Biotech Article From Barrons Interactive Weekday Trader
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Subject: Monday's Weekday Trader -- Small Biotech firms
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Weekday Trader
Small Biotechs May Offer Big Value
by Corinna Barnard
Biotechnology has grabbed the limelight in recent weeks since Pfizer
(PFE)released Viagra and reports surfaced of EntreMed's success in treating
tumors in laboratory mice.
Just last Friday, Icos (ICOS) stock soared 30% after a newsletter reported
that its anti-impotence pill IC351, still in early clinical tests, has
fewer side effects than Viagra does. The shares gave back some of those
gains Monday, closing at 20 7/16, down a little over 3%.
Yet investors often find it hard to play the smaller biotechnology
companies that make these kinds of breakthrough discoveries. Small biotech
stocks remain notorious for their volatility and the "bio-bombs" that
cause share prices to collapse when promising drug trials or marketing
alliances with major pharmaceutical partners go sour. And the 300 or so
small-cap biotech companies are much more likely to burn capital than turn
a profit.
That's probably why the Nasdaq Biotechnology Index is lagging the market
badly -- up by just over 1% from a year ago, compared with a nearly 28%
advance for the Nasdaq Composite Index, although they have gained almost 6%
so far in 1998. As with the overall market, small-cap biotechs have lagged
their larger peers.
But some champions of the group are beginning to notice signs of life
after five or six miserable years. In a late April report for Hambrecht &
Quist, "The Case for Biotech: A Rally Approaches," industry analyst Richard
van den Broek declares: "The biotech wave is building quietly, but
steadily, and will have gained significant momentum before its strength
becomes apparent to a wider audience." The biotech industry should begin
verging on
profitability in the "next 12 to 18 months," he predicts.
Kurt von Emster, fund manager of the $80-million Franklin Biotechnology
Discover Fund, also sees some light ahead. "I think it's a good time to be
involved in the group," von Emster told Barron's Online, adding that this
is the first time he's been comfortable investing in the sector this decade.
Why the change in sentiment? Primarily for two reasons: valuations and
technology. "This is a group that has underperformed the broad market for
the last five years," says von Emster. In the meantime, he says, their
technologies have progressed and the companies are closer to delivering
products that can make money.
In his report, analyst van den Broek says that "about 40 new therapies
being developed by biotech companies.have the potential to reach the market
during the 18 months between early 1998 [and] mid-1999....Even if only some
successfully meet commercial expectations, the universe of biotech
companies with revenues and profits will be significantly broadened."
How to tell which ones will reward shareholders? The key signposts are
clinical tests and regulatory approvals. Phase III trials are the most
important of all the clinical tests of human subjects. If the test drug
fares well in Phase III, the company will file for regulatory approval. An
advisory panel of the Food and Drug Administration decides whether to
recommend the drug for marketing, and the FDA usually abides by the panel's
judgment. Most drugs are launched on the market almost immediately upon
approval.
With many drugs now going through this process, David Stone, an industry
analyst at Cowen & Co. in Boston, sees strong potential growth ahead. He
says it's better "to invest in a group that is lagging, but where the
fundamentals are very strong, than when the cover of every news magazine
has an article about how well they are doing."
What's more, Stone points out, years of underperformance have caused the
price/earnings ratios of many biotechnology stocks to be either in line
with or below their expected earnings growth rates. By contrast, stocks of
the major pharmaceutical companies trade at P/Es that are roughly twice
their growth rates.
Which stocks should investors look at? Most advisors prefer companies that
have been around for a while, have a diversified product line and have
struck alliances with larger pharmaceutical companies that can provide
marketing muscle. Most important: look at companies with products that have
already gone through clinical trials and have gotten FDA approval, leaving
earlier, development-phase period to venture capitalists. Investors, says
van den Broek, "are best served by investing in companies after they have
successfully crossed these hurdles."
Dr. Charles B. Engelberg of AmeriCal Securities, a San Francisco-based
investment advisor to fund managers, also suggests focusing on companies
whose products fill large, unmet medical needs and that will enjoy a
favorably reception among practicing physicians, who can make or break a
new drug.
One such stock AmeriCal recommends is Scios (SCIO), in Mountain View,
Calif., whose shares closed Monday at 8 15/16, off by a little more than
4%. For the last year and half, the stock has bounced between a low of 3
5/8 and a high of 13 5/8. The one Wall Street analyst who follows the
company, according to First Call, expects Scios to lose 90 cents a share
this year.
But on May 26, Scios formed a strategic alliance with German pharmaceutical
giant Bayer AG to market Natrecor, a drug for congestive heart failure that
is in the late stages of Phase III clinical trials. Americal's Dr. Richard
Gaston, a cardiologist, has high hopes for Natrecor, a genetically
engineered form of the cardiac hormone human b-type natriuretic peptide.
Congestive heart failure, currently among the leading diagnoses in hospital
admissions, is ripe for better treatments, he says, and hopes that Natrecor
will be a breakthrough drug for the widespread heart ailment
by enhancing the body's natural defense mechanisms. And, he adds, the drug
could help contain medical costs as well. If it is administered in the
doctor's office or emergency room, Natrecor could keep many people at home
who currently account for a high proportion of hospitalizations.
AmeriCal also likes Menlo Park, Calif.-based Sequus Pharmaceuticals (SEQU),
which makes the anticancer drug Doxil. Sequus is conducting a Phase III
study for FDA approval of Doxil, or doxorubicin HIC1 liposome injection,
for the treatment of cancer. (For a look at some biotech stocks
specializing in anticancer drugs, see "Life Support," May 18.)
Last year the company received clearance to market the drug as a treatment
of Kaposi's sarcoma -- a cancer that afflicts some AIDS patients -- through
Schering-Plough. Sequus ended last week at 11 3/8, about midway between its
recent low of 5 3/4 and high of 16 5/8. Although analysts expect the
company to report a loss this year, they estimate that the company will
earn 25 cents a share, according to Zacks Investment Research. Projections
for its five-year compound annual earnings growth go as high as 47%.
Corinna Barnard is a writer for The Wall Street Journal Interactive Edition.
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