Best Bets In Biotech
Wednesday January 9, 1:20 pm Eastern Time
By Missy Sullivan
Forbes.com
Buzz runs high in biotech. One company is working on technology that will regrow your organs. Another has developed a new and improved Viagra. How do you tell the solid deals from the snake oil? Patience, says John McCamant, editor of The Medical Technology Stock Letter, or MTSL. McCamant, an avid fly fisherman and investor in companies that can take eight to ten years to get a product to market, knows a thing or two about the benefits of waiting for the big one. With its long-term growth strategy, MTSL has been rated byHulbert Financial Digestas one of the top-five performing newsletters over the past 15 years. Begun by McCamant's father Jim in 1983, the bimonthly letter is the longest consistent voice in biotech. Younger McCamant, a graduate of the University of Denver, began working at the letter in 1987. In 1996, he worked in business development for Burrill & Company, a private merchant bank focused on life-sciences companies. After stints as an analyst for the American Healthcare Fund and partner at Ten Peaks Capital, his own VC firm for small biotechs, McCamant returned to the family business in mid-2000, and officially became editor of MTSL last year. He is also a general partner in the Double Play Biotech Fund, a hedge fund launched in December 2001 with assets just under $10 million.
Forbes: How big is the biotech field today, how many biotech firms are out there at the moment?
JM: We believe that there are roughly 300 public biotech companies today. That's our universe. We also track close to a hundred privates, some of which will develop products in competition with those whose stock we track.
Aging baby boomers, now hitting their 50s, will provide unprecedented market demand in this field. There will be a significant increase in pharmaceutical demand, particularly in the near term, for everything from lifestyle (baldness, male erectile dysfunction) to more chronic conditions (cholesterol, diabetes) to the bigger diseases (cancer, cardiovascular). Up until now, the big pharmaceuticals have owned the supply side. We believe that in next two to three years, more than half of the new products will come out of biotech. Big pharma has had tremendous growth in the last ten years, but in order to fuel growth and meet earnings numbers, the companies had to spend on things other than R&D, while neglecting their long-term pipelines. Sure, big pharma will still come up with some major hits, but we like the bang for the buck in biotech. If you took Merck and one other large pharma, that would equal the entire valuation of the biotech industry.
So are biotechs just newer, more nimble versions of the big pharmas?
No, because they take a totally a different research approach. Whereas big pharma does more small-molecule research, the biotech industry focuses on the cause of the problem, what's actually going on inside the body. It's a longer-term approach, but it can be more rational, less hit or miss, and lead to more information about how to stop a disease before it starts--or at least get it earlier in the cascade.
And obviously biotech is a lot more volatile. We think biotech is where electronics was 20 to 30 years ago. It's starting to merge into other fields, like specialized industrials, agriculture and food. It's now moving farther into diagnostics, where you hear talk about putting biology--like different proteins--onto chips. We can envision a time when we'll have each of our individual genomes on a chip and we'll go to a doctor and that can help them prescribe or know what we're susceptible to.
What about funding? I have heard that biotechnology is one area VC firms haven't shunned.
2001 was the second-best year in biotech financing ever. The VCs are feeling a little burned in the high-tech areas, so biotech has caught their attention. They like the clarity of the metrics in biotech. The stringent FDA drug-approval process means that everyone has to cross the same goal line. Unlike with wireless companies, say, you can measure a biotech and its competition by whether they're in Phase 1, 2 or 3. Plus, you don't see a lot Chapter 11s in this business. If nothing else, someone comes in and swoops up your intellectual property (IP), your manufacturing and your labs. IP is a crucial asset: You can't really design around something too easily if someone else owns certain drugs and certain receptors. We contrast that with high tech where, if someone comes up with a better idea, your IP is worthless. We believe that approved pharmaceuticals are the closest thing you can get to a monopoly.
It was also a huge year for mergers and partnerships. Some of the biggest deals were COR Therapeutics/Millennium Pharmaceuticals, Bristol-Myers Squibb/ImClone Systems, Amgen/Immunex and Merck/Rosetta Inpharmatics. The merger trend is away from big pharma and more biotech to biotech.
Biotechs are richly valued in this market. They trade at about 56 times next year's earnings versus 24 times for the big pharmas. Are there many buying opportunities out there at this point?
We agree that the first tier is richly valued--stocks like Amgen. The bargains are in the second- and third-tier biotechs, so that's where we're focusing our investors. We distinguish them by market cap. Third tier is $250 million cap and down. Second tier is $250 million to a billion. Everything above that is a tier-one. After Sept. 11, the first tier had the biggest moves, as people looked for quality. There are higher expectations now, so those companies are more vulnerable. It's harder to meet those expectations. The second and third tiers don't have those expectations. We think we're going to see some of those companies have 200% to 300% moves this year.
Read more...
How long do you hold?
Very long. We recommended Chiron in 1986; it's still in our model portfolio and has earned us over 350%. When do we sell? COR Therapeutics just got bought by Millennium, so we'll probably drop it--we don't want to be part of a merged company. We'll get out of that with a gain of over 360%. We believe that one of the best ways for individuals to play biotech is to be aggressive when things fall out of favor. If you've done your homework and you see that the fundamentals are intact and the price has come down significantly, that's when you step up.
There was a lot of hoopla about genomics last year. But it seems that the real revenue producers, the drug products, are still out on the horizon. How are you recommending people play that area?
We advised our subscribers to stay out of that area because we couldn't see solid business models that equated to the valuations. The core business of biotech is drugs, and genomics companies are still far away from making them. More of what they had to sell were databases and tools, which made us very skeptical. Those are not proven business models. Celera was going to sell databases; it's almost out of business. Rosetta got bought by Merck for its genome database and some of its tools. But Merck got value out of that deal--it has over 100 different research programs it can apply those tools to.
Which genomics company, if any, is furthest along in drug development?
We like HYSEQ Pharmaceuticals. It's very small--valued at only a little over a hundred million dollars. We're talking bang for the buck here. It will bring its first product to human clinical testing this year, which is pretty significant in the genomics world, since there's not much out there, and won't be for a few more years. It hasn't disclosed the nature of it yet--could be in cardiovascular, cancer or inflammation. Its chairman, George Rathmann, also happens to be the most successful biotech creator ever. He founded both Amgen and ICOS. It has assets in other areas, like a chip business, which it spun out into subsidiaries. That way, it will benefit from the upside while keeping its main focus on developing drugs. We recommend it at under $12. It is currently selling at $8.
Anti-infectives. With the threat of bioterrorism looming in people's minds, who is doing the most important work here? Are government projects really lucrative for these companies?
The government will pour a lot of money in this over the next few years. And it should. We need new and better vaccines and anti-infectives. But waiting on a government contract can be a nightmare for a public company. So our focus here is on public firms that have these projects as a free upside, or wild card, on top of a core business developing their own drugs. Avant Immunotherapuetics is one of those (buy it at under $8). It does some oral vaccine work in the travel market, things like cholera. Another company would be Corixa (buy at under $20). It plans on being a major vaccine player in the long term and does a lot of cutting-edge research in antigens.
Any other biotechs you care to mention?
Cell Genesys is a buy at under $25. A few years out, it will be a leader in cancer vaccines. Growth potential is strong here: It owns all its intellectual property rights, is very well capitalized and is going into three pivotal Phase 3 trials by year-end. It has a lot of manufacturing assets now, and has acquired another small company that's increasing its pipeline opportunities. We like the way management is executing right now, creating value out of its many assets.
Ligand: We like it at under $20. It has really spread the risk out with a broad portfolio of products--some on the market, some about to come. Its blockbusters are partnered with large pharmas, like Pfizer and American Home Products, but the potential on these drugs is so large that even the royalties would be a very nice revenue stream for them. Ligand develops second-generation estrogen, which can be used to treat conditions like osteoporosis. It provides all the benefits of estrogen without the cancer risk. This is the hallmark of biotech: making something more specific by understanding the biology that underlies it.
ICOS (buy under $50): George Rathmann's second success story. It's a broad-based company, focused on inflammation. While it's had several Phase 2 failures, the company was actually engineered to do that. They'd rather have a product fail there than go all the way to Phase 3, where it's a much more expensive failure. The lead product is called Cialis, a second-generation Viagra. ICOS partnered 50/50 with Eli Lilly on it.
Isis Pharmaceuticals has been very controversial over the years. Many people doubted that its core property, antisense, represented a viable new class of therapeutics. But its recent deal with Eli Lilly seems to have quieted most of the naysayers. It has one product approved, Vitravene, for a niche market--retinitis in the eye--which showed some of the potential of antisense, and there are another 13 in the pipeline. We believe the company has one of the best intellectual property portfolios in the business. It owns antisense at this point and is doing lots of deals with other companies to create more value. Buy it at under $20.
What about smaller companies?
Curis is a buy at under $10. It has a lead product called OP-1, a bone cement, conditionally approved in the U.S. and already approved in Europe. OP-1 stimulates bone growth, replacing the need for painful bone harvesting when you have a fracture. Stryker, one of the leading orthopedic companies, is its marketer. It's got exotic, cutting-edge technology, much of which is coming out of MIT--like its work growing a new bladder for a child who had lost his to cancer. The researchers there already did it for dogs, using a scaffolding technology. They seed the cells into the scaffold to grow parts of your body back. It's a leader in the area of cell regeneration, but doesn't always advertise it because it tends to be more product-focused rather than getting people all hot on the buzz.
NeoRx. It works in radio pharmaceuticals, or targeted radiation. Buy at under $8. The lead product is currently on FDA hold, but we expect it to come off shortly. It's in Phase 3 to treat multiple myeloma, a blood cancer. The underlying platform is a targeted radiation delivery device, which can be adapted to multiple cancers. Rather than just blanketing your body with radiation, it sends a monoclonal that's specific for the cancer cell directly to that cell, then releases the radiation. There could be broad utility there.
We hear a lot about stem cells. Anything there?
That's still way out. We recommend one small company there, called StemCells, which you should buy for under $5. It's way out in the future. They have very strong intellectual property, though. In early-stage stuff, it's one of the key things we look for.
Any worthwhile mutual funds in this area?
There are only a few biotech funds out there--like Dresdner RCM Biotechnology and H&Q Healthcare Investors--but very few have been around for more than three years. Since it takes eight to ten years for something to get to market in this business, they haven't been around long enough to see too deeply into the life cycle of many companies they're watching. A key criterion is not just the fund's performance, but the continuity of the manager. Dresdner's manager just left, so you have to start from scratch there.
If you want diversification, one way to go is with a stock called Elan, probably the single most diversified company in the sector. It's a first-tier, specialty pharmaceutical company that is transitioning from drug delivery to biotech, which means that they're focusing more on owning rights rather than licenses. Dublin, Ireland-based Elan has acquired over ten biotechs over the years and has over 30 joint ventures with its counterparts, where it takes equity interest. It owns upward of 20% of Ligand alone. We put it as a buy at under $55.
Thanks. |
