Biotech Basics 26-Apr-02 11:42 ET
[BRIEFING.COM - Robert Walberg] The industry, which has a history of boom and bust periods, is unfortunately suffering through the latter right now. Year-to-date, the Biotech Index (BTK) has shed 26%. Though oversold short-term technicals and some major chart supports (see chart below) suggest that the sector could enjoy a modest near-term bounce, we would need to see the index break above the 550 level before altering our intermediate-term bearish outlook. Given ongoing concerns over a less accommodating FDA, high-profile clinical setbacks, and the slowdown of capital into the cash-needy industry, it is difficult to make a compelling case for a sustained recovery over the next couple of quarters. Seasonally, this is also not the best period for the industry.
Nevertheless, the long-term outlook for this sector remains very promising. There's a record number of drugs/therapies in the pipeline and advances in technology have reduced the time and cost of bringing new drugs to market. While investors might want to wait for the sector to settle down before adding exposure to the group, now is a good time to start researching companies so that when sentiment turns you're ready with the stocks you want to add.
Briefing.com maintains that there are four main considerations when looking at any biotech company. They are:
Cash, Cash, Cash
One of the first steps to take in analyzing a biotech company is to make sure that it has sufficient cash to cover its burn rate for at least 1 1/2 years, though 2+ would be better. The burn rate is the amount of money spent on R&D each year. We also look for companies with current ratios of more than 2:1 (current assets/current liabilities) and low levels of debt.
Drugs in Development
It is also important that a company have drugs/therapies in the latter stages of development. And that generally means Phase II trials or later. If a company only has one or two Phase I or pre-clinical drugs/therapies, profitability is simply too far off for anyone to make anything but a wild guess as to potential earnings. Investing in such companies is a big gamble. Not that there's anything wrong with placing a couple of longshot bets in this sector, just as long as you understand the high risks going in. Recombinant Capital's web site provides an easy way to check on the number of drugs/therapies a company has in the various stages of development. You can also get a list of collaborating companies, which brings us to qualifier number three.
Collaborative Agreements
One of the most significant changes in the biotech industry over the past decade was the shift in the business model toward collaboration. Instead of trying to become the next Pfizer (PFE) all on their own, most smaller, cash-shy biotech companies now seek to form ties with the large, cash rich pharmaceutical companies. Such collaborations are usually structured so that the major drug companies provide R&D dollars (in the form of milestone payments) to the biotechs in exchange for exclusive marketing rights to any drugs that ultimately receive FDA approval. Revenues from any final drugs are typically shared as well. 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. This structure works well in that it allows each firm to do what it does best. Unfortunately, the Bristol-Myers/ImClone debacle could lead to a temporary slowdown in the pace and scale of these collaborations, thereby reducing cash flow into the biotech industry. And cash, as noted above, is the life-blood of the biotech sector.
Management
As with any industry, management is key. In researching biotech companies, look for those with experienced management teams (often top researchers/managers from old-guard drug companies) that boast a track record of successfully meeting milestone/earnings goals. Experience and success in turning research into saleable product is also an underappreciated key. Guiding drugs/therapies through the cumbersome FDA review process to marketability is not easy. Those management teams that have accomplished that task (the more the better) deserve notice.
Conclusion
Just because a company meets these guidelines, does not mean that its a sure winner. Conversely, there will be stocks that don't meet Briefing.com's guidelines that skyrocket. However, it is our experience that companies that meet these basic standards have a far greater chance of succeeding over the long haul. And if today's unforgiving market teaches us anything, it is that we need to get back to the basics.
Finally, here are a few 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. Signals Magazine, an affiliated site of Recombinant Capital, often provides well written analysis of industry trends/developments. And for general information on approved drugs, regulatory activities and industry developments we suggest looking at the Biotech Industry Organization (BIO) site.
Robert Walberg |
