Franklin Biotechnology Discovery?s Biotech Favorites TODAY
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Research Analyst: Bob Hirschfeld (1/19/00)
The Franklin Biotechnology Discovery Fund (NASDAQ: FBDIX - Quotes, News, Boards) is out of the millennial gate at a searing pace, returning over 13% so far this year, compared with relatively flat returns for the S&P 500 Index.
Over the past three months, the Discovery Fund returned 80%, versus 17% for the S&P, and over the past year, returned 98% compared to 21% for the S&P.
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This open-end fund, managed by Kurt Von Emster, is invested almost entirely in biotech stocks.
Morningstar, the Chicago-based mutual fund tracker recently termed the fund?s willingness to focus on small cap biotech stocks as both a strength and weakness -- strength in that the fund offers investors access to early-stage biotech companies, and a weakness, because the volatility of small-cap biotechs is high.
The fund, Morningstar concluded, is best taken ?in small doses.?
Von Emster noted he was one of the few managers running a biotech fund that stayed focused on biotech stocks, and didn?t migrate into pharmaceutical stocks. Emster says he looks for companies that have the attributes of biotech industry kingpin Amgen (NASDAQ: AMGN - Quotes, News, Boards) but are under- recognized by the Street.
As an example, Emster mentioned Inhale Therapeutics (NASDAQ: INHL - Quotes, News, Boards), which is developing a product that offers diabetic patients the ability to inhale, rather than inject, their insulin doses. The product is currently in Phase III trials and is being co-sponsored by Pfizer (NYSE: PFE - Quotes, News, Boards). Emster says there is a $2 billion market for the product, which is about the size of the market for Epogen, one of Amgen?s two main products. (The other is Neupogen).
But Amgen, with a market cap of $69 billion, is well recognized, and Inhale, with a market cap of $1 billion, isn?t, even though the likelihood is very high that its product will be on the market within two years.
Emster has identified three biotech macro trends. The first, a financial one, is that of ?biotech companies turning profitable.? In fact, only about 14 of the 350 or so biotech companies are currently profitable, though Emster thinks that, over the next 18 months, about 40 profitable companies will make the cut.
One portfolio holding to fit this classification is Affymetrix (NASDAQ: AFFX - Quotes, News, Boards), a company that encodes genomic data on microchips, and which Emster expects will reach profitability during the second half of 2000.
Emster?s second trend is consolidation. The manager notes that more than $17 billion worth of biotech mergers and acquisitions occurred in 1999, and Emster expects that number will be easily surpassed this year.
One holding expected to fit the trend is Cor Therapeutics (NASDAQ: CORR - Quotes, News, Boards). Cor, which had modest success with its heart drug Integrilin -- achieving $75 million in revenues -- might be acquired by a larger firm with a more extensive portfolio of cardiac care products. Emster noted that ?other people have speculated that Abbott Labs (NYSE: ABT - Quotes, News, Boards) might be a possible suitor.?
Emster?s third biotech theme is scientific in nature -- the sequencing of the human genome, a research project that will probably be completed as early as April.
Emster likes Celera PE (NYSE: CRA - Quotes, News, Boards) in this sector, which he thinks will be the first to sequence and map the entire genome. Emster noted that Celera has the second-largest computer in the U.S., and the local power grid had to be enhanced to accommodate its power. Noting that Celera shares have multiplied tenfold, rising from $20 per share to over $200, Emster says he has been recently adding shares, and that ?we?re still at the beginning of an upward cycle.?
Another name in the fund that Emster thinks is still fresh is Vertex Pharmaceuticals (NASDAQ: VRTX - Quotes, News, Boards), a company with $60 million in revenue that makes a protease inhibitor used to treat AIDS. It is sold by partner Glaxo-Welcome (NYSE: GLX - Quotes, News, Boards). Though still unprofitable, Emster says the company is a leader in small-molecule drug development, is a solid potential acquisition candidate and that it is currently trading about 100% below its intrinsic value.
?It?s been tough to make mistakes in biotech recently,? says Emster, modestly, while also admitting that, in more typical years, about five of the 40 or so names in his fund would get ?blown up,? usually on news of drug trial failures. That hasn?t happened lately, Emster said, partly because ?there haven?t been any trials announced.?
As for Morningstar's contention that the fund is risky, Emster acknowledges that his fund ?is not for the faint of heart,? while adding that his record speaks for itself.
Emster believes this year will continue to be a good one for biotech, saying, even though the fund is ?up 13% so far, he would ?hopefully add to that.? Noting that the ?group has only really been moving for 4 or 5 months? Emster says he thinks the real potential in biotech will manifest itself over the coming decade.
?If you compare biotech with the Internet,? Emster says, ?here you are getting real companies with real products with a real impact in terms of health. With the Internet, valuations can get pretty funky. There you value companies per click; here, it?s more like, per life saved,? he adds.
He wishes.
Bottom Line:
The Franklin Biotechnology Discovery Fund has a number of volatile small-cap biotech stocks that are likely acquisition targets, and are therefore positioned for tremendous revenue growth.
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