From MSN Money Central
Jubak's Journal
10 biotechs with a sky's-the-limit future
The latest blockbuster deal shows again why every investor should place a bet on biotech. Here are my choices -- and four rules to help you find yours.
By Jim Jubak
Even though neither Johnson & Johnson (JNJ, news, msgs) nor Alza (AZA, news, msgs) is a pure biotechnology stock, I think the announcement that Johnson & Johnson will buy Alza for $10.5 billion in stock is great news for biotechnology investors.
The deal confirms, in my opinion, that despite the stomach-churning volatility in the sector over the last year, the fundamentals driving the long-term appreciation in the value of biotech stocks remain intact.
That’s not small comfort, either. In the last year, biotechnology stocks have ridden a roller-coaster course that makes the path of the Nasdaq Composite ($COMPX) look almost sane. After peaking just shy of 800 on March 6, 2000, the biotechnology index ($BTK.X) fell to just a little over 405 by April 17 -- a 50% drop in a little more than a month. By late summer, though, the index was closing back in on 800. In what is now, in retrospect, a clear triple top, the index closed at 773 on Aug. 31, 801 on Sept. 28, and 786 on Nov. 2. By March 21, 2001, however, it was back at 423, having repeated the ride it took in 2000 from 800 to 400. On March 27, the index closed at 474.
I’ve been following the recent debates among analysts over whether the March 21 low marks some kind of a double-bottom in the sector. Frankly, I don’t have any idea if that’s the case, and I suspect that it’s no more possible to call the exact bottom in a sector than it is to pinpoint the exact bottom in the market as a whole.
But fortunately, the “buy and forget” strategy that I use for the portfolio of biotechnology stocks that I’ve been putting together for Jubak’s Journal since 1998 doesn’t rely on calling bottoms and tops. Following that strategy, it’s enough for me to know that biotechnology stocks are relatively cheap right now -- and that the fundamentals driving the appreciation of these stocks over the long term are still intact.
Betting on the future
Which brings me back to the Johnson & Johnson/Alza deal. Why does this convince me that the sector is still a good long-term bet despite its recent volatility? Because the willingness of big drug companies such as Johnson & Johnson, Merck (MRK, news, msgs), Pfizer (PFE, news, msgs), Eli Lilly (LLY, news, msgs) and others to pay biotechnology companies to find new drugs, and then often to buy those companies when the research pans out, is the single most important factor in supporting the stock prices of biotechnology companies.
Oh, it’s great when a biotechnology company such as Cor Therapeutics (CORR, news, msgs) actually gets a drug approved by the Food and Drug Administration, launches a successful attack on the market and racks up significant sales. Integrilin, Cor Therapeutics’ drug for angina, has recorded more than $100 million in sales over the last 12 months and is now the top drug -- by one measure, anyway -- in a three-drug market.
But most biotech companies have to be valued on their drugs-in-progress. Even a company such as Cor Therapeutics deserves a market capitalization of $1.3 billion only if its pipeline contains at least a few future winners. Biotechnology companies depend on the big drug companies to strike research and development partnerships that will help them finance the most promising of these drugs -- in exchange for a piece of the future action. Investors, in turn, depend on these deals for information on which drugs in development might be the most valuable when they finally reach the market. Investors also depend on the occasional acquisition of an entire drug development company to value a development-stage biotechnology company.
You can see how this works pretty clearly in the purchase of Alza. Johnson & Johnson is paying $10.5 billion to buy Alza, a company that analysts project will have $1.2 billion in revenue in 2001. The deal fills a growth hole in the big drug company’s current drug lineup. Pharmaceuticals accounted for about 40% of Johnson & Johnson’s overall sales in 2000 and about 60% of the company’s profits. But Johnson & Johnson has had several promising products fizzle in development recently, and blockbuster drugs such as Procrit/Eprex for anemia and Risperdal, an antipsychotic, are about to face tough new competition. In buying Alza, Johnson & Johnson gets ownership of promising drugs such as Concerta, a treatment for attention-deficit-disorder, and Ditropan XL, an incontinence drug, that Alza doesn’t have the money or the sales force to fully market. Plus Alza’s drug-delivery technologies will give Johnson & Johnson a way to improve the efficacy of its existing drugs and perhaps a way to extend their lives in the market. (Johnson & Johnson has gone this route before, having bought biotech leader Centocor in an earlier deal.)
The trends that have driven stock prices higher in the biotechnology sector in the past, and that will do so again in the future, are on exhibit in this deal. Big drug companies are still hungry for new products to fill holes in their pipelines and will pay top dollar for promising compounds. And they will pay even more for drugs that are far along or at the end of their clinical trials. That’s not a minor point. Biotechnology companies, after years of bringing almost no drugs to clinical trials, have scores of candidates ready for the Food and Drug Administration.
A sky's-the-limit future
My four-rule biotechnology strategy is based on the real potential and the real risk of investing in this sector. I think biotechnology has a sky’s-the-limit future. Some of the companies using these technologies will produce drugs that will rack up $1 billion in annual sales. Every investor, in my opinion, should have some money in the sector.
But I also know that predicting precisely which companies will wind up owning $1 billion drugs, and which will end up blowing $1 billion in investors’ capital on the drug-industry equivalent of dry holes, is extremely difficult. And I know that the long lead time from research program to drug test, and the incredible volatility of stocks in this sector, can wear out the nerves of even the steeliest investor.
That’s why I’ve built my biotechnology portfolio around these principles:
Buy enabling technologies. Look for companies that have mastered a research approach that is likely to lead to scores of potential drugs.
Buy products in the pipeline. Look for companies with a solid calendar of potentially positive news on drug tests and approvals.
Buy cash. Look for companies that have cash in hand or a proven record of raising cash to reduce the danger that they might run out of money at just the wrong moment.
Buy cheap stocks. Build a portfolio of inexpensive but promising companies, rather than trying to hit a home run by guessing the next Amgen (AMGN, news, msgs) or chasing the current market favorite.
Portfolio review
From the time I began constructing this portfolio in September 1998 until last August, I used these rules to pick 10 stocks to fill out a portfolio. Now that the list is complete, I’m going to concentrate on fine-tuning it every six months or so by replacing the stocks of companies that have lost their way -- or that simply look less promising -- with the occasional newcomer. In this column, for example, I’m going to make one new pick and drop one stock, Microcide Pharmaceuticals (MCDE, news, msgs), from the list.
Cell Genesys (CEGE, news, msgs)
3/27/01 price: $14.69
8/11/00 price: $23.94
2/15/00 price: $23.13
9/24/99 pick price: $7.88
Market cap: $501 million
Gain since 9/24/99 pick: 86%
Cell Genesys is awash in patents -- 260 granted with 320 pending -- and cash -- $260 million at the end of the December quarter (plus $190 million in Abgenix (ABGX, news, msgs) stock at the March 27 price). And its science doesn’t seem to be doing too badly, either. Cell Genesys concentrates on gene therapy, and its vaccines work by using modified genes to treat diseases such as cancer and hemophilia. On March 7, the company announced it had initiated a Phase I/II clinical trial of its GVAX cancer vaccine for multiple myeloma, the second-most-common hematological malignancy in the United States. The same GVAX technology also shown antitumor activity in an initial Phase II trial in patients with advanced metastatic prostate cancer. The company has a total of four GVAX drugs in either Phase I or Phase II trials and an additional four gene therapy candidates at the preclinical stage.
Cor Therapeutics (CORR, news, msgs)
3/27/01 price: $24.47
8/11/00 price: $46.50
2/15/00 price: $24.36
3/4/99 pick price: $4.84
Market cap: $1.3 billion
Gain since 3/4/99 pick: 406%
Cor Therapeutics has been under attack lately as a one-drug company. Every biotechnology company should be so lucky. Cor Therapeutics now projects that Integrilin, the company’s platelet blocker used to treat unstable angina and for patients undergoing heart surgery, will show revenue of $245 million to $260 million in 2001. The drug will have, the company estimates, about 20% of the market measured by dollars of sales and 45% of the market measured by patients taking the drug. Cor Therapeutics and its marketing partner Schering-Plough (SGP, news, msgs) are also hard at work to extend Integrilin’s market to other cardiovascular conditions such as myocardial infarction. But Integrilin isn’t the company’s only drug. Cromafiban, a drug with the potential to treat stroke and peripheral vascular disease is currently in Phase II trials. Other drug candidates to treat pulmonary embolism and stroke are currently working their way toward clinical trials. Cor Therapeutics had $340 million in cash and cash equivalents at the end of December 2000.
Hyseq (HYSQ, news, msgs)
3/27/01 price: $8.94
8/11/00 pick price: $36.75
Market cap: $122 million
Loss since 8/11/00 pick: 76%
There’s a new wave of hybrid genomic platform companies that sell equipment but also hope to make money out of developing drugs using the new knowledge about the specifics of the human genome to target drugs to individuals or groups of individuals. Hyseq is my favorite of this group for two reasons: The company owns a huge data base of rarely expressed human genes and it recently added George Rathmann, the founder of Amgen and Icos, as chairman. Rathman, who joined the company in February 2000, knows from experience how to guide a biotechnology company down the long road from promising technology to marketable drugs. He’s been instrumental in focusing the company on the goal of bringing two compounds into clinical trials each year. Right now, the company projects that it will take its first two candidates into the clinic late this year. Keeping that pace up for a long period of time shouldn’t be too hard for Hyseq, either. Rarely expressed genes are often triggers that control complex biochemical processes -- that makes them ideal drug targets. Hyseq has four partnerships currently -- with Chiron (CHIR, news, msgs), BASF Aktiengesellshaft (BF, news, msgs), the pharmaceutical division of Kirin Brewery (KNBWY, news, msgs) and the University of California at San Francisco -- to identify drug targets. The company is currently meeting its cash needs through a line of credit from Rathmann and will have to go back to the capital markets some time this year.
Icos (ICOS, news, msgs)
3/27/01 price: $48.13
8/11/00 price: $53.75
2/15/00 price: $35.50
9/25/98 pick price: $17.75
Market cap: $2.3 billion
Gain since 9/25/98 pick: 171%
It’s easy to forget that Icos isn’t a one-drug company. The company’s Viagra-killer, Cialis (IC351), gets most of the attention, of course. Trials on male sexual dysfunction continue on track -- it looks like the drug has fewer side effects and better onset than Viagra -- with an application to the Food and Drug Administration likely in the second half of 2001. (Trials for female sexual dysfunction are now in Phase II.) In addition, though, Pafase, the company’s drug to treat sepsis, a cascading collapse of the body’s immune system in response to a severe infection, is set to go into Phase III trials this spring. (There is no current adequate treatment for sepsis. More than 30% of the 750,000 annual cases in the United States end in death.) The company will also put Sitaxsentan, a drug to treat pulmonary hypertension, into Phase III trials this spring. A second drug for sepsis, IC14, has just entered Phase I trials. Icos finished December 20000 with $229 million in cash or cash equivalents.
Isis Pharmaceuticals (ISIP, news, msgs)
3/27/01 price: $9.69
8/11/00 price: $12.06
2/15/00 price: $11.06
9/25/98 pick price: $12.13
Market cap: $389 million
Loss since 9/25/98 pick: 21%
It’s been an up and down year for Isis Pharmaceuticals. The company recorded mixed results from a Phase III trial for ISIS 2302, its drug candidate for treating Crohn’s Disease, that led to the termination of a partnership with Boehringer Ingelheim. The stock then went under pressure as Boehringer Ingelheim sold off its shares. However, Isis will begin new Phase III trials for the drug this year. And the company has four other compounds in Phase II trials, including ISIS 14803 for hepatitis C. ISIS 3521 for non-small cell lung cancer, is currently in Phase III trials. On March 19, Isis announced a one-year extension of its research partnership with Merck (MRK, news, msgs) to develop drug candidates for treating hepatitis C. The company finished 2000 with $127 million in cash and short-term investments.
Ligand Pharmaceuticals (LGND, news, msgs)
3/27/01 price: $9.47
8/11/00 price: $10.63
2/15/00 price: $18.75
9/25/98 pick price: $9.66
Market cap: $536 million
Loss since 9/25/98 pick: 2%
You certainly wouldn’t know it from the stock price, but Ligand Pharmaceuticals has been making progress. By the end of 2001, the company should have five products in Phase III trials to go along with its FDA approved drugs ONTAK, Panretin, and Targretin for the treatment of T-Cell lymphoma and Kaposi’s Sarcoma. A fifth drug, Morphelan, a once-a-day oral form of morphine, is now waiting for regulatory approval. The knock on Ligand is that all these are very specialized cancer drugs with small markets. True enough, but in taking these drugs from trial to market, the company has developed critical expertise in managing a process that frequently trips up biotechnology companies. The company has a huge pipeline of drugs for larger markets currently in development with partners such as Pfizer for osteoporosis and breast cancer, with GlaxoSmithKline (GSK, news, msgs) for diabetes and with Abbott Laboratories (ABT, news, msgs) for inflammation. At the end of December 2000, the company had $58 million in cash and cash equivalents.
Ribozyme Pharmaceuticals (RZYM, news, msgs)
3/27/01 price: $5.92
8/11/00 price: $26.13
2/15/00 pick price: $28.50
Market cap: $91 million
Loss since 2/15/00 pick: 79%
Ribozyme shows the power of money. The company used some of the almost $60 million it raised in the first half of 2000 to reacquire product rights from Chiron and Eli Lilly and to accelerate its drug development program. Along with its partner Chiron, Ribozyme has taken Angiozyme into Phase II trials for metastatic breast cancer and has begun planning for Phase II trials for the drug candidate in colorectal and kidney cancer. Heptazyme, a potential drug to fight hepatitis C, has moved into Phase II trials after successfully completing its Phase I test in April 2000. Two other drug candidates for breast cancer and hepatitis B are about to enter trials. Ribozyme Pharmaceuticals finished September 2000 with $37 million in cash and cash equivalents. In late December, the company entered into an agreement with Acqua Wellington North American Equities Fund that would require the fund to buy up to $60 million in Ribozyme stock in $1 million to $8 million lots, at Ribozyme’s request, during the next 28 months at a discount of no more than 5% from the current market price.
Vertex Pharmaceuticals (VRTX, news, msgs)
3/27/01 price: $34.63
8/11/00 price: $61
2/15/00 price $26.40
9/25/98 pick price: $12
Market cap: $1.9 billion
Gain since 9/25/98 pick: 189%
Vertex Pharmaceuticals has a lot on its plate. Its one drug already on the market, Agenerase, a protease inhibitor sold in partnership with Glaxo, is projected to show sales of $95 million in 2001 -- resulting in about $15 million in royalty income for Vertex. The company has an additional 12 compounds in development. The most promising include VX-745, now in Phase II trials for rheumatoid arthritis, VX-497 in Phase II trials for the treatment of hepatitis C, and VX-175 in Phase II trials for the treatment of HIV. Thanks to a huge deal with Novartis (NVS, news, msgs), the company will be ramping up spending on research on discovering new drug targets for kinase proteins, a class that has been implicated in everything from cancer to cardiovascular disease. Vertex is obligated to provide Novartis with eight clinically and commercially relevant drug candidates and Novartis is to provide research funding and milestone payments that could reach as high as $800 million over the life of the deal. The company ended 2000 with $707 million in cash and cash equivalents
Vical (VICL, news, msgs)
3/27/01 price: $10.31
8/11/00 price: $18.38
2/15/00 price: $50.88
9/25/98 pick price: $10.88
Market cap: $206 million
Loss since 9/25/98 pick: 5%
At the American Association of Cancer Research annual conference this month, Vical presented evidence showing positive results for its Vaxid naked-DNA vaccine in the treatment of low-grade non Hodgkin’s B-cell lymphoma. This is the first time that the company has presented evidence that a naked DNA vaccine is safe for human cancer patients and marks an important milestone in establishing that a naked DNA cancer vaccine -- based on each patient’s own cells -- could work. Besides Vaxid, the company is conducting Phase II trials for Allovectin-7 in melanoma, Phase II trials for Leuvectin in kidney cancer and Phase II trials for a malaria vaccine. The company expects results for the trials for kidney cancer and malaria in the second half of 2001. The company finished September 2000 with $20 million in cash and cash equivalents and $131 million in marketable securities on its balance sheet.
One more for the portfolio to replace Microcide -- and I’ve got 10 again. I’m dropping Microcide not because the stock has tanked -- it’s up 8% since I added it on March 4, 1999, at $3.88 a share -- but because the company hasn’t made enough progress, in my opinion, toward developing a full pipeline of drug candidates. That relative lack of progress sent me looking for a company with a broader drug discovery platform and a larger stable of promising drug targets. My candidate?
NPS Pharmaceuticals (NPSP, news, msgs)
3/27/01 price: $24.31
Market cap: $565 million
The company, formed in a merger with Allelix Biopharmaceuticals in 1999, has developed an expertise in the body’s calcium receptors and is specializing in developing small molecules and proteins as drugs for bone and central nervous system diseases. Its lead project, ALX-11 for osteoporosis, is not in Phase III trials. But the “jackpot” product, under development with partners Kirin Brewery and Amgen, is a potential drug for hyperparathyroidism. That disease, which is characterized by excessive levels of parathyroid hormone and calcium in the blood, affects more than 1 million people in the U.S. The drug candidate is currently in Phase II trials. The company finished December 2000 with $237 million in cash and cash equivalents.
That’s it for now. I’ll update this portfolio in another six months. At that time, since we’re at the 10-stock maximum for this portfolio, I’ll again look for candidates to improve the group. I hope no buy-and-holder will be too upset if we trade once every six months or so. |
