$GERN Geron Corporation (NASDAQ: GERN), a small-ca

$GERN Geron Corporation (NASDAQ: GERN), a small-cap cancer specialist, has consistently been one of the most shorted stocks listed on the Nasdaq stock exchange over the past year. In fact, the biotech's short percentage, relative to its outstanding float, stood at a staggering 21% at last count.

I think short-sellers may want to reconsider their position on this speculative biotech soon, however. This tiny biotech, after all, is nearing a critical clinical update for its ongoing blood cancer collaboration with Johnson & Johnson (NYSE: JNJ) that could produce enormous losses for bears in short order. Here's why.



The opportunity
The backstory is that Geron and J&J are presently co-developing the telomerase inhibitor imetelstat for the myeloid-based malignancies myelofibrosis and myelodyspastic syndromes. The duo apparently also have designs on expanding imetelstat's label to include other high-value indications like acute myeloid leukemia. All together, imetelstat is targeting several indications that could produce well over $2 billion in peak annual sales.

The global blood cancer market is forecast to rise from a stunning $29 billion in 2015 to over $50 billion by as early as 2020, according to a report by EvaluatePharma. And myeloid-based diseases, or diseases of the bone marrow, in particular are projected to generate over $5 billion in drug sales by 2022, and perhaps a lot more depending on the rate of innovation within this space.

Reflecting the value of this high-growth drug market, biotech heavyweight Celgene (NASDAQ: CELG) recently struck a back-ended licensing deal with Impact Biomedicines worth up to $7 billion for its experimental myelofibrosis and polycythemia vera drug, fedratinib, earlier this year.

While this deal is heavily dependent on sales milestones in order to realize its full value, Celgene did fork over a healthy $1.1 billion in up-front cash to secure fedratinib's rights. The biotech also struck a rich licensing deal with Acceleron Pharma a few years back to develop luspatercept for myelodyspastic syndromes and myelofibrosis, along with another rare blood disorder called beta-thalassemia.

In short, myeloid-based malignancies are a red-hot area of interest within biotech due to their enormous commercial opportunity. And Geron, by virtue of its licensing deal with J&J, could be about to grab a significant portion of this multibillion market.

The risk
With such a large commercial opportunity looming, Geron's sky-high short interest doesn't make a lot of sense. The short thesis seems to center around the drug's well-documented failures in the solid tumor arena, as well as its problematic safety profile when used at high doses. Another key issue is that imetelstat has so far failed to produce the type of consistent spleen responses in advanced myelofibrosis patients that would signal a clear-cut clinical benefit.

However, these concerns are starting to appear to be largely unfounded, as imetelstat nears the finish line in its ongoing myelofibrosis study known as IMbark. The drug, after all, seems to have far surpassed the historical median overall survival rate for patients that no longer respond to frontline therapy, and J&J has continued to tout imetelstat as a top clinical candidate during recent investor presentations.

Given that Geron and J&J are only weeks away from unveiling the drug's latest clinical update, I personally find it hard to believe that J&J would still have that much faith in the drug if things were going off the rails. J&J, after all, did have to hand over the latest clinical data to the FDA as part of an information request last October. No way would this highly conservative healthcare giant continue listing imetelstat on investor presentations if these data were trending toward futility.

An asymmetric risk-to-reward ratio
If the shorts do turn out to be right, my guess is that Geron's valuation will fall to around its current cash position. So, using some back-of-the-envelope math, I think Geron's stock stands to fall by as much as 80% from current levels.

On the flip side, I've long thought that Geron and J&J essentially have a buyout deal in place in the event that imetelstat works as advertised. Geron, for instance, can't entertain an outside party for imetelstat's U.S. rights if J&J remains in the picture. In other words, Geron gave up its ability to create leverage in a buyout scenario if imetelstat hits the mark.

That fact implies that J&J has probably already agreed to a healthy premium in a buyout. My guess, based on the prevailing trends within the blood cancer space, is that a buyout would come at no less than $3 billion, representing upside potential of at least 560% from here.

That may sound outlandish, but that estimate is a testament to just how much big pharma values these drugs right now. You only have to look at Celgene's deals with Impact and Acceleron to know this jaw-dropping estimate isn't science fiction. And that's why I think shorts are playing an extremely dangerous game with this tiny biotech right now. They could be right, but the potential gains are strongly outweighed by the potential losses.

via The Motley Fool