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Evotec AG: This Biotech Stock Bargain Is No Bargain

Sometimes, when a stock’s price drops sharply – more than, say, 10% – it can be an excellent buying opportunity. Take Netflix, for example, which is due to launch in Germany later this fall. During the second half of 2011, it fell nearly 80%, from a high of almost $300 a share to just over $66. Since then, though, it has roared back to a current price of about $480 a share! If you had bought in at $66, you’d have made more than seven times your original investment!

But a price that drops once can also drop again, and again, and again, making the stock a disaster for investors. Early last week, the stock of biotech company Evotec A.G. (ETR:EVT) fell 24% because of a drug cancellation. It’s since crept back up as investors – seeing a possible bargain – have bought in. So is this stock a bargain, or not?

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Foul play

The drug that caused Evotec’s problems wasn’t even manufactured by Evotec! Diapep277, a diabetes treatment drug, was being developed by two companies, American biotech firm Hyperion Therapeutics and Israeli drugmaker Andromeda Biotech. Hyperion was in the process of acquiring Andromeda in order to take full control of Diapep277, which is in Phase III of clinical trials — the final pre-market phase of drug testing.

On September 7, however, Hyperion announced that it had uncovered evidence that Andromeda employees had falsified the results of its earlier clinical trials. “We’re shocked and disheartened at the serious misconduct and deceit,” said Donald J. Santel, Hyperion’s President and CEO. It immediately halted the development of the drug, and shortly thereafter, canceled its scheduled acquisition of Andromeda.

Hyperion expects to take a loss of $25-55 million (19-43 million Euro) as a result of the drug’s cancellation. But why did this cause Evotec’s stock price to drop?

Be careful who your friends are

Well, way back in 2007, a company called Devologen entered into a licensing deal for the Diapep277 drug. When Devologen was acquired by Evotec in 2011, Evotec inherited the deal, which entitled it to royalties for the development of the drug. The halting of the drug’s development will result in losses of tens of millions of Euros.

Not only is Evotec going to take a charge of 8.7 million Euros, it’s also currently owed 3.4 million Euros by Hyperion and Andromeda, which it’s now unsure it will receive. Publicly, an Evotec spokeswoman expressed confidence in receiving the payment…but she also conceded that if it didn’t receive it, profits would drop below last year’s level.

Evotec’s stock dropped almost immediately on the news in premarket trading on Monday and it still hasn’t recovered. Given that Evotec had nothing to do with the cancellation or the fraud, could this be a good time to buy?

An empty pipeline

I wouldn’t. When looking at a stock that has dropped, one needs to consider both its short-term and long-term prospects. If the company’s short-term prospects are not good, but its long-term prospects are more exciting, an investor must decide if it’s worth the wait. Unfortunately, I don’t see either for Evotec.

Diapep277 was the only drug that Evotec had in Phase III of clinical trials, meaning that its other potential moneymakers are in earlier stages of development and years from the market. Even if it receives its payment from Hyperion and Andromeda – and that’s still a big if – it will barely be in as good a financial shape as last year.

There is also little reason to consider buying and holding. While one of Evotec’s early-phase drugs may pay off in the long run, it’s just as possible they won’t. And with no dividend to reward investors for biding their time, I think there are better places for your money. If you’re looking for a dividend payout from a biotech firm, you could consider Bayer, with its 2.1% dividend yield, or Eli Lilly, an American company with a substantial German presence and a 3% dividend yield.

The Foolish bottom line

It’s tempting to buy or sell stocks right after a big price drop, but that can lead to trouble. It’s better to keep calm and examine the company’s full picture before jumping in. And in the case of Evotec, the full picture doesn’t look very rosy to me.

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John Bromels owns shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix.

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