'Moonshots' In Biotech Beg Patience
By Fred Barbash
Sunday, June 11, 2000; Page H01
I confess that of all the market sectors, biotechnology is the one that is most daunting to me. I've been wary of putting money into it and wary of writing about it.
It carries unique risks. Apart from the complexity and the volatility of biotech stocks, many companies in the industry go public not only without earnings, but also without a product to sell.
Investing in the sector seems to require someone who combines investing skill with degrees in molecular biology and medicine.
As it happens, such a person actually exists. He's Kris Jenner, manager of T. Rowe Price's Health Science Fund. He earned his doctorate in molecular biology from Oxford and his MD from Johns Hopkins. For good measure, he did cancer research at Harvard Medical School and played Big Ten football as a quarterback at the University of Illinois.
Jenner is passionate about the promise of biotech. "There's a sense that this industry really matters. . . . It's developing products that can fundamentally impact our well-being." And he can get excited about the potential financial rewards.
"The majority of these companies have small capitalizations. The potential for an investor is that you can get an enormous leveraged effect if one of these companies gets a drug"--twenty-fold returns and higher, what he calls "moonshots."
But he's sober about the risks. The drug may never get off the launch pad. And the company, having burned through its money doing research, can disappear.
A perfect example of risk and promise, he said, is Neurocrine Biosciences (NBIX), which his fund holds. It's working on drugs for depression and sleep disorders.
"That could absolutely be a moonshot, provided that their new mechanism of action to treat depression is successful," said Jenner. "It could go up twenty-fold from here. Yet it carries a fair amount of risk because it doesn't have approved drugs on the market, isn't producing recurring revenues and is clearly testing new areas of biology.
"Biology is one of the last great frontiers of complexity. The scientific knowledge allows us to understand the behavior of subatomic particles. But when we build up from that, the complexity expands geometrically for biological systems."
So despite what he considers justifiable excitement about breakthroughs, he said neither scientists nor investors "have good methods to say that compound A will be successful and compound B will not."
"We are dealing in a universe where you have tens of thousands of variables that can affect the outcome," he said.
The two big lessons I drew from our conversation is that investors in biotech require not only time for research and knowledge, but also extraordinary patience--10 to 15 years' worth of patience--and a willingness to buy a bunch of companies to offset the ones that fail.
The alternative--quite naturally recommended by Jenner--is to turn over your money to a fund manager.
Let's start with patience.
The companies that have produced great earnings started researching their drugs 10 or 15 or 20 years ago.
It can take a decade just to bring a product from concept to testing on human beings. Many don't make it that far through the regulatory process.
"During this period, the company is not generating cash. It's consuming cash, and therefore its financial health is generally not improving. It's either staying the same or getting worse," said Jenner.
Those products that pass regulatory muster--approved as safe and effective by the Food and Drug Administration--then must confront the marketplace. "I can show you situations where the product, while approved, never had enough potential" to build up the company. The product just isn't big enough to move the company to the next level.
"This is where a lot of these companies run into trouble. They don't have enough money to enable them to have success number two and success number three."
Is there any way to reduce the risk of a biotech investment? Yes, said Jenner. Buy the company after its product is approved for late-stage human testing or, indeed, after its product has been approved for sale.
Surely, I responded, this is too late.
He pulled out a chart showing the growth of the stock of Gaithersburg-based MedImmune (MEDI), based in part on its development of a drug called Synagis for respiratory problems in infants.
Synagis went into late-stage human testing in November 1996, at which point MedImmune stock was trading at about $2.50 (split adjusted). The FDA approved Synagis for the market on June 19, 1998, when MedImmune was selling for about $10.
Friday, MedImmune closed at $64.
Those who bought before FDA approval for testing have gains of up to 3,500 percent--but they took enormous risks.
Investors who waited as long as two weeks after the FDA's final approval took much less risk and did much less well--though well enough. Those who bought then and have held the stock since have a gain of roughly 500 percent in two years.
Buying after commencement of late-stage human testing or after FDA approval "eliminates the regulatory risk," if not the commercial risk, said Jenner.
MedImmune's annual net earnings, meanwhile, soared to $123 million in 1999 from a loss of $30 million in 1996. The company now has three products on the market and seven in the testing pipeline.
That, said Jenner, is the biotech business model.
"Most biotechnology companies are striving to be fully integrated biopharmaceutical companies. . . . What distinguishes them is that they have a product or products on the market that produces cash. A large chunk of the cash goes back to research and discovery," with the idea of producing more cash.
Other examples he and others cite of such success are Genentech (DNA) and Amgen (AMGN).
If you could identify these companies early, of course, you'd become very rich. But predictability seems more elusive in biotech than in any other field of investing.
Jenner cites the struggles of a company called PathoGenesis (PGNS), good enough to have marketed a drug for treatment of cystic fibrosis but unable to make sufficient money from it to go further. It's hired Goldman Sachs to help it out of trouble, perhaps by finding a partner or a buyer.
"The product just isn't big enough to move the company to the next level," said Jenner. "This is where a lot of these companies run into trouble." The stock traded for $20 last August and closed Friday at $23.50.
At a further end of the risk spectrum is North American Vaccine (NVX) of Columbia, which is working on whooping cough vaccine, among other things, and at its peak in 1997 traded at about $28.50. With little financial progress to show, it closed Friday at $4.25.
Baxter International is a likely buyer of North American Vaccine, for a price to be determined by North American's stock value at the end of June.
So here was a relatively solid biotech bet that nevertheless stumbled.
With such variations, said Jenner, "you've got to take a portfolio approach."
T. Rowe Price's own Health Sciences Fund is indeed quite broad. It is about a third biotech, a third pharmaceutical, and a third medical devices and related health and science services.
Among Jenner's holdings now, in addition to the successful companies already mentioned, are Neurocrine Biosciences (NBIX); QLT Photo Therapeutics (QLTI), which developed Visudyne, an FDA approved therapy for macular degeneration; and Cephalon (CEPH), which has a drug approved for treatment of narcolepsy.
Incidentally, Jenner believes that human genome research, private and public, is a "milestone in human history" but many years away from producing marketable therapies.
And why did Jenner, 38, leave medical practice?
He had been steering a "friends and family" investing club through the 90s, he said. While in his surgical residency at Johns Hopkins, he found that while all his colleagues were reading medical journals in their spare time, he was reading about finance and investing, his hobby.
"I never wanted my hobby to be more important to me than my profession. So I realized I needed to make a change," Jenner said. He joined T. Rowe Price three years ago.
To find out more about biotech funds generally, I recommend Morningstar's screening tools at www.morningstar.com.
For a fuller listing of biotech stocks, see biz.yahoo.com/ research/indgrp/ med_drugs.html.
Fred Barbash can be contacted at barbashf@washpost.com. He will be away for a few weeks. His column will resume when he returns.
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