Investigation Leaves ABIOMED Shareholders Uncertain And Vulnerable

A lot of uncertainty is currently priced into shares of the cardiovascular medical device company ABIOMED Inc. (ABMD), which saw a 31.3% drop on November 1st in reaction to its second quarter earnings report (for fiscal year 2013) released on November 1st, 2012.

The company posted record earnings and double-digit revenue growth relative to the numbers posted in Q2 2012, as well as some developments in its product portfolio. It wasn’t disappointment in the financial data tor the operational hat caused the post-earnings selloff though – it was the disclosure of an investigation by the US Attorney’s Office for the District of Columbia regarding the marketing and labeling of their flagship Impella 2.5 device.

Investigations centered around pharmaceutical and medical device companies’ flagship products are very frightening to investors, and it causes prolonged damage to share prices when considered serious enough. We saw something similar occur with Questcor (NASDAQ: QCOR) after an 8-K filing made on September 21st, which dropped shares an extra 20% after it had already suffered a massive selloff on Aetna’s healthcare reimbursement policy. Their flagship product, H.P. Acthar gel, was also being investigated for potentially illegal marketing and labeling practices which would artificially increase sales figures.

Impella has a medical device product line that falls into two major platforms – the Impella platform and the AB platform. Impella is a catheter-based, percutaneous platform that includes the Impella 2.5 catheter introduced in June of 2008, which is small enough to reach the left ventricle of the heart through the femoral artery. The other Impella catheters, Impella 5.0 and Impella LD, were cleared in 2009 followed by an automated controller cleared in 2010. The AB platform is an artificial heart that allows for greater patient mobility. There is also the upcoming Symphony device which is intended to improve circulatory system function, although it has not been cleared by the FDA yet.

Impella platform revenue in the second quarter brought in a total of $32.8 million, representing a whopping 88% of the company’s total sales revenue of $37.3 million. At a profit margin of 14.7% (including tax expense), this brings total earnings to $5.5 million per quarter. The stock prices in a continuation of the double-digit sales growth that Impella has been seeing since FDA clearance, although news of the investigation does make things more complicated for investors.

The seemingly permanent 30% drop in shares of ABIOMED equates to a rough discount of $230 million on the market capitalization of ABIOMED, which implies that the market is considering this to be a fair cost for the potential risks that ABIOMED faces with the litigation fees and possible lawsuits filed against them for improper marketing and labeling of Impella 2.5. Until the investigation is halted, or until it leads to additional action, I expect that the associated uncertainty will keep some pressure on ABIOMED due to the extreme sensitivity that the company’s earnings and valuation have to Impella’s performance in the medical device market.

ABIOMED is seeing general upward trend in short interest after a huge short-covering rally that occurred in early February 2012 due to a stellar Q3 2012 earnings report. I would expect to see higher short interest in reaction to the Impella 2.5 investigation (which was disclosed after October 31st, the last time that NASDAQ released short interest), although it’s not clear how long these positions will have to wait to hear more news about the district attorney’s investigation. This is also true for investors and traders who are holding ABIOMED stock. Even if the company’s financial data remains strong, the market will question the long-term sales growth of the Impella system (the bulk of the company’s valuation) so long as there is reason to believe that their marketing and labeling practices may have been illegal.