Margin Rules Might Make Development Stage Biotech Financials Matter

Tweet Margin Rules Might Make Development Stage Biotech Financials Matter

David Miller
February 20, 2007

For development-stage biotechnology companies, quarter-to-quarter revenues don’t matter much because these firms – by definition – don’t have significant revenues. What revenues they do have tend to be expense reimbursements from partners or amortized partnership dollars (up-front cash and milestone payments).

This makes financial analysis of these companies a relatively easy bottom line affair – you largely ignore everything but the net cash burn.

That could change for customers of TD Ameritrade (AMTD). Some time before the end of February for “original” Ameritrade customers and at an unknown date between February and June for “original” TD Waterhouse customers, the firm is changing its margin maintenance rules on biotechnology stocks. Generally, maintenance requirements will increase for those who hold development-stage biotech companies. Those who have concentrated portfolios will be the most affected.

Thanks go out to a correspondent, who wishes to remain unnamed, for alerting me to this potential change and sharing his conversations with the Ameritrade people. I made a few calls and came up with the following information.

TD Ameritrade has had significant trouble with collecting on margin calls from investors who were overly concentrated in one biotechnology stock. Not everyone has the “benefit” of my constant harangue on diversification, so there are people out there who have sunk everything into one stock only to see it detonate. Telik’s (TELK) recent 70% overnight decline is probably one of the better recent examples of this sad phenomenon.

TD Ameritrade is addressing this by changing the maintenance requirements for holders of biotechnology stocks in margin accounts. This is more than a little complicated, but I’m going to lay this out in a series of tables. If you are a TD Ameritrade customer with a margin account, I can’t urge you enough to call them and get specific guidance about your account.

It is probably best to start with the current rules:

In addition to these requirements, TD Ameritrade has placed more stringent maintenance requirements on a few hundred individual stocks. The company is changing their web site to make the list of these stocks easier to find. Currently, select the “Trade” tab on the new interface and start looking for a link named “Special Margin Requirements.” Some users will find this at the top. I found it in the small print at the bottom of the page.

The first change applicable to biotechnology investors has to do with different concentration requirements. Concentration refers to what percentage a particular stock makes up of your entire portfolio. As you can see above, normal concentration requirements kick in at 70%. For biotechnology stocks, there are now three tiers with the first one beginning at 50% instead:

This is relatively straightforward thus far. The more concentrated your portfolio, the higher your maintenance requirements will become.

The complicated part is how TD Ameritrade is going to determine the margin requirements on individual biotech stocks. They’ve decided to use a price/sales ratio, the market cap of the company divided by trailing twelve-month sales. If you don’t want to do the calculation in your head, both the TD Ameritrade site and Yahoo! Finance list the price/sales ratio.

I think this is a particularly odd choice, likely made by people with limited understanding of the sector. It creates the odd situation where, for a given revenue level, low-priced stocks – arguably those the market has voted to be the most risky – have lower margin requirements than high-priced stocks the market has voted to be less risky. It’s backwards, really. Additionally, it doesn’t even make sense from TD Ameritrade’s standpoint. A 50% loss on a $5 stock is the same as a 50% loss on a $25 stock, the only difference is the number of shares involved.

I’ve written at some length how traditional valuation metrics simply don’t apply to the biotech space. This is a perfect example of that.

Nevertheless, them’s the rules. Here is how the maintenance requirements break down according to the concentration tiers noted above and the price/sales ratios:

For people with undiversified biotechnology portfolios, the change from the current maintenance rates can be as much as 30 percentage points.

I’ve pulled a few examples from our own coverage universe to highlight how reliance on price/sales ratios create some unexpected results.

Would an objective observer determine YM Biosciences (YMI) is a lower risk than ZymoGenetics (ZGEN)? Or that Targeted Genetics (TGEN) is less risky from a “could go to zero” standpoint than Repros (RPRX)?

Of course not. TD Ameritrade has chosen a blunt quantitative instrument instead of working on a qualitative analysis of the situation in the sector.

If you are a TD Ameritrade margin customer with significant biotech holdings, call the company and ask to speak with the margin department. Have them run the numbers on your account to tell you what your maintenance call will be under the new rules. This is especially important if you are over 50% concentrated in any one stock.

I’m interested to see if other brokerages will follow suit.

Disclosure: Positions in YMI, RPRX, TGEN

Interest Rates

Tweet Interest Rates

Sally Limantour
February 20, 2007

We had a long weekend to digest Mr. Bernanke’s statements and his views on unemployment and inflation were telling. The Fed’s forecast for unemployment for the next two years is for the rate to remain between 4.5-4.75 per cent –right where it is. My interpretation is that he feels the economy is in a sweet spot and employment is good enough to keep the politicians at bay while foreign wage competition is dampening inflation potential of strong employment.

While Bernanke spoke of the downside risks of housing, he also said, “To the upside output may expand more quickly than expected.” This translates to mean that there is a chance for a stronger economy. Had he left this statement out, Treasury Bond Futures (US H7) may have closed the week closer to or above the 11200 level.

We have a slew of Fed speeches this week (this could restore rate hike fears) and CPI due out on Tuesday. While the Fed will focus on the core PCE Index, it is interesting to look at expected CPI as a general guide. The difference between the yield on a 10-year Treasury Note and the yield on an Inflation-Protected 10 year Treasury Note is basically the bond market’s forecast of the US CPI’s future rate of change. According to Ray Hanson, of the Speculative Investor, over the last 3.5 years expected CPI has been in a range of 2.25%-2.70%. “In other words, over the past 3.5 years there has been neither a deflation nor an inflation scare” hence, the Goldilocks economy and the strong stock market. Were we to break out of this range on the upside, rates would tighten and the stock market would suffer. On the downside deflationary concerns would spark interest rates to fall and commodity markets would be spooked. This brings me to the central banks and the current problems they face today in assessing “stability.”

Historically, central banks attempt to achieve stability by looking at changes in interest rates against measures of the amount of spare capacity within an economy. If interest rates can be moved to set demand at a level consistent with “supply potential”, then central banks will achieve stability.

Another more familiar approach is for central banks to monitor money supply growth in order to gauge inflation. These two models have worked well in the past but with globalization the central banks seem to be having a more difficult time measuring inflation and determining stability. In The Independent, 02/20/07, Stephen King wrote about the problems central banks are having with measuring the economy using an old paradigm in a world of increasing globalization.

The first approach has inherent problems in that countries dealing with large scale immigration are trying to figure out the size of supply potential. “The Bank of England, for example, has to fret about the scale of labour immigration. It knows the scale of recent immigration has been big, but beyond that, information is sketchy.”

The second problem is with measuring money supply. At the touch of a button and with the speed of light capital is flowing across borders while bank deposits are switching from one jurisdiction to the other making it difficult to know the “real” level of money supply. Perhaps this is one reason why the Fed stopped reporting M3? It may also explain why it has been difficult for traders to get a handle on interest rates – remember how bullish the market was towards a decrease in interest rates only to see them move higher? Market expectations have changed often over the last 12 months and the transparency the central banks are offering may in fact, be “revealing the uncertainties” they are confronting.

Readers in the Hamzei Analytics' Virtual Trading Room know I have been a seller of Treasury Bond Futures since Nov-Dec 2006– selling rallies and buying back on dips. After trading down to the low 110 area I have been flat looking to sell 11200 – 11208. In the big picture I believe we are in an upward multi-year trend in interest rates which will take years to develop.

Keep a heads up this week with regard to Fed speakers, Govenors Kohn, Bies, and regional Presidents Yellen and Fisher. Tuesday’s CPI number and the BOJ rate decision are also potential market movers. In addition, stay alert to more talk of a potential credit crunch precipitated by the housing downturn and rising default rates.

PBS Interview -- Master Traders

Tweet PBS Interview -- Master Traders

Fari Hamzei
February 20, 2007

We are thankful to AJ Monte and Rick Swope, co-hosts of Wealth & Wisdom with The Market Guys , who arranged for us to receive the master DVD of this interview recently. Last Fall, James DiGeorgia of Gold & Energy Advisor sponsored the W&W series. The interview was originally aired on October 20, 2006.

Video Part 1


Video Part 2


Video Part 3

Market Timing

Tweet Market Timing

Fari Hamzei
February 16, 2007

For next week, we will take our queue from the NASDAQ semiconductor space.

Keep an eye on BRCM, MRVL and QCOM.

Do not panic about Ballmer-Gates comments on MSFT's Vista -- they are in rational expectation management business --- nothing about mass behavior during new market highs is rational.

We should see NAZZ take off next week -- this week it put an outside bar reversal -- this is very noteworthy !!

SPX daily is in its +1 to +2 sigma channel and SPX weekly put in at outside bar reversal.

Many perma bears have begun to panic after Uncle Ben's Humphrey Hawkins Testimony on the Hill last Wednesday and Thursday while the Street gleefully celebrated its best Valentine's Day ever!!

STAY LONG -- add some high beta stocks to your account -- market will return some alpha back to you !!

Read more about why Market Timing matters in BusinessWeek, February 19 issue, pp 80-81: http://www.HamzeiAnalytics.com/docs/BW_TD.pdf

Equity Index Update

Tweet Equity Index Update

Brad Sullivan
February 16, 2007

The index markets traded in a light volume narrow range as Dr. Bernanke finished his testimony on Capitol Hill. The SPH7 contract produced a range of 0.4% for the entire session as players held their bids from Wednesday’s sharp advance.

This morning the indices are marked slightly lower on news that MSFT’s Vista software projections are a bit too optimistic. After trading through yesterday’s low in the SPH7 contract, buyers bid the pre-market higher on a rumor that AMR would be taken private in a deal led by GS. The morning’s economic data was right in line on the PPI with a headline reading of -0.6% and a core reading of +0.2%. Housing Starts came in a bit weaker than anticipated. Since that news, the indices have lost their slight bid and now rest around -1.00 pre-open.

We are focusing on an early close in the treasury market, option expiration in the equity markets and a pretty aggressive back and forth trade in the dollar. The Yen carry trade and its potential unwinding is in the back of everybody’s mind. However, I still hold that only a move below 115 in the Yen/Dollar would get the carriers frightened. And if that were to happen, it would be a short term detriment to the equity markets.

Keep a close eye on the “normal” expiration trade, which consists of a sharp mark higher just prior to and through the first minute of the open. Afterwards, look for a break around -0.3% in the SP before sideways action hits.

S&P, Yen and Gold

Tweet S&P, Yen and Gold

Sally Limantour
February 16, 2007

The risk appetite is increasing in the financial markets and the shortest term indicators are now back at high levels. Consequently, my short term model is back to a sell signal. There was a notable short covering of put options yesterday and the 3 day put to call ratio is also moving back towards a sell. Closing long positions today ahead of the 3 day weekend and will execute short positions with a stop loss of about 1% above current levels between today and Tuesday.

The monthly capital flow report from the Treasury yesterday showed a net portfolio inflow of only $15.6 billion in December versus the “norm of $50-80 billion (Nov. was 84 billion). This is due to record net outflow of foreign investment from US equities and record US investment in foreign securities, according to Bank of NY economist, Woolfolk.

The Yen moved higher against every currency and the probability a rate hike at next week’s BoJ policy meeting is growing. The question is if the BoJ yields to foreign pressure, thereby raising rates, will the whole carry trade unwind and if so, will it be orderly? The Carry Trade was covered here on my February 4th post. The last time we saw an unwind was the summer of ’98 when the carry trade ended violently and some are concerned given the size of the short position today we could witness a protracted and painful event. This must be monitored closely. The BoJ members are in a “blackout” mode ahead of the policy meeting next Tues/Wed., so we will not hear policy statements until after this time.

Gold has formidable resistance between $668-674. Gold is trading lower this morning and next support for April gold is 663. Many cycle folks are writing about a cycle high due at the end of February. Perhaps if the market continues to reject closes over the 672 area we will go back and test the low 650’s. The real action of late is in the base metals, particularly nickel which rose 5.4% yesterday due to tight supplies. Nickel is up 22.3% for the year, versus copper which is down 7.2% year-to-date. There are a number of attractive companies to look at in the base metals sector.

Equity Index Update

Tweet Equity Index Update

Brad Sullivan
February 15, 2007

The index markets caught a strong bid on the heels of Fed Chair Bernanke’s testimony on Capitol Hill. Dr. Bernanke gave a rather stunning assessment of the current domestic economy as he came across quite “dovish” versus his global counterparts (Trichet anyone?) on the future direction of interest rates, inflation and employment. On the inflation front …“while we have not had much new information, the recent readings on inflation are encouraging.” Perhaps his key catch phrase was “sustainable and not overheated” when discussing the current economic situation --- Golidlocks is alive.

The index markets did not wait for another utterance from the esteemed Fed Chair as buyers took in 95,000 SP mini contracts from 9:00 to 9:05 cst. An aggressive stance to be certain, and when the dust had cleared new trading highs for the move were established in both the SPX and DJIA. Interestingly, the Russell 2000 felt the brunt of rotational selling and finished the session with slight gains. This highlights the internal strength of the current marketplace. The Russell 2000 broke to new highs after nearly two months of a 3% trading range…in doing so the index rallied around 2.5% from its previous closing high. The SPX remains about -5% below its all-time highs established in the spring of 2000 and retested later that fall. Could we be in a position where the small and mid-cap indices mark time while the SPX makes a run at 1515?

Today is chalk full of data for the markets…and so far it has been generally favorable to “goldilocks.” The Philly Fed data at 11:00 cst always smacks of lunchtime desperation trading, so be cautious.