The Risk-Reward Case for Sarepta — Stock Going to $19 or $47 by Mid-May

March 25, 2013 by Jon C. Ogg

Sarepta Therapeutics Inc. (NASDAQ: SRPT) should have received a huge boost from “The Barron’s Effect” on Monday. The financial publication, which historically has been referred to as the “Investor’s Weekly Bible Reading,” gave Sarepta a great write-up, full of all sorts of great upside. Andrew Bary of Barron’s wrote “A Critical Moment for Sarepta,” saying that the stock could soar another 65%.

So why are shares only 2% or 3% higher this Monday. even with the stock market all green due to a Cyprus resolution?

Sarepta is expected to seek an accelerated approval process from the Food and Drug Administration (FDA) for its Duchenne Muscular Dystrophy (DMD) drug. Bary’s article calling for another 65% upside is based on the potential for this drug to reach $500 million in sales each year in the United States alone. With this DMD family having no treatment, the case is that the company’s sales could race far higher if approved.

One thing keeping a lid on the gains here is gravity and knowledge. This was not the first time that Barron’s has made a positive case for Sarepta. It also should be known that shares have effectively quadrupled over the past year. If you just screen the 52-week range, Sarepta’s closing price of $32.77 compares to a 52-week trading range of $3.30 to $45.00. In short, the stock has already made close to a tenfold gain off of its 52-week low. Even with a 2% gain to $33.44 on Monday in early trading, the market cap is a mere $1.06 billion.

The consensus price target according to Thomson Reuters is $42.00. If you took the Barron’s article at face value for 65% upside, that would come close to $54.00 for the stock. Barron’s pointed out a Deutsche Bank analyst covering it with a Buy rating and a $45 price target, but it also noted the firm saying that this could go to $192 if this DMD drug family gains wide acceptance. Barron’s also pointed out that William Blair started coverage last week with an Outperform rating and a $52 price target.

Another concern is that the target population is small, about 35,000 boys in the United States and Europe. The good news is that the rare disease drugs can come with a monstrous price tag. Barron’s threw out $300,000 as a possibility.

Barron’s gave what is really a very fair and balanced write-up of this stock. The issue is a risk-reward case.

With only 12 boys in the latest Phase IIb group, the publication gave a chance of less than 50% that Sarepta will be granted an accelerated approval. The publication also warned that this stock could fall back into the $20s if the company does not seek an accelerated FDA approval. The flip side is that the stock could rise to $50 if it seeks approval. A final flag here is the warning that Sarepta shares could collapse if eteplirsen ultimately fails to win approval.

The long and short of this is that, even with the favorable incident reported by one family whose son is now out of a wheelchair, Sarepta is a major battleground stock. We are not going to bother trying to predict the outcome here, with such a small group and a very long road ahead for the company. Options traders are all over this stock, as are short sellers.

As far as the short interest, this was 4.42 million shares at the end of February. That was the highest nominal shares short going back to last April, when the short interest was more than 6 million shares. That short interest almost certainly will grow if any problems arise here. On the other hand, short covering will exacerbate any move to the upside if rumors leak out about more positive eteplirsen news or over the FDA process.

The open interest is rather active in Sarepta. This is a binary options strategy play with many puts and calls being owned (or short) by investors looking for big price moves without picking the direction. For instance, at almost $33 a binary option costs close to $11 for both puts and calls at the $33 strike for April alone. If you go out to May, that is closer to $14 for the same $33 strike. For that to be profitable by April 19, 2013, the binary options traders are betting that Sarepta shares will fall to less than $22 or rise to more than $44. For the binary option to be profitable by May 17, the stock would have to fall to under $19 or rise above $47.

Barron’s gave a fair analysis of the upside and the downside for Sarepta. The problem is that this is just going to be far too risky a gamble for many investors. This is a situation in which investors are likely to have a home run or a disgraceful third-out strikeout with the bases loaded.