[Biotechs - background articles] I'm starting a series on biotechs, beginning with articles going over background issues. While some articles mention specific companies, I'm including them since they show the thought process in biotech selection, not as my personal recommendations in terms of the companies mentioned.
This firest one was by a newsletter writer who specializes in biotechs. Keep in mind my file date for this article was 3/2/97.
Biotech is Back
Jim McCamant offers a fresh analysis of the risky realm of biotechnology
stocks
By Clay Martin
Ever since the biotech bust of January 1992, this volatile sector looks
like Las Vegas to many investors -- the payoffs can be big, but the risks
are substantial.
Jim McCamant, founder and editor of the Medical Technology Stock
Letter in Berkeley, Calif., argues that the biotech sector has matured.
And as an increasing number of drugs are being approved or are nearing
approval, it is worth a fresh look.
McCamant has endured the highs and lows of the sector and reports a
365% return on his model portfolio since December of 1987 (compared to
260% for the Dow). The Hulbert Financial Digest also rated his
newsletter the No. 1 performer of 1995, with a 108% return. So far this
year the prognosis continues to be rosy with a 15.8% return.
In an interview with Investor, McCamant reveals his current favorites,
explains how he evaluates biotech stocks and tells why he thinks this is
a good time to find biotech bargains.
Why biotech?
Given the uncertainty of the sector, why take the chance?
The main factor here is long-term potential. While biotechnology is
obviously having its biggest impact in the medical area, it's actually
going to have impact in other areas as time goes on. I think of biotech as
being today where electronics was in the early '60s. We've got this huge
potential and we're just beginning to realize it. So investors interested in
growth stocks are going to find a lot of good ones over the next 10 years
in this sector.
Would the investor who doesn't know a whole lot about this sector
be well advised to just stick with the biotech blue chips like
Amgen Inc. (AMGN), Genzyme Corp. (GENZ) and Biogen Inc.
(BGEN) until there's some evidence of earnings from the others?
You're going to have significantly less risk in the large companies that
are already making money. But the big profits come from buying the
future Amgens and Chirons (CHIR) and Biogens. The easiest way to do
this is probably to spend some time finding a group of four or five stocks
in this second tier of companies. Then, when products get to the market,
the companies are poised to make the large moves that happen as
companies near profitability.
Identifying these second-tier companies can be difficult. A lot of
them don't have earnings or current sales. How do you make that
determination without getting a Ph.D. in biology?
Actually, I don't know if a Ph.D. in biology really helps a lot. The key is
to identify the second-tier companies with good technology. Within the
biotech community, it's pretty easy to get a consensus about where the
really good science is. And often, those aren't at the companies that
have been popular with the investment community.
The other thing that reduces risk is if the company has some good
corporate partners who are financing much of the research effort. This
means the company will need to raise less money and will have less
dilution before it gets products to market.
One of the mistakes investors sometimes make is to buy a stock
because the product sounds really sexy. What they don't realize is that
there are four other companies doing the same thing, a couple of which
may be ahead of them.
What are some of your favorites for '97?
People sometimes do like to keep their risks reasonable, and that can
be done with the larger biotechs. Our favorite there is Chiron. They have
the broadest product portfolio of any of the large biotechs; they probably
have the best science of anybody in the industry; they have good
management; and the stock is not overvalued at current prices.
Then we go to the second-tier companies. We're particularly looking for
companies that have modest risk because of their multiple partners in a
broad technology platform. One that is attractive now is Isis
Pharmaceuticals (ISIP). They have a number of products in late-stage
clinical trials, and I think it's going to emerge over the next year or 18
months as a big winner. Ligand Pharmaceuticals Inc. (LGND) also has a
broad-technology base, and a number of partners. It has stuff in
late-stage clinical trials in cancer and some really interesting programs
in obesity. I think it's going to emerge too.
Some that are a little further away from having products on the market,
but which also have a broad technology base would be Arris
Pharmaceutical Corp. (ARRS) and ICOS Corp. (ICOS) up in Seattle --
that's run by George Rathmann, the founder of Amgen. These all fit into
this category of companies that don't have profits yet. But they have
money in the bank and they have good partners and good technology.
Any others?
We have a couple of companies we've been recommending where the
risk is a little bit higher because they don't have as broad a technology
platform, but where the potential is also much higher, because the
products they're working on have the chance to be real blockbusters. Our
favorite in that category is Somatogen Inc. (SMTG), which is one of the
companies developing a blood substitute -- the only one using
recombinant technology to do that. This is a stock that was over 50 in
1992, and it's around 11 today. And the company's probably worth three
or four times what it was then. To me, that creates a great opportunity.
At the previous high, they'd never put their product into a human being.
And now they're in late Phase II trials.
They have, along the way, found an excellent partner in Eli Lilly & Co.
(LLY). One of the reasons the stock was down is that the clinical trials
have gone slower than they, or we, expected four years ago. But that's
because they've been extremely careful, and some of that is the
influence of Lilly. But these questions of safety have now pretty much
been answered. And so the upside potential as the product gets a little
closer to market could be huge.
Do you think there's more evidence of concrete results coming
from biotechnology now than there was a few years ago?
Yes. In fact, it's very dramatic if you look at it over the last five years.
January of 1992 was when biotech stocks hit their last peak. At that time
there were maybe 25 or 30 biotech products in late stage clinical trials.
And now we probably have something in excess of 200. Yet the total
market capitalization of the industry is roughly what it was then. So as
the year goes on, we should begin to get some momentum and the
enthusiasm that follows.
What are some of the companies with the most significant
products nearing approval?
There's an awful lot going on in the anti-cancer area. Chiron has some
anti-cancer stuff moving along in the pipeline, and we mentioned Isis and
Ligand. ImmunoGen Inc. (IMGN) is a smaller, higher risk company, but
one that is almost exclusively devoted to anti-cancer. That stock is also
down, but I think it has big potential because they're probably going to
file for marketing approval for this product later this year. And with the
(streamlined) FDA rules now, those get at least a six-month turnaround.
Is this quicker FDA turnaround significant for investors?
I don't think there's any question this is a big plus. Not only are they
meeting the commitments for a six-month turnaround, but they're also
changing what they require in the way of clinical data. They used to only
approve cancer drugs based on survival data. Now they'll use things like
regression of the tumors and other secondary indicators.
Which biotechs do you see becoming profitable in 1997?
Companies that have had products approved in the last year, or which
are about to be approved. Agouron Pharmaceuticals Inc. (AGPH) will turn
profitable later this year. Companies like Centocor Inc. (CNTO) and
Interneuron Pharmaceuticals Inc. (IPIC), which introduced new products
last year, are likely to turn profitable this year. And the biggest gains
come from products that are just about ready to be introduced. That's
when the big moves usually come.
The Approval Process
Can you briefly explain the process that takes place in bringing a
product from the lab to the consumer, and what each step means
for the investor?
The key is that you often get a lot of publicity when a discovery is made.
But investors often don't realize that it's a minimum of five years after that
discovery before there will be a product on the market. And it can be as
much as 10. Once you've made a discovery, then you have to find the
actual protein or a small molecule that you want to use to treat the
condition you're looking at. That has to be tested in animals. Then you
have to go into human clinical trials, which is the longest part of the
process. First you have to prove that it's safe in the Phase I trials. Then
in the Phase II trials, you have to prove that it has some indications of
efficacy. And then in Phase III, you confirm results in larger trials with
more patients.
Once that product actually makes it onto the market and the
company starts making money, Wall Street often turns less
positive on the company. Why?
Before a product starts making money, there's just hope and
expectations. And often analysts will make excessive estimates of what
sales are going to be. If a company doesn't meet those, then the stock
goes down. This happened with the first really big blockbuster product
out of biotech, which was Genentech, Inc.'s (GNE) TPA. That stock
declined substantially within a year after they introduced TPA (a
genetically engineered blood clot dissolver) because the estimates were
just too high.
People begin to ignore some of the good things that are going on in the
research pipeline, because they start focusing on earnings. And they
think, well, there's a huge P/E ratio; we can't afford to pay that. But if
they were looking at the potential for some of the products, they might
even be more excited. In the case of Chiron, one of those products in the
pipeline is PDGF, which is a wound-healing product they're developing in
a partnership deal with Johnson & Johnson (JNJ). It has worked in its
Phase III trials and they filed in December for approval to market the
product. That will get approved later this year and is one of the things
that should help Chiron be a superior performer over the next 12 months.
Can you really have that much certainty about a product getting
FDA approval?
Once you've got good Phase III data, the chances of approval are very
high. In this case, the public hasn't seen this data, which is part of the
reason it's not reflected completely in the price. But Johnson & Johnson
and Chiron have seen it, and they made the decision to go ahead and file
with the FDA. And both of the organizations are pretty conservative. They
have said publicly that the data was good and will get published some
time later this year in one of the peer-reviewed medical journals, and that
will probably be one of the things that causes the stock to move the
most.
When to Sell
How do you decide when to sell a stock?
That's the toughest part of the business. And what we've done in the
newsletter is to tell people to find good companies, buy them -- hopefully
when they dip, which happens periodically -- and then hold onto them.
The big money has been made by people who bought Amgen and Chiron
in the early years. We're talking, in these cases, about 10 or 12 years for
the really big gains. On a split-adjusted basis, we recommended Amgen
at below 50 cents. And we probably encouraged people to sell it too
soon on the way up. That was a mistake we made.
Chiron, on a split-adjusted basis, is down to just over a buck a share on
our original recommendation price, which was back in 1984. It's now at
about 20. In the case of Amgen, we've had a better than 100 to 1 return.
You've said the biotech sector is probably the least efficient on the
market. Why?
The problem is that Wall Street has focused increasingly on earnings
and growth rates. It's easy to do earnings models on your computer. So
more and more, this sort of quantitative approach has come to dominate
investing. But for biotech stocks -- most of which aren't making money --
you can't use that. You've got to look at the quality of the people, the
quality of the science, and the potential of the products. Even in those
that are making profits, Wall Street is more excited about somebody like
Biogen -- whose earning are going up currently -- than somebody like
Chiron, which has a much more interesting product portfolio, but is
currently not growing as fast.
If investors are uncomfortable with the risk in this sector, but still
want to get the benefits, would they be well-advised to put their
money in a biotech mutual fund?
Well, I wish that we had some good mutual funds in the sector. I think
that, by and large, if people are willing to assume a two- to five-year time
frame, they'll do significantly better making the decisions themselves.
The Clamor over Cloning
The topic everyone's buzzing about this week is the sheep-cloning
breakthrough in Scotland. What does it mean for biotech
investors?
Very little (laughs). Despite the media hype, this doesn't have much to
do with values among the biotech stocks. The real message is that the
science is moving faster than most people realize and eventually most of
it will add to profits. This particular technology has more social and
ethical implications than it does investment implications.
Is the media attention a good thing for the sector?
Always. The fact that it makes people realize how fast the science is
progressing is very positive. The sector has been out of favor, and when
that happens, people wonder if the technology is real and if it's making a
difference. When they see this kind of breakthrough -- even though it
doesn't have substantial investment implications -- it reminds people of
the power of the technology. |
