An Evaluation Of Citron Research’s Attack On Inovio

Citron Research, led by Andrew Left, is known to make headlines. The company, over the years, has made some bold calls, some of which have been successful beyond the wildest imaginations of investors. At the same time, many other calls by Citron have proven to be baseless and not fact-checked. Citron’s latest target is Inovio Pharmaceuticals, Inc. (INO). On April 27, the company issued a research report claiming that this biotech company is worth only $1 a share, which indicates a significant downside from the market price of around $13 on April 28, at the time of writing this article. Going a step further, Citron compared Inovio to Theranos. As much as these are hefty claims, thorough due diligence should be exercised before reaching any investment conclusion about Inovio, or any stock for that matter.

Does Citron get it right always?

No. However, Citron and Andrew Left have a stellar reputation for getting it right most of the time. In 2015, The Wall Street Journal conducted a study to find out the success of Left’s calls. The Journal analyzed 111 Citron short-sale reports from 2001 to 2014 and concluded that the share price of the companies covered by Citron has declined, on average, 42% in the first year after the release of the report. If you ask me, that’s an eye-popping return. Not to forget, all these reports were short reports, meaning that he was betting on the eventual collapse of a company. As many investors are aware, it’s difficult to find such companies with any degree of precision as there are a lot of odds against short sellers. Citron, however, has stood up to its reputation as one of the most reliable short sellers in the U.S. markets today.

However, even the best in the business eventually gets things wrong. As much as this is true for Warren Buffett (think about his investment in Kraft Heinz), this is true for Andrew Left as well. Citron Research famously bashed Tesla in 2013. In a detailed 9-page report, the short-seller pointed out why Tesla, at best, would provide a return of 20% to investors who are long, whereas the downside risk was much larger. To put things into perspective, Tesla was trading below $200 per share throughout 2013. Below is the ‘Conclusion’ segment of the Citron Research report on Tesla released in 2013.

Source – Citron Research

Needless to say, this advice did not age well. Tesla has been one of the best performers over the last few years, and Andrew Left remains pessimistic about Tesla’s ability to generate meaningful profits.

Citron got it absolutely wrong about Luckin Coffee (LK) as well. In January, an anonymous report was publicized by the renowned short-seller Muddy Waters. Citron engaged in a Twitter war with Muddy Waters claiming that they have looked into all the micro details about Luckin and remain bullish on the prospects of the Chinese coffee retailer.

Source: Bloomberg/Twitter

As many investors are aware, Luckin was exposed to a massive accounting scandal that led to an 80% decline in the market value in a single trading session. To make things worse, shares of the company are still halted for trading ‘pending news’.

Both these examples should serve to establish that Citron (and anyone for that matter) can get it wrong. And when they do get it wrong, things would look very bad.

Now that we have established a few important performance metrics and facts about Citron, let’s discuss whether their claims on Inovio seems to be acceptable.

Citron’s thesis

First, the performance of Inovio shares in 2020 is worth a look at. As you can see from the below illustration, shares have gained a staggering 300% so far in 2020, thanks to the outbreak of Covid-19 that resulted in shares of biotech companies soaring to new highs.

Source – YCharts

Citron’s claims against Inovio is based on empirical evidence. According to data presented by the short-seller, Inovio has a history of claiming the development of vaccines against whatever the epidemics that break out in different regions of the world. Below are some of the instances highlighted by Citron in its recent research report.

1. 2009 – Inovio announced the development of a vaccine to fight Swine Flu.

2. 2011 – the company claimed significant progress in developing a cure for H5N1.

3. 2017 – Inovio announced that a vaccine to fight Zika is delivering promising results.

4. 2019 – Inovio announced that its vaccine trials for Ebola delivered very promising results.

As Citron correctly points out, investors need to be very cautious in absorbing all the announcements of the company regarding the development of vaccines against seemingly uncontrollable and incurable diseases and virus outbreaks. Things are no different this time around as well. Inovio was one of the first companies to announce their mission to curb the spread of the virus by successfully developing a cure.

There’s more to the story. Inovio has already diluted existing shareholders by issuing a record number of shares since the beginning of the year. This, in every sense, is not a favorable development for an investor.

Source – YCharts

To make things even worse, Inovio is a loss-making company. In fact, the company has never made positive earnings in any of the last 10 years.

A risk-reward study is all that an investor needs to make a decision

If Inovio comes out with a vaccine to curb the spread of the virus, shares will skyrocket. There’s no doubt about that. But, there are a lot of “if”s involved in this thesis. The downside risk is massive as the failure of Inovio will lead to a market rout that could see the share price dropping to low-single-digits. Is it worth taking the risk? The odds are stacked against small players such as Inovio as regulators prefer to work with renowned companies. On the other hand, Inovio does not have the capacity nor the funding to develop any vaccine on a mass scale. Therefore, the best-case scenario for Inovio is an acquisition by a large pharmaceutical company. For this to happen, however, Inovio needs to come up with positive results in its clinical trials.

Now let’s look at the worst-case scenario. What if all these companies, including the biotech giants, fail to develop a product successfully before herd immunity kicks in and the virus is contained? Companies that solely depend on the success of this vaccine such as Inovio will be wiped off the market by investors, virtually. The biotech giants, however, will take a temporary hit and will continue to function normally and bring in billions of dollars in revenue and earnings thanks to the deep pipelines and existing products in the market.

As an investor can observe, the risk-reward profile is definitely aligned against shareholders. The best course of action, therefore, is to bet on the leading biotech names in the industry in hopes that one of these companies will be successful.

The best and the safest way to play Covid-19 is to bet on big names

Inovio announced on April 28 the full enrollment of 40 volunteers in a phase-1 clinical trial of its Covid-19 vaccine. The company is planning to report the results of the phase-1 trials by June. This is comforting news for investors who are reeling from the recent losses. Even the smartest minds in the business, including top-level epidemiologists, have no clue about the successful development of a vaccine. This serves as a warning sign for investors to not be too excited about Inovio’s prospects.

True, there’s a very real opportunity to invest in the biotech sector as all the leading governments in the world are willing to pump whatever the amount of money it takes to develop a vaccine to put an end to the spreading coronavirus. However, it’s also important to note that the billion-dollar biotech giants are the sole beneficiaries of this influx of money. Fair enough, considering the likes of GlaxoSmithKline, Moderna, and Gilead Sciences have worked closely with governments for many years. This underlines the risks of investing in a lesser-known name such as Inovio without any reliable data. As Citron correctly points out, there’s reasonable doubt about Inovio’s claims, going by empirical evidence. Not to forget, Inovio has never had any success in developing vaccines to fight epidemics, and the company is loss-making and has forever made losses!

As much as retail investors will not enjoy reading this conclusion, Citron Research seems to be spot on about Inovio. There’s a caveat. They could be wrong. Beat Billions could be wrong too. But, investing is not about getting everything right all the time. That’s impossible. Rather, it’s about tilting the odds in our favor. An investment in Inovio shares, however, does not seem to be doing this.

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