"That's how we know we're alive; we're wrong."
-- Philip Roth, American Pastoral
The trading desk where I started at Deutsche Bank's 280 Park Avenue building (aka "The Old Banker's Trust Building" aka "The Building with the Starbuck's in the Lobby") was a pretty quiet place, and on the Friday before Memorial Day 2004 it was quieter than usual. No phones rang. Half hours passed with no words spoken. Except for the occasional "THWACK" of the big green key on one of the Bloomberg keyboards as one of us entered a trade, the room was completely silent.
The options trader and the volatility trader were the only occupants of the ten seats on our row of ten terminals other than me. One pointed to and touched his computer screen and nodded to himself; the other sat motionless. In contrast, I rocked back and forth in my Aeron, tapped my index finger on the computer mouse and bounced my knees up and down. I sucked in my cheeks, jutted my jaw and exhaled as if I were blowing out cigarette smoke.
It had been six months since I had walked home from CarCash with a box of medical textbooks and a balled-up white coat under my right arm and the license plates from the Toyota Land Cruiser that I no longer needed in my left hand, having temporarily permanently retired from medicine. My year off to write a book about reproductive bioethics had lasted about five weeks, and I happily found myself consulting on a quant trading desk, swapping good healthcare stocks from the short side to the long side and replacing them with not-so-good healthcare stocks that the trading algorithm should have bet against from the start. Within a few weeks I was running my own small portfolio, first using play money through a Wall Street flight simulator, later making real, albeit small trades.
At no time was I more than a rounding error of a rounding error for Deutsche Bank, but I took my trading seriously. I set up a market neutral healthcare book, small to large cap, biotech to healthcare services to healthcare IT. I set out to learn merger arbitrage, convertible arbitrage, option spreads, delta hedging and event-driven trades. The last category included the scary binary events in my favorite sector, biotechnology, the sector where I figured that my science and medical backgrounds were most likely to provide an edge. My first big (for me anyway) one-directional, unhedged, make-a-lot or lose-a-lot on a single outcome trade was based on the coming FDA approval decision for a tiny Massachusetts company's drug that treated the urgent impulse to empty a not quite full bladder. The company's name was Indevus. It's ticker was IDEV.
The FDA had promised to provide the company with an answer at the end of May, and I had a large long position (in other words I owned a lot of stock) in anticipation of the drug being approved. Approval transformed the company from a drug developer to a drug seller. Approval meant revenue and then profits.
Approval meant that the stock had to go up. Rejection meant the stock would go down. Get hammered. Get crushed. Get killed. Be decimated. And I would get hammered, crushed, killed and be decimated with it.
The morning passed slowly, and just before noon I got up to get lunch, barely making it to the door when I heard Kosmo calling me.
"David --"
I turned back into the room.
"...your IDEV. It's halted."
(Camera pulls back to show me staring at screen while clock on the wall ticks...)
(Cut to commercial)
Approved!
The FDA approved Trospium chloride for sale in the US using the commercial name Sanctura. A few months before the approval, Indevus had licensed commercialization rights to the Croatian pharmaceutical company Pliva, rather than build its own sales force. The approval was timely for Pliva, which faced the imminent loss of patent exclusivity for its biggest drug, the antibiotic Zithromax.
Sanctura was an anticholinergic, a drug that blocked one of the chemicals that carries signals in the central nervous system. Anticholinergics have good and bad properties. The good includes a blocking of smooth muscle (the type that lines the bladder for instance) from spasming, which caused the sudden need to urinate. The bad includes dry mouth, drowsiness, dry eyes, dizziness and a host of other annoying and uncomfortable side effects. Sanctura's side effect profile was less severe than some of its competitors, and Indevus and Pliva were counting on that lesser side effect profile to convince doctors to prescribe it -- and to take a big chunk of a 2 billion dollar a year market.
That was not going to be easy, however, since the competition was Pfizer (the drug Detrol) and Johnson and Johnson (Ditropan). The fact that Sanctura needed to be taken four times a day didn't help either.
I knew from my doctor days that four times a day doesn't work. Once a day is great: put the pills next to your toothbrush and you'll remember to take them. Twice a day -- same thing, toothbrush. Three times a day? Take one with each meal.
Four times a day? Uh...
Still, the big binary had passed and the outcome was the one I wanted. On Thursday, Sanctura had yet to be approved and faced the possibility of being worthless; on Friday it was approved and was a real, marketable product. Outcome had defeated optionality. Common sense, logic, physics, mathematics and universal truth all dictated that Indevus, by replacing uncertainty with a positive outcome, had to be a much more valuable company after the approval than it had been before.
In other words, the stock had to go up.
IDEV opened at 8.52 that morning, after starting the year just under $6.
If I remember correctly, the stock was halted for about an hour, and resumed about 2:00. I sat back and waited for the fireworks...
(roll credits and move to small corner of the screen while next show, "Real Housewives of the Upper West Side" starts...)
Finale:
IDEV started trading again and it popped to 10.25.
And then it came right back down again. Sensing a great opportunity (after all, we had replaced optionality with certainty and the stock had to go up) I doubled my position.
The stock traded for another two hours. And. went.
Nowhere.
Indevus Pharmaceuticals opened at 8.52 on May 28, 2004, received FDA approval for its first major drug around midday, and finished trading at 8.33, a 2.2% drop on a day when by any calculation the company's fundamentals had improved.
I spent the long holiday weekend trying not to think about Indevus Pharmaceuticals, and trying not to think about why the stock price dropped when the company became more valuable. I repeated to myself Warren Buffett's and Charlie Munger's observation that the market was a voting machine in the short term but a scale in the long run. But I was no longer convinced that I was right and the market was wrong. Coming from a science background, I knew scales and reproducibility and evidence-basis and knew that extrapolating patterns and trends from short-term volatility was not a good basis for drawing valid conclusions. But I also knew that the stock traded almost 13 million shares that day -- 18 times its normal trading volume. The share price change did not come from a statistical blip downward. There was an underlying cause-and-effect in play here, one that I would need to figure out and learn from if I hoped to master my new field.
So for the next several months I became the world expert in Indevus pharmaceuticals. I traveled to Lexington, Massachusetts to meet with management (Them: "We just flew under the radar! It was the day before Memorial Day weekend and no one noticed that we got approved!" Me: "Really? How do you explain the 13 million shares traded?") I listened to the quarterly conference calls, read the old 10Q's and 10K's, studied Pliva, learned about Zithromax, Ditropan, Detrol, as well as the other drugs buried back in the Indevus pipeline.
But none of the Indevus-specific information seemed to hold the answer. No -- the real truth dawned on me while discussing hedging strategies with the other traders. Our soft-spoken expert in convertible arbitrage had given me a list of healthcare companies with large amounts of convertible debt and asked me to circle any with particularly poor fundamentals. He briefly explained to me the relationship between common stock and convertible debt, and how each was in some way a derivative of the other, and how you could hedge a long position in the convertible by shorting the common. Further, convertible debt that was "in the money" -- in other words could be converted to common stock at a price lower than the current market price -- provided an opportunity for a risk-free trade. As the common stock went higher, over and above the in-the-money strike price, that trade got more and more profitable.
I looked down the list and found -- you guessed it -- Indevus Pharmaceuticals, with close to 200 million dollars of convertible debt, with a strike price of 6.75 (200 million and 6.75 are as best as I remember.)
Finally -- I understood.
The debt holders had been waiting for someone just like me to come along and, knowing that the stock had to go up when the FDA approval was announced, buy stock well above the 6.75 convertible strike price on a high volume day. Armed with their convertible-debt and the get-out-of-jail free risk protection that it gave them, the debt holders could borrow shares and sell them short.
They figured -- correctly, it turned out, that Pliva would never mount a serious sales challenge to Pfizer and Johnson and Johnson. They figured -- correctly, it turned out, that IDEV would drift downward for a long time, would eventually use up the cash that the convertible debt generated and possibly never again reach the levels of May 28, 2004.
Which is exactly what happened. Indevus never again traded higher than its $8.52 share price when the market opened on the Friday morning before Memorial Day weekend in 2004. It was eventually acquired for $4.50 a share in 2009.
As for me, I left Deutsche Bank in 2005 to join my current firm and launch a life sciences fund that I still run, investing in good science and good companies, run by good management teams that maintain clean capital structures -- with no convertible debt.*
*Convertible debt can be a completely appropriate financing vehicle, but usually not with pre-revenue life sciences companies.
