Robert Walberg
briefing.com
Biotechs: Not Again
10-Mar-00 08:00 ET
Those with long memories are probably skeptical of the near vertical advance in the biotech industry. They remember the group's similar rush in the early 80's. A rush that was followed by a sharp, broad-based, long-lasting decline. Are today's biotech investors setting themselves up for another fall?
Yes, and no. Mostly no. As we noted in a Brief dated 2/6/98, the biotech industry has transformed itself over the past few years by adopting a new business model based on collaboration. The 80's game plan called for biotech firms to spend big on R&D, develop a host of new drugs, bring them to market and take on the large pharmaceutical companies. For all but a few players the plan was a disaster, as the barriers of entry (manufacturing, marketing and distribution costs) proved to be too high and the drug conversion rate too low and unpredictable. But by moving to a collaborative model, in which the smaller, cash-shy biotech companies form alliances with the large, cash rich pharmaceutical companies, the biotech industry has prospered.
Under this model the drug companies provide R&D dollars to the biotechs in exchange for exclusive marketing rights to any drugs that ultimately receive FDA approval. The companies then (typically) share the revenues from the approved drugs. The drug companies benefit in that collaboration reduces discovery failures, lowers costs, increases productivity and improves innovation. Biotechs win out by tapping into a large and steady source of capital, and by obtaining access to the sales and marketing power of the major drug companies. Whereas there were about 60 such alliances/joint ventures in 1993, there are now several hundred. The result has been an increase in R&D spending and a surge in the product pipeline.
Advancements in drug discovery methods, favorable demographics and an improved political climate (in which the approval time for new drugs/therapies has been cut in half) are a few more reasons why today's biotech investor need not fear a 1980's like crash. But even so, investors must be careful in choosing stocks. A task made difficult by the complexity of the industry. Let's face it unless you have a degree in molecular biology this stuff can get pretty murky.
To clarify the picture a bit and to make the selection process easier (and we hope more successful), Briefing.com devised a four-step screening process for biotech stocks. It has served us well over the past couple of years. Here they are:
Cash, cash, cash. Companies should have sufficient cash to cover their burn rate for at least two years. The burn rate is the cash needed to fund R&D. We also look for companies with high current ratios and low debt/equity.
Several drugs/therapies in the later stages (Phase II or later) of clinical development.
Numerous collaborative agreements with major pharmaceutical companies. Biotechs that meet this standard will be better positioned to deliver on the promise of strong earnings growth. You also want to make sure that the large drug companies have experience in marketing the kind of drugs being researched by their biotech partners.
Management should be experienced and boast a track record of successfully meeting milestone/earnings goals. Experience/success in turning research into saleable products also an underappreciated key.
Briefing.com maintains that companies that score passing grades in at least three (and preferably all) of these areas stand a very good chance of continuing to outperform the market over the long-term.
You might also want to take a look at a number of valuable industry Web sites to assist you in making the right investment decision. One of our favorites is Biospace.com. The site provides a wealth of information on hundreds of companies. It identifies the day's biggest percentage movers; provides industry news; IPO info; upgrades/downgrades; and a comprehensive events calendar. Recombinant Capital offers another excellent site. What we love about their site is that you can type in the name of a biotech company and find out how many drugs/therapies it has in the various stages of development. You can also get a list of collaborating companies. An affiliated site is Signals. Finally, for general information on approved drugs, regulatory activities and industry developments we suggest looking at the Biotech Industry Organization (BIO) site.
Using our own screening process and information gleaned from the sources profiled above, Briefing.com has enjoyed decent success in selecting biotech winners over the past couple of years. Some of our successes include Myriad Genetics (MYGN +982%), Human Genome Sciences (HGSI +718%), Biogen (+335%), Incyte Pharmaceuticals (INCY +323%), Chiron (CHIR +211%), Vical (VICL +206%) and Ligand Pharmaceuticals (LGND +162%). We also issued a Brief entitled, "Ten Biotechs for the Next Decade" back on 12/21/99. As of yesterday's close, the group is up 122%.
Nevertheless, in strong industry-wide rallies such as the one taking place in biotechs at the moment, undeserving stocks usually rise right along with the quality ones. Those investors who haven't done their homework, and have bought stocks because of price, press release, or chat room hype, are likely to suffer the same fate as the biotech investor of the 80's. Maybe not today, maybe not tomorrow, but soon. Conversely, if you adhere to a disciplined approach to stock selection, avoid the hype and take advantage of the myriad of online resources, you should be able to profit from the great potential this industry has to offer over the next decade.
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