"Halftime Review"--Multex/MarketGuide:>>>Biotech Corner Fire And Ice
By Erik C. Dellith
June 29, 2000
Although biotech stocks were very volatile during the first six months of this year, the second half should be a little calmer
In recent weeks, I have discussed biotech stocks grouped by indication, that is, the disease or disorder that each researches. This week, I will take a break from that theme. Instead, as part of our Halfyear Report Series, I will provide a recap of the biotech sector's performance during the first six months of this year and take a look at what we may expect for the latter half of 2000.
And They're Off
Biotech stocks churned out a solid performance last year, which provided strong momentum for the first couple of months of 2000. At the tail end of 1999, many genomics companies (those biotech firms involved in the mapping of the human genome) announced vast research gains. Celera (CRA), in particular, was making considerable headway in mapping the human genome. News of research advances drove the stocks of many biotech companies to record highs, and triggered a round of buying throughout the group. Companies like CRA, Incyte Pharmaceuticals (INCY), and Millennium Pharmaceutical (MLNM) posted stunning stock-price gains that helped make biotech one of the best performing sectors last year.
This enthusiasm carried over into this year. Investors continued to plow money into biotech stocks, pushing share prices through the roof. In fact, the AMEX Biotech Index, already at a record high, more than doubled from the first of the year to early March. And then, as I pointed out in the 3/16/00 Biotech Corner, given a run-up like that, one has to figure that investors were going to take a breather at some point in time.
What Goes Up, Must Go Down
Following the run up that peaked in early March, investors left the sector with much haste, sending shares plummeting. This sell-off was exacerbated by concern over patents and rights to intellectual property. On 3/14/00, both President Clinton and Britain's Prime Minister Tony Blair proposed making public the raw data on the human genome. The statements sent many biotech issues, already trading off of their recent highs, spiraling lower, as investors feared that these companies would lose their proprietary rights to this information (and lose out on lots of revenue and profits). However, this was largely misread by the market.
One key factor to point out here is that the Clinton/Blair comments pertained to the raw data of the human genome. This is information that was going to enter the public domain once the government completed the mapping, anyway. Also, the raw data is not necessarily where many of these biotech companies were going to be earning their money. Mapping the human genome is a goal for many of these companies, but not necessarily for commercial purposes. In fact, it is estimated that only about 3% of the genes in the entire genome will be of any commercial value to these biotech companies.
General equity market volatility, brought about by uncertainty over the potential for the Federal Reserve to raise interest rates, did not help matters. While this sector may generally be resilient to interest rate fluctuations, investor sensitivity was already heightened. The result was the financial equivalent of pouring salt into an open wound.
A Volatile Market
This sector continued to lose ground until April, dropping to approximately its early January level. Although biotech stocks bounced off of these lows, they really were not experiencing a rebirth. Instead, many of these issues gyrated within a large band. The Index, for example, traded between 400 and about 550 until late May.
The market sell-off, and the following volatility, also hampered many initial public offerings (IPOs). Many biotech firms expecting to reap massive profits from an offering in March or April suddenly found themselves having to rethink this plan. Some put the idea on the shelf for the time being, while others wound up selling more shares and for considerably less than management had initially intended.
Genomic Solutions (GNSL) is an example of a recent IPO that felt the ill-effects of this volatile market. The company, which develops and markets genomic and proteomic (relating to proteins) services, instrumentation, and software, started off in February looking to raise about $100 million in an initial offering. By the time of its offering in early May, GNSL sold 7 million shares at a price of only $8. Then, when the underwriters purchased additional shares (660,000 shares at a price of $5.28 million), pursuant to their overallotment option, GNSL had raised only $61.28 million and sold nearly 7.7 million shares.
Heading Higher, Again?
Since then, however, investors have found their way back to this sector, and it has been rebounding nicely. As a result, the AMEX Biotech Index is up about 63% from its April low (but it is still about 18% off of its 52-week high established in early March).
Although the Index is rebounding, it has not yet again doubled its early January value. However, that is not to say that many biotech stocks have not accomplished this feat. In fact, out of the 443 stocks in the Market Guide Biotechnology & Drugs category, 129 of them are currently at least double their value from six months ago. Click here to download an Excel spreadsheet of the 129 winners so far this year.
(By comparison, there are 97 biotech stocks that are either unchanged or below their value from the beginning of this year. Click here to download an Excel spreadsheet of the 97 laggards over the trailing six months.)
As you can see by these two lists, the market has not favored any particular market cap or segment of the biotech industry. For instance, even though genomics firms have been making headlines, there are still many biotech companies doing this kind of research that have not done well. While there are many factors that go into investing in this sector, there are a few key points that are especially worth mentioning.
Factors To Consider
In early Biotech Corner articles, I mentioned several factors that investors should take into consideration when thinking about investing in a biotech stock. The first is the company's product lineup, and whether or not it already has a product on the market. If it does not, then the next thing to look for with a development-stage company is where its investigational products are in the regulatory approval process.
Another factor to consider when investing in this sector is the potential size of the market. In other words, take a look at the number of people who have the certain type of disease or disorder that the company is researching. I have written the Biotech Corner articles over the last several weeks with this particular thought in mind. Take a look at a disease, and see what companies are developing treatments for it. This way, you get a clear picture to the firm's true competition.
Also, it is important to note any partnerships. As I pointed out in the 3/9/00 Biotech Corner, many of these firms pursue research and marketing agreements with either other biotechs or pharmaceutical companies. This helps to reduce the costs of research and thereby spreads the financial risk of failure. Furthermore, through these agreements, biotech companies partner with other firms for obvious marketing benefits. In exchange for a portion of the revenue, a large pharmaceutical firm will have its sales force push the product. In doing so, the product will likely reach a larger part of the market faster than if it were sold by the biotech company alone.
These general ideas provide a starting point for investing in this sector, though it should be remembered that nothing is 100% fool proof. While it is doubtful that all of the top-performing companies for the first half of this year fully meet these criteria, these factors do provide a stable framework for making investment decisions in this sector.
The Second Half
Given the current state of the economy, with growth slowing and inflation still under control, it is likely that market volatility relating to uncertainty over interest rates will ease. With this extra risk taken off the table (and the formerly salted wound now healing), the biotech arena should be a much friendlier place to established companies and IPOs alike.
Overall, the members of this sector continue to make substantial research gains, developing and introducing safer and more effective methods of treating disease. With this in mind also, the general outlook for biotech stocks through the rest of this year is rather optimistic. But that does not mean that we will see the same kind of across-the-board buying and selling that characterized the first quarter, especially now that investors have a clearer picture of the human genome and the limits to the current technology. As such, it is likely that there will be more discriminate trading taking place. In this environment, it is even more important to keep in mind those key points about investing in this sector, which I discussed above.
Looking at the top and bottom performers of the biotech arena thus far this year, we notice that success does not necessarily depend on size or market segment. After all, there are some companies in the hottest areas of biotech that were among the bottom dwellers. Meanwhile, just because a biotech company servers a cooler part of the market, does not mean that its stock is doomed. In short, there are many attractive opportunities out there for the investor willing to do some research and stick to the fundamental points.<<<
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