief Medical Officer would be leaving the company.
As you would expect, CMO of a pre-revenue biotech is the second most important role only after CEO. Obviously, the stock market did not like this news – punishing its stock down by -9.5%, underperforming XBI by over 700bps (XBI was down -2.2% today).
Relative to where $ZYME stock have traded as recently as January 2021, $ZYME stock price could looks like a juicy dip to buy… It touched mid-$50s and now the stock is below $30!
HOWEVER, I DO NOT LIKE BUYING DIPS LIKE THIS and DID NOT BUY THIS DIP. I discuss my rationale for not buying this dip.
REASON 1: EVERYTHING THAT THE CMO COMMUNICATED / PROMISED TO INVESTORS GOES OUT THE DOOR
CMOs not only drive internal R&D strategy / planning, but also carry investor messaging and discussions along with CEO. As shown in below slide, CMO biography was right next to that of the CEO.
The outgoing CMO may have felt that he / she could no longer meet those expectations that they set to investors and decided to leave the company. What’s next (and what investors fear) is that the new CMO may come in, review the situation, and set low expectations for investors (kitchen-sink the whole expectations), so that the new CMO can start on a low base.
This is common with CFO transition – investors are concerned about guidance being lowered / suspended with new CFO as the new CFO will probably want to start on a clean slate.
I don’t want to own the stock in that moment when a new CMO comes in and sets a new low bar that is easier for him/her to clear.
REASON 2: CMO MAY HAVE SEEN SOMETHING THAT WAS VERY NEGATIVE
CMOs have access to the most confidential clinical data that are not communicated publicly – obviously this is why every investor pays attention to what CMO says publicly in detail to get any read-through to clinical development process. CMO leaving is generally viewed as an ultimate negative read-through to clinical development programs – otherwise, why would they leave?
In biotech investing, it is extremely dangerous to simply reference the historical trading range to estimate upside or especially downside. The downside of a failed program can be as much as -90%. CMO departure could be very bad and can potentially indicate that a catastrophic event is within the realm of possibility. This type of risk/reward is OUTSIDE of my risk appetite.
As an investor, I am thinking “What did he/she see that I or other investors have not seen?
REASON 3: CMO DEPARTURE WHEN THE STOCK IS IN THE GUTTER IS ALSO NEGATIVE
CMOs receive a lot of company stock over time and expect to receive a LOT of stock in the future. When the stock is in the gutter but if CMO is optimistic about prospect of clinical development, the rationale move is to stick through. For me, CMO departure when the stock is down more than 50% from its recent high signifies throwing in the towel.
As an investor, I am thinking “management promised on the pipeline.. but can they actually deliver?”
CONCLUSION
I just used $ZYME as an example, but there are many dips in biotech that happen because of management departure.
While I tend to avoid these type of dips, there have been some massive success cases in biotech that followed key management departure – one of the most notable one is $IMMU.
New CEO decided NOT to join the company, but the company was acquired by $GILD for a massive premium.
There are many success stories, but I try to avoid them because many of these often fall out of my risk appetite – I also remind myself that downside scenario that comes within the realm of possibility from key executive departure is -90%.
What do you like to do with key management departure? Did you buy $ZYME dip? Please leave in the comment section below. Thank you for reading!
*not investment advice.
