FYI to all:
"5 biotech plays for the long term. Battered and bruised, the sector still has life. Along with my picks, here are the four principles that guide me.
By Jim Jubak
When the price of fuel climbs, the stocks of the companies that burn it fall.
That's pretty easy to remember when you're investing in airline stocks or trucking companies. But it's just as critical for a portfolio of biotechnology stocks. These companies don't burn jet fuel or gas. Instead, they run on money. And when the price of money goes up, these stocks take a pounding. The stocks of companies burning money the fastest take the worst beating.
That's helped make 1998 a really tough year for investing in biotechnology stocks. I know these are supposed to be extremely long-term holdings -- buy and forget them for five years at least -- but I also know that it's hard to stick to that discipline when you're looking at double-digit losses. The two biotech stocks in Jubak's Picks, Ligand Pharmaceuticals (LGND) and Isis Pharmaceuticals (ISIP), are down 39% and 24% respectively since last October. It doesn't help that I included them in a list of picks that are supposed to turn into winners in 12 to 18 months. And since I also own these two stocks in my own, personal portfolio, more than my ego has been bruised.
So, as I promised a number of columns ago, I'm going to move those two biotechnology picks onto a separate biotech pick list that I'll revisit once every six months. That should make sticking to a long-term strategy easier -- and less painful. At the same time, I'm going to improve my system -- by considering how fast a company burns cash -- in order to cut the risk of biotech investing during this very volatile market.
This year, like last year, I went looking for stocks of companies specializing in a core enabling technology that is broad enough to produce multiple products over time. I concentrated on companies that haven't yet produced a home-run drug since that's the kind of company most likely to earn you the best return for the amount of risk you've assumed.
Since I think it's awfully tough to pick the winning technologies and the winning companies at this stage, I searched for biotech stocks cheap enough that I could afford to build a portfolio. Profits from my winners should more than cover the inevitable losses from companies that wash out. But because I didn't want to sit in any of these stocks forever, I also looked for companies scheduled to move potential products up the ladder of studies and trials at the Food and Drug Administration in 1998 and 1999. That should give me the positive news stories that move a biotech stock up in price.
And finally, I looked for companies with enough cash on hand -- and a slow enough rate of cash burn -- that they wouldn't soon be forced to go back to the market, hat in hand, to raise more money. This last rule, I think, should cut down on the volatility of the stocks in my biotech portfolio and lessen the chance that I'll pick a winner but wind up with little to show for it after the company issues millions of new shares at low prices.
I'm going to explain those four principles quickly and then lay out the portfolio of five stocks that I've put together.
1. Buy core-enabling technologies. I'm not interested in biotech companies with one or two "promising" drugs. What I'm looking for are companies that have mastered a research approach that is likely to lead to scores of potential drugs. For example, Millennium Pharmaceuticals (MLNM), a company that has concentrated its research on identifying the specific human gene implicated in a disease and then mapping the proteins used by that gene, recently signed a five-year deal to supply Bayer (BAYZY)Bayer with 225 new drug targets. In the last 20 years, we've discovered a lot more about how a disease works at the cellular level and about what human genes are correlated with specific diseases. We still don't know precisely how a specific gene functions or malfunctions to create a disease or what the most effective way to "fix" the problem might be. But researchers have targeted broad mechanisms and tactics -- core technologies -- which seem promising. My list of core technologies includes genomics (Millennium's area of research), drug design, cell signaling, neurobiology, new mechanisms for fighting infectious disease and new approaches to cancer therapy. (My list isn't definitive, and if you want to argue, I'll be glad to yak it out in the discussion group for Jubak's Picks. Discuss It
2. Buy cheap companies. In the world of biotech, there's Amgen (AMGN) -- with a market capitalization of $19 billion -- and everyone else. I think the odds are that I won't pick the next Amgen -- but I'd be very happy owning a handful of stocks that climbed from market caps of, say, $300 million now to $1.5 billion. That's a five-fold increase. So in building my portfolio I only considered companies with a market capitalization below $1 billion.
3. Buy products in the pipeline. Each step a drug takes through the highly structured U.S. Food & Drug Administration approval process brings it closer to the day when it will actually be on the market, producing revenue and earnings. So biotech stocks rise on news of trials successfully completed, when a drug moves from Phase I to Phase II studies, and when a drug actually gets agency approval, among other events. In building my portfolio, I looked for companies with a solid calendar of potentially positive news. Here's a partial calendar for Isis Pharmaceuticals (ISIP), for example: Potential FDA approval of fomivirsen (October), filing for topical formulation of ISIS 2302 for psoriasis (first quarter of 1999), and Phase II trial results for ISIS 3521 and 5132 for cancer (first half of 1999).
Companies that run out of cash in the current stock market are going to really put the hurt on anyone who owns their stock.
4. Buy companies with a cash cushion. Companies that run out of cash in the current stock market are going to really put the hurt on anyone who owns their stock. Because these stocks have been so badly crushed, selling more shares to raise capital now is very expensive -- a low share price means the company has to sell a bigger stake in itself. And that would mean substantial dilution for existing shareholders. After the sale of new shares, previously existing ones each represent a smaller piece of the company and its future earnings. (The same is true if the company gives up rights to future profits when it signs a partnership deal with a big drug company.) An investor wants to find a company with enough cash to ride out the current down market, or, better yet, with enough in the bank to take the company to break-even.
To figure out how long a company's cash will last, you need to know both how much cash it has on hand and how quickly it's using up that supply. To find that out, you'll need to look at the company's balance sheet and income statement. For example, Isis Pharmaceuticals ended the second quarter of 1998 with $87 million in cash and equivalents. In that quarter, it posted a loss of $14 million. If Isis continued to burn cash at the same rate (Wall Street would say the company has a "burn rate" of $14 million a quarter), it would be out of cash in six quarters. That should be enough to get Isis to a better period for raising capital -- but it won't get the company to profitability. Analysts now project that Isis will lose slightly more money in 1999 than it will in 1998.
After applying those criteria, I built this portfolio of five stocks. I've listed them in alphabetical order. Prices and other data are as of the close of trading on Sept. 23.
Icos (ICOS), $17.75. Market capitalization: $705 million. Cash on hand: $17 million
Icos specializes in the cellular mechanisms that cause inflammation. And if you think that's too small a niche to support a major company, you don't know your science or Icos CEO George Rathman, who previously founded and built Amgen. The company has major research efforts under way to study how cells adhere to each other, how the body amplifies the inflammatory response, and how signals are sent in cells to activate or suppress a specific gene or pathway. The company is in Phase II trials with its Pafase compound for treating acute respiratory distress, in Phase II trials with its LeukArrest compound for treating stroke patients, and in Phase I trials with a compound for treating psoriasis. The company's cash position may seem skimpy -- analysts project that Icos will lose 92 cents a share in 1998 and $1.12 a share in 1999 -- but Rathman has shown the ability to raise money in creative ways from a very well-heeled group of private backers while minimizing dilution. (Full disclosure: I own shares of Icos.)
Isis Pharmaceuticals (ISIP), $12.13. Market capitalization: $316 million. Cash on hand: $87 million.
This year, the FDA gave Isis preliminary approval for its first drug -- a crucial vindication of the company's novel anti-sense technology. Anti-sense drugs work to interrupt the process by which disease-causing proteins are produced by binding to a specific sequence in a cell's DNA. As already noted, Isis should get formal approval to market fomivirsen in October. The big news for 1999, however, should be the completion of Phase II trials on Isis's two cancer drugs with partner Novartis (NTSY). Success in those trials would demonstrate that anti-sense drugs have broad potential in cancer therapy. Isis isn't expected to break into the black anytime soon: Analysts are projecting that the company will lose $1.54 a share in 1999. (Full disclosure: I own shares of Isis.)
Ligand Pharmaceuticals (LGND), $9.66. Market capitalization: $354 million. Cash on hand: $52 million.
Ligand has built up an expertise in making small-molecule drugs that regulate the intracellular receptors. The company's drugs bind with these receptors to tell the cell to block a signal. The company's technology shows promise in regulating the flow of estrogen -- crucial in treating osteoporosis -- and in treating cancer tumors. But partner Eli Lilly (LLY) is helping to fund research that will expand Ligand's approach to diabetes, cardiovascular disease, and metabolic disorders such as obesity. News for the remainder of 1998 and into 1999 is expected to include approval and launch of Panretin Gel for Kaposi's sarcoma, and filing for approval of Targretin in the treatment of cutaneous T-cell lymphoma. Analysts expect the company to break into the black in 1999. (Full disclosure: I own shares of Ligand.)
Vertex Pharmaceuticals (VRTX), $26. Market capitalization: $703 million. Cash on hand: $258 million.
Nothing makes me feel better about a company's ownership of an enabling technology than a patent. On Sept. 21, Vertex received a patent for a class of compounds including VX-497, an enzyme inhibitor currently in trials for the treatment of hepatitis C and psoriasis. Vertex's VX-497 seems to have potential in attacking a variety of autoimmune diseases and RNA and DNA viruses. In September, the drug went into Phase II trials against hepatitis C, a disease that currently infects 4 million people in the U.S. That's not the only news on the Vertex calendar either. The company's VX-740 drug candidate for acute and chronic inflammation is in early clinical trials and started Phase II trials for compounds that would prevent the development of drug resistance in patients undergoing chemotherapy for cancer. The company is sitting on a wad of cash -- which is a good thing, since analysts are projecting that it will lose $1.26 a share in 1998 and 81 cents a share in 1999.
Vical (VICL), $10.88. Market capitalization: $164 million. Cash on hand: $45 million.
Now that we know something about the connection between genes and disease, every researcher with an ounce of ambition wants to figure out how to develop drugs that will fix the gene. I think we're still a long, long way away from that -- but Vical is building drugs that use strands of DNA, our raw genetic material, to stimulate an immune response. The company expects to complete Phase II trials for Allovectin-7, for head and neck cancer, in the second half of 1998. That would provide some of the first statistically significant data on the efficacy of gene therapy. The company has six other products in trials and major deals with Merck (MRK) -- $98 million -- and Pasteur Merieux Connaught -- $60 million -- for the development of DNA vaccines. Losses are still growing at the company with analysts projecting red ink of $.51 a share this year and $.64 in 1999. But its cash reserve seems ample in light of its deals with a total of six different drug companies. (Full disclosure: I own shares of Vical.)
These five stocks don't cover all the biotech bases -- and I'm looking to add more exposure to the gene-based drug design in future portfolios. But that can wait until I update this portfolio in six months. Meanwhile, I'll carry updates on these stocks from time to time at the end of my regular Jubak's Picks columns."
From article in Microsoft Investor, 25 September 1998
Regards, Bo |
