Biotech's Quiet Rally


Biotech's Quiet Rally

A good first quarter and a rush of deal-making has revived the sector. For smart investors with a stomach for risk, there could be some finds.

News that billionaire takeover artist Carl Icahn has pushed Medimmune (MEDI) to put itself up for sale is one reason that biotechnology is back on the financial pages. It seems like ages since biotech reigned as the investment world’s Next Big Thing, only to crash and burn. But the sector’s long-awaited resurgence appears to be in sight.

A fair number of laboratory-stage companies with names that all sound alike are closer to marketing useful medicines. Venture capitalists, private-equity investors and large pharmaceutical companies are ramping up their stakes. In 2006, biotech “financings,” which includes public stock and debt offerings and private-equity commitments, totaled $47 billion. That was up 35% from 2005.

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If you’re a small part of this investor base, you should be feeling good so far this year. In first quarter 2007, stocks of small and midsize biotech companies rose about 4% on average, according to Burrill & Co., an investment firm that specializes in the sector. Big biotech only broke even, but that’s mainly because Amgen (AMGN), the second-largest player after Genentech, fell 18%. Genentech (DNA) was up 1% for the quarter.

Both of these giants have held steady so far in April. But shares of other big biotech companies and, especially, the stocks of some of the small outfits are going places. Two exchange-traded funds, First Trust Amex Biotechnology Index Fund (FBT) and PowerShares Dynamic Biotech & Genome Portfolio (PBE), which are light on Amgen and Genentech, are both up 8% year to date through April 17. The sector’s five-year annualized return is an uninspiring 4%, so the trend is encouraging.


Analyst Brian Lester of Manning & Napier, which runs several mutual funds, including Manning & Napier Life Sciences, says the industry is indeed back in favor. “It’s getting more and more analyzable every day,” he says. That’s opposed to the older (can’t say old) days when speculators, including some mutual fund managers, would buy stocks on the basis of expected announcements at medical conferences or on the results of clinical trials. This bred exaggerated all-or-nothing thinking and gave biotech the reputation as a place for making—or losing—a fortune quickly. Remember how Martha Stewart got in trouble? Trading in biotech.

The reality is that science doesn’t work on stock traders’ schedules. The waiting period for research and investment to generate sales and profits is as long for biotech as for any other industry, probably longer.

Lester says it is impossible to predict what the Food & Drug Administration will do with any drug application, so he advises strongly against short-term trading or picking out one or two small companies. But he also refers to a Bear Stearns study that concludes that if you invest in small biotech companies after their prices fall, you can do well if the company still has cash in the bank and products in the pipeline.

Dendreon (DNDN) is an example. Late in March, its shares tripled after an FDA committee declared that Provenge, Dendreon’s drug for prostate cancer, should be approved quickly because there is substantial evidence that it is safe and effective. A final decision is due May 15. Dendreon hadn’t been much of an investment for several years, but unless the FDA’s higher echelons overrule the staff’s recommendation, the company suddenly has real potential.


Other companies with cancer-related drugs in the later stages of clinical trials include Antigenics (AGEN), Ariad (ARIA), Biomira (BIOM), Cell Theraputics (CTIC), Immunomedics (IMMU), Introgen (INGN), Medarex (MEDX), Pharmacyclics (PCYC), Regeneron (REGN), Sonus (SNUS), Spectrum Pharmaceuticals (SPPI), Telik (TELK), and Threshold (THLD).

All of these stocks have collapsed from insanely high prices in the late 1990s or early in this decade and most now trade for less than $10. But these companies are all still in business, which tells you something. If you have a few spare bucks in your account for taking a flyer, this is the best time in years to bet on back-down-to-earth biotechs. Just make sure to spread your money around several of them—and, please, use only money you can afford to see disappear entirely.

If you prefer your biotech served up in a fund, and that’s clearly the right way to go unless your risk tolerance is off the charts, look for one that’s willing to invest in lesser-known names. The two ETFs mentioned above are good candidates. But Fidelity Select Biotech (FBIOX), a regular mutual fund, and exchange-traded Biotechnology Holdrs (BBH) are stuffed with Amgen and Genentech—which you can buy on your own.

What about those biotech giants? Lester and other research analysts now lump Amgen and Genentech with other big drug stocks, such as Eli Lilly, Merck and Pfizer. Amgen, which closed April 18 at $60.01, trades at 14 times estimated 2007 earnings per share, which is a good value based on its past price-earnings ratio. But the relatively modest valuation may be investors’ way of saying that the days of fast growth for its key anti-anemia product are over. Genentech, which closed at $82.09, trades at 28 times 2007 estimates. The stock seems to be in a rut.


This leaves the middle layer of biotech companies. One of those is Medimmune, which has been a strong stock so far in 2007 because of the buyout talk. It shares are up 33% year-to-date. The story started in February when Icahn said he owned more than 1% of Medimmune and indicated that he would fight for a change in management.

Icahn may have had good reason to take on Medimmune. The company has been a world-class tease because of its disappointing efforts to develop and sell a flu “vaccine” you take through the nose. FluMist is a real product, and the idea sounds great, but it’s failed to grab a big slice of the market, partly because it doesn’t store well. Sales volumes have been moderate and those FluMist containers that make it to drug-store shelves sometimes spoil. That’s why the five-year return of Medimmune’s stock was zero until a few weeks ago.

However, the FDA now has approved Medimmune's CAIV-T, a refrigerator-stable version of FluMist. And Icahn’s campaign to get the company sold and the stock price into the $40s or higher has already worked.

Look for Medimmune -- which does have some other drugs -- to be sold for between $45 and $50 a share before it gets too hot outside. The stock closed at $46.70 on April 18, up 3.6% for the day.


Will any other midsize biotech firms go the way of Medimmune? Probably. There were four acquisitions in the first quarter of 2007 valued at more than $1 billion, plus about a dozen “partnering” agreements of small biotechs with big pharma companies. Those deals testify to a biotech firm’s legitimacy and provide regular cash flow. The sector will continue to have trouble shedding its reputation as the Wild West of health care, but you get the sense that it’s becoming a more settled place.