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The World's Most Hated CEO Strikes Again!

Investopedia logoInvestopedia 24-11-2015 Adam Hayes, CFA
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KaloBios Pharmaceuticals, Inc. ( KBIO ) is a bio-pharmaceutical company  that up until last week, was struggling to survive. The company, which makes  monoclonal antibody therapeutics for rare diseases, has not had any positive earnings in its existence, and in the year 2014 it had a dismal return on average equity of  -89.25%.

Enter Martin Shkreli, the "most hated" CEO of Turing Pharmaceuticals, who earned the ire of the Internet and politicians alike after buying the rights to the AIDS drug Daraprim and promptly raising its price from around $10 per pill to $750 a pop. To Mr. Shkreli's chagrin, the free market reacted and another biotech company, Imprimis Pharmaceuticals stepped in to offer a “customizable compounded formulation” of the drug to for a mere $13.50 a dose, circumventing regulations that would have given Turing virtual monopoly power on that drug.

On November 18th, the price of KalBios shares jumped sharply, rising 26.16% to from $1.60 to $2.17 a share. The next day, it was announced the Martin Shkreli had arranged a group of investors to acquire a majority stake in the failing company. His group bought up to 70% of all shares outstanding, and Shkreli appointed himself the new CEO. Shkreli and company announced a $3 million cash infusion with a $10 million guarantee via an equity financing mechanism. KalBios traded with a market capitalization of around $3 million earlier last week, and with the combined investment the market cap could have increased to perhaps $20 million. It now commands a staggering $140 million market cap.

Shorts Decimated

The price of a KalBios share has erupted to over $40 since November 18th, a $2,400% rise in just 5 days. The reason seems to be a massive short squeeze. Nobody really believes this company is worth $140 million, even with Martin Shkreli at the helm and his cash infusion of $3 million. Because of that, many investors sold shares short after the initial price increase from $2.17 to over $10 in a single day. But the next day it rose again to $20, prompting margin calls for those shorts to buy those shares back at a higher price, incurring a loss. But if fundamentally $10 a share is a sale, then certainly $20 a share is a screaming short. Perhaps, but when the stock rose to $25 and then $30 and then $40+, those shorts too, had to cover at ever higher prices. Now, shorts are worried about selling even here for fear the squeeze will continue. 

One individual investor who shorted a small amount of shares of KBIO in his E*Trade account went to sleep with a portfolio valued at $37,000 and woke up with a margin call and a negative $160,000 tab. He was able to raise approximately $5000 through a GoFundMe campaign, but is still on the hook for a lot more than that.

Market Manipulation Speculation?

By buying up 70% of the shares and then holding them tight and not lending them to potential short sellers, has Martin Shkreli engaged in market manipulation, purposefully or otherwise? While there is no overt evidence of bad behavior, the price action is surprisingly similar on the surface to the stock fraud committed in CYNK in July 2014, a penny stock that rocketed to a $6 billion market cap – and subsequently collapsed back down to nearly nothing – for which the main perpetrator was caught and pled guilty. It also looks strikingly similar to what happened with Volkswagen shares in 2008 when the stock spiked due to more shares short than float available – and subsequently collapsed. Only time will tell. Regardless, such price action should make short sellers wary.

Source: Zerohedge

The Bottom Line

KalBios is a biotech stock with no revenues and no profits, on the verge of bankruptcy. Yet in the past week, the stock has soared over 2,000% on news that Turing Pharmaceuticals CEO Martin Shkreli would attempt to rescue the company, buying up 70% of its shares for $3 million. Shorts, unfortunately, have had to cover at high prices, sending the stock even higher. If Shkreli decides not to lend out his shares to shorts, and worse, if he demands delivery on outstanding shares which he has purchased, the stock may go even higher levels, and leaving many people burned. 

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