The Smart Way to Play DNA
individualinvestor.com
Research Analyst: Bob Hirschfeld
Genomics is the study of the human genome, the biological database that nature downloads into our cellular structure.
To investors, genomics means pure stock market adrenaline.
As Salomon Smith Barney analyst Meirov Chovov points out, since last November, genomics stocks have outperformed biotech stocks, as measured by the BTK index, by 50 percentage points, gaining 180% versus 130%. And the S&P 500? Up a meek 5% over the period.
Since most of us know that the human genome is almost fully sequenced, investors are asking, "What's next?"
According to Chovov, the next big thing is companies that "go behind the code" and "provide biological context" for therapeutic intervention.
Helping put the code into context are two segments, SNP analyzers, which study the effects of genetic variations on clinical outcomes and thereby help refine drug targets, and genetics database firms, those that help to statistically validate drug targets.
SNPs
SNPs (single nucleotide polymorphisms), called "snips," are the variations in our DNA that make each of us unique.
A recent example of SNP analysis, reported in John McCamant's Medical Technology Stock Letter, concerns Genaissance (NASDAQ: GNSC - Quotes, News, Boards), which recently calculated that asthma sufferers respond to the drug Albuterol according to genetic differences.
Knowing this, it's possible that future patients can be tested to see if their genes indicate a muted response to Albuterol, in which case a separate asthma medication might be prescribed. A further possibility, the Letter notes, is that drugs with harsh side effects that are SNP-linked to a particular genetic make up can be "resurrected."
The implication is that if genetic databases can sort the human genome and suggest targets of opportunity for potential new drugs, SNP analysis can refine the entire process of drug targeting.
And the pharmaceuticals industry could use some help. As Chovov notes, drug companies currently face multiple patent expirations and a dearth of new products. In short, the industry needs promising drug targets, and that's where genomics firms can help.
In the highly targeted SNP space, Chovov rates just two stocks as 'Buys,' Orchid (NASDAQ: ORCH - Quotes, News, Boards), which provides screening tools to study minor genetic variations, and Genaissance, which correlates individual variation with drug responses. Both are recent IPOs. Orchid came public in May and Genaissance in August, and neither company has much in the way of current revenue. Chovov forecasts year 2000 revenue of $17.9 million for Orchid and just $700,000 for Genaissance.
Though Orchid just recently went public, it's considered one of the oldest companies in the SNP space. Its primary business is developing SNP-scoring instruments that detect and score medically relevant SNPs, which can be used to determine drug efficacy, as well as drug susceptibility in any given individual. Orchid also runs a lab testing business, GeneScreen, which provides forensics and paternity testing.
On September 27th, GeneScreen received a contract from the New York Police Department to screen existing criminal evidence for DNA samples, which are to be compared with DNA "fingerprints" in other law enforcement databases. The hope is to solve heretofore "unsolvable" cases using DNA evidence already available.
Chovov wrote that Orchid's second quarter revenue, at $4.6 million, exceeded her estimates, adding that the company beat its delineated milestones by achieving higher placements of its SNPstream 25 K product (its platform for conducting SNP genotyping) with a growing list of partners, including key industry suppliers Applied Biosystems (NYSE: PEB - Quotes, News, Boards) and Amersham Pharmacia Biotech (NYSE: NYE - Quotes, News, Boards).
Citing Orchid's "superior SNP testing technology" and forecasting a 35% revenue growth rate, Chovov values Orchid stock at 52 times year 2002 revenue, generating a target price of $60. Orchid was recently at $27.
Genaissance, another "pharmaceutical support group" company, employs population genomics data to improve the processes of drug development and drug prescription. The company provides clients with its proprietary haplotype, or HAP markers, to predict either a drug response or disease predisposition.
Haplotypes are groups of SNPs and such markers are considered more predictive than single SNPs. Genaissance generates revenue from subscriptions to the HAP Maker database and fees from the use of DecoGen software, which correlates genetic variations and drug responses in a graphical interface.
Chovov says fees-for-service may come from HAP typing of clinical samples, which is expected to help drug companies initiate "smarter" clinical trials. And additional revenue is expected from Genaissance's Mednostics program, which uses HAP technology to investigate drugs already on the market and to resurrect those taken off market.
A potential case of "drug resurrection" would be the former Warner Lambert, now Pfizer (NYSE: PFE - Quotes, News, Boards) drug Rezulin, a drug of known clinical utility with toxicity problems. Rezulin was supposed to be a blockbuster Type II diabetes drug, until it was found that the drug induced liver toxicity in a small percentage of patients. That discovery forced the withdrawal of the drug from the market, depriving the company of about $4.5 billion in potential revenue.
In theory, the use of Genaissance HAP Technology could identify the markers associated with Rezulin-induced liver damage, and with those patients safely excluded, the drug could be safely reintroduced. But that is pure theory, as no "resurrection"-type contracts have been announced.
Genaissance is a very early stage company. Chovov forecasts year 2000 revenue of just $700,000, ramping to an expected $43 million in 2002. The analyst values Genaissance at 20 times the $43 million figure, which produces a target price of $32 per share. The stock was recently at $20.63.
Are SNPs the answer to the drug industry's need for more and better drugs? Maybe -- someday.
Mehta's Dr. Yi Ri notes, "SNPs are exciting, but it's way too early to call the winner. Remember, the genome right now is like a lot of jumbled letters. There's definitely a good story in there -- maybe a million good stories -- but nobody's gotten to the point where they know what the story is."
That view was echoed by John McCamant, who said it may take years to develop SNP-based drugs, adding that such early-stage biotech companies as Genaissance and Orchid bear an unusual amount of investment risk. Noting that both firms are small caps and that Orchid is involved in an intellectual property dispute, McCamant said, "Sometimes it's better to be bigger."
Genomics Database Companies
Who is bigger? Consider database companies like Incyte (NASDAQ: INCY - Quotes, News, Boards) and Celera (NYSE: CRA - Quotes, News, Boards), says McCamant. Both are at the forefront of the current "land grab" to patent SNPs, and neither company needs to trumpet its accomplishments in the SNP space. McCamant's preferred and safer way of playing the latter issue would be to buy Perkin-Elmer (NYSE: PKI - Quotes, News, Boards) , the parent holding company of Celera.
Among genomics database companies, Chovov mentions Incyte, Celera, which recently announced that it has located 2.4 million of the 3 million SNPs predicted for the human genome, and Affymetrix (NASDAQ: AFFX - Quotes, News, Boards), a company that produce chips based on DNA microarrays. The analyst is cautious on Affymetrix, citing an increasingly competitive environment and pending patent litigation, rates Celera Outperform, calling it "not cheap," and rates Incyte a Buy.
Incyte, a leading provider of genomic information, makes its money by selling subscriptions, typically for about $5 million per year, to clients, which include 19 of the top 20 pharmaceutical companies. The company may receive milestone and low single-digit royalty payments from collaborators who successfully develop products using its databases. To date, Incyte holds over 30,000 royalty licenses, and these might be considered, Chovov suggests, "call options" on potential drugs.
According to Chovov, "the company has build significant barriers to entry that lower the competitive threat to its core database business." Protection of sorts is provided by the gene patents the company has staked out: Incyte is currently the single largest holder of gene patents, holding about 8% of all gene patents issued to date.
Nor is Incyte any stranger to SNPs. According to McCamant, because Incyte did most of its data sequencing within genes, "their database may contain many of the most valuable SNPs." Incyte's SNPs are the basis for its collaboration with Sequenom (NASDAQ: SQNM - Quotes, News, Boards), announced October 2nd, under which Incyte exchanges SNP data for royalties and pull-though revenue on its other genomic information products.
Though Incyte will be unprofitable this year due to high technology investment, Chovov forecasts $180 million in year 2000 research and development (R&D) spending, compared to $195 million in revenue. The company has been profitable in the past and will likely turn profitable in 2002 when R&D expenses as a percent of sales begin to ramp down. Chovov forecasts earnings of $0.25 per share for 2002.
Chovov looks for a year 2000 loss of $0.45 per share, though she argues that Incyte's R&D expenses might as well be capitalized, rather than expensed. Given that premise, and assuming a four-year amortization rate, Incyte is clearly profitable, and would in fact earn $0.35 this year.
Chovov values Incyte in terms of its technology/revenues ratio, and believes that a multiple of 10.5 times forecast 2002 revenue is appropriate. The analyst notes that the stock, which currently trades at 7 times revenue, is attractively priced compared to Celera, its closest genomic database comparable, which trades at 29 times revenue. The analyst's target price on Incyte is $54 per share. The stock was recently at $41.31.
Bottom Line:
Buying buzz-word stocks like "snips" can be risky. When investing in a white-hot sector like genomics sometimes it pays to be cautious. A lower-risk approach is to buy the genomic database companies, which contain a mountain of SNP data, all of it for sale, that are working from enormous revenue bases: for 2000, Incyte should post $195 million, and Celera $47.5 million. The combined revenue of Orchid and Genaissance, in contrast, is estimated by Chovov to total just $18.6 million for 2000.
I.I. Online's profiles are condensed reports on companies that may be attractive investment opportunities. You should thoroughly investigate any company presented here before making any investment decisions. |
