At the 28th annual JP Morgan Healthcare conference, which ran from January 11- January 14th2010, there were more than 300 companies represented, making theirpresentations to more than 6000 public and private equity and venturecapital investors.
Leading up to the conference and early last week there was bullishmovement in many companies presenting at the conference. Many of themany of the larger companies like Amgen (AMGN), Genzyme (GENZ), Biogen (BIIB), Celgene (CELG), Gilead Sciences (GILD), TEVA Pharmaceuticals TEVA), Watson Pharmaceuticals (WPI) and OSI Pharmaceuticals (OSIP) previewed 2009 earnings during the conference.
There was considerable enthusiasm for the sector this past week; itseemed like every biotech company rallied and closed the week up. Somenotable mentions are Amag Pharmaceuticals (AMAG) up nearly 25%, Sunesis Pharmaceuticals (SNSS) up nearly 20%; BioCryst (BCRX) up 10%, Jazz Pharmacueticals (JAZZ) up nearly 15% Idenix Pharmaceuticals (IDIX) up nearly 20%, Inspire Pharmaceuticals (ISPH) up nearly 10% , Other companies who saw significant movement at some point but didn’t hold their gains were NovaVax (NVAX) up nearly 20% at one point, Micromet (MITI) up 11% at one point , Cyclacel (CYCC) up 15%, Cardica, (CRDC) up 50%, Rosetta Genomics Ltd. (ROSG) up 50%, and MDRNA (MRNA) up 70%.
But what will happen after the JP Morgan Healthcare Conference? Wasthe activity the last couple weeks just due to short term investorenthusiasm? There is thought to be an established cycle to biotechwhere the stocks tend to rally in the last 3 months of the year andending January, which would put us at the end of this cycle. But thebullishness is probably not temporary, it seems: Reports coming outfrom the conference strongly suggest that 2010 will be a booming yearfor biotech and pharmaceutical as mergers and acquisitions run wild. In2010, I don’t expect an ending to the rally for biotech.
As many of us have witnessed in the end of 2009, I expect manysmaller-cap biotech stocks to continue coming into investors view. Ibelieve that smaller-cap biotech stocks will be the best place to makemoney in 2010. In fact, I believe the case may be extreme; where thereis an aversion to big pharma and a homing into biotech, causingsustained rallies not seen since 1999.
Capital funding activity does suggest a new bull market forbiotechs: Rough estimates show that in 2009, biotech companies raisedabout $50 billion; and the capital raises are clearly continuing.Perhaps this is due to backlog of much needed funding that ground to ahalt in 2008; but regardless these necessary capital infusions areallowing promising small companies to survive, and better yet thrive.
To me, this is reminiscent of 1999: After a year of unbelievablegains in large pharmaceutical companies 1998, the rally continued withvigor through 1999 in biotech companies after in the industry wasalready run up over 100%, and the rally in big pharma lost itsstrength. In 1999 and 2000 the NASDAQ Biotech Index gained a whopping148%, with many companies like Human Genome Sciences (HGSI) gaining over 1000% in that period. (It should be noted that the same index plummeted 54% over the following two years).
During this time, in 1999 biotech firms raised $7.8 billion and wenton to raise a staggering $37 billion in 2000. This was obviouslyreflective of the bullish sentiment of biotech, and in my opinion 2010vs 1999 is likely to be a similar comparison.
Why do I make the 1999 comparision? Many large pharmaceuticalcompanies are bracing for the patents for their largest revenuegenerating to expire over the next few years. With few in-house drugscoming through the near term pipeline, the answer is to focus onbiotech acquisitions instead. 2009 was a huge year of large mergers ofthe giants- this was the first step: consolidation.
The next step is acquisition of technology/drugs. I expect in 2010to hear about numerous acquisitions or partnerships with smallerbiotech firms with drugs late in development (coming out of phase II orgoing into phase III). In the case of partnerships you can expect alarge company to pay a small biotech company tens of millions ofdollars up front with continued milestone payments to support thestudies; with royalties upon marketing of the drug.
This is obviously a huge boon to the smaller company, but is also aworthwhile investment for the large pharmaceutical company because thedownside is defined and limited to their investment in the smallercompany. The upside upon approval and marketing, however, can meanhundreds of millions for the larger company and tens of millions forthe biotech company.
The same factors that are triggering the current health care crisisare the very same factors favoring biotech companies right now.Biotechnology is offering some of the best solutions for diseasemanagement related to an aging population full of degenerative diseasesand rising cancer rates, who are living longer than ever before. Thegrowing need for more potential drugs to treat the large host ofdiseases drives the development for them.
However, the boon for biotech will likely be big pharma’s expense:Investors worry the health-care reform won’t be good for bigpharmaceutical companies as potential reform will lower prices of drugsthrough Medicare and Medicaid. They worry that drugs protected bypatent in the US will be circumvented by importing generics fromoutside the United States.
Beyond this, investors worry the government will de-protect patentsand accelerate the approval of generic drugs. On top of all this, moredrugs will become generics as their patents expire. Investors arelikely to leave big pharma and trade it in for small biotech.
Such changes to health care, if they occurred, would indeed be quitedetrimental to the profits of large pharmaceutical companies. The onlyway that big pharma can protect itself from such possible changes isthrough innovation. This is where biotechnology comes in: acquisitionsand partnerships are the most expedited way to gain innovativetechnology.
This innovation is needed because our understanding of and approachto modern medicine is changing: We will soon see more personalizedmedicine, where drugs are matched to an individual’s genetic profile.Patients will be pre-selected for a particular drug, which requires thedevelopment of a companion diagnostic to select for the suitablepatients. Both of these are potential sources of revenue for the drugcompanies.
This will push small biotech companies to identify innovativeproducts to meet these needs. Biotech companies will not only becreating such drugs and companion diagnostics, they are most likely theones who will be identifying the genetic markers which predispose apatient to a disease and also to respond to a particular drug. Theirsuccess in understanding these relationships will in turn bolster thetrend of more acquisitions of smaller companies and the biotech 1999party.
Rod Raynovich, a freelance writer for Genetic Engineering andBiotechnology News, recently reported some broad themes and markettrends he gleaned from company presentations at the JP MorganHealthcare conference in this article.
His conclusions, which in my opinion are highly relevant and quite worthy of reiteration, were as follows:
1. There is a shift from small molecule drug development to biologicals and vaccines, exemplified by Pfizer’s recent deals.
2. "Bolt-on" acquisitions of smaller companies are being done tobolster product portfolios and positions in emerging market, forexample, GlaxoSmithKline has inked a number of agreements in India andChina.
3. There is increasing synergy between diagnostics andpharmaceuticals, like is the case with Roche’s new drug developmentactivities.
4. A migration of diagnostics out of the lab and into the homewill occur for chronic diseases such as obesity and diabetes, as seenfrom Inverness’ focus.
5. Pure-play personalized medicine companies are targeting cancer treatments through genomics, for example, Genomic Health.
6. There continues to be an increasing number of partnerships between pharma and biotech.
7. Pharmacogenomics also continues to gain traction.
8. On the healthcare reform scene a luncheon presenter ThomasScully, an ex-administrator of the Centers for Medicare and MedicaidServices, said the reform will trigger an expansion of insurancebenefits that will be positive for the industry in the short term dueto increased demand but will create federal budget problems in the longterm from around 2013.
But remember, we are still in the middle of a great recession thatshows little signs of easing soon. Banks are not lending money, venturecapital funds are hesitant, and the number of initial public offeringsfor upstart biotech companies has dropped considerably in recent years.Don’t assume that permissive venture capitalism, capital raising, andIPO funding of 1999 will occur in 2010- credit is still quite tight.
Nor should you assume that investors and board members are willingto tolerate reckless buyouts by big pharmaceutical companies like in1999. In this decade, pharmaceutical companies must be much moreconservative about what they will pay for cash-burning,development-stage biotech companies that will not offer anything in theform of revenue in the near-term.
At the same time, pharmaceutical companies may take advantage of thereduced ability of biotech to raise cash and may be unwilling to paythe large premiums seen in past biotech deals.
So what companies are the ones most likely to find themselves tenderoffers or partnerships from big pharma? Consider the timelineapproaching: Blockbuster drugs are going generic; a more nationalizedhealthcare system may not pay for expensive biologics; and big pharmaneeds to come up with new drugs and applications that will fit underthe intentions of the pending health-care bill.
Many pharmaceutical companies are looking for new drugs that matchthe indication and purpose of their current revenue generating drugsthat are threatened with patent expiration. These types of drugs areoften called “biosimilars”, and can serve to replace versions of drugsthat are now generic or will be threatened with generic competition inthe future.
These drugs have reduced development risk, as their biology andmechanisms are known, and the company has experience in gainingregulatory approval for these types of drugs.
Beyond this, the company may already have an assembled and effectivesales force which can immediately gain the current market share bysimply “replacing” the current marketed drug with the “new version”.
So what companies are ripe for a buyout or lucrative partnership?There is obviously more value for the buyer in companies with early- tomid-stage programs, but give the length of time it may take for thosedevelopment programs to generate revenue, the more risk-aversesentiment these days favors buyouts and partnerships with companies whohave very late stage programs.
Be mindful that a phase III study can still take 2-3 years tocomplete and 1-2 years to gain approval and bring a drug to market.Companies who are just entering phase I or even phase II studies willlikely be ignored as potential acquisitions despite their potentialvalue.
Look for companies who have completed or are close to completing atleast phase II trials as buyout targets. There are many companies outthere with a couple drugs who are completing phase II trials or arecurrently running phase III trials who do not have enough cash to seethe drug through approval or marketing. Many development-stage biotechcompanies are surviving the financial crisis by cutting costs orfocusing on a single, late stage drug.
Indeed, most of the capital raised in 2009 went to such companieswith a single product on the market or a single drug close to finishingdevelopment.
Companies with highly experimental drugs or devices will most likelyat best be offered an alliance- a deal containing small upfront cashpayments, with continued milestone payments as the program progresseswith promise of partnership if the technology comes to fruition. Theseare indeed quite beneficial for these types of companies, but thepayoff to shareholders is still quite a long way off.
These days big pharma may steer clear of buyouts and focus onpartnership and alliances, which share revenue from drug sales, ratherthan making large upfront payments in the case of buying a company orits technology.
Although this is quite beneficial to the smaller company, the largercompany has the majority of the leverage in the partnership andlicensing talks, so don’t expect them to be as favorable as the typesof partnership that have occurred in prior years. It is still a toughbattle for smaller drug companies that will have to count onpartnerships larger companies to bring their drugs to market.
One way to take advantage of all these factors is to invest incompanies who are developing a “biosimilar” or a companion diagnosticfor a disease. Ideally, you may expect these companies to make apartnership or his year.
To get in on the offerings and mergers and acquisition activity, youwill be looking for companies who are looking to expand the uses ofsome existing drugs or are developing drugs to treat more than just onedisease. Look for companies who are making notable scientificdevelopments in molecular biology, immunology, and genomics: Thesecompanies will be targets for takeover and partnership if theirtechnology will result in more targeted approaches and betterdiagnostics for the “personalized medicine” which big pharmaceuticalcompanies are developing.
This approach to investing will take significant understanding bythe investor in the technology they are investing in. As well, theyneed to have a fundamental understanding of the development process andwhat it takes to gain FDA approval; investors should know at what stagein development the technology is in and what it is needed to completethe process. Investors need to determine if the company has goodmanagement teams that know what has to be done to market a potentialproduct. Investors need to understand the significance of thepre-clinical and clinical trials.
However, as the average investor does not likely have the knowledgeand experience base to judge this, he/she will have to rely on theopinion of experts. Remember that a majority of a biotechnologycompanies market cap is not related to products already out on themarket but to the in the development stage; market cap is reflectingthe likelihood of success only.
Ironically, the lack of understanding by the average investor may bein fact what fuels the biotech boom of 2010: As analysts (“experts”)recommend stocks, investors will generally have to act on good faith inthe analyst recommendations. This tends to create a “herd mentality”,where investors flock into stocks based on analysts recommendationsalone.
Success in this way for analysts encourages bolder and bolderrecommendations, which in turn drives more investor momentum. All ofthis feeds into a cycle that drives speculation, urgency, andvolatility, creating the same type of bubble for biotech as was seen in1999. Biotechnology sector is high on risk but also reward, and thistype of momentum only adds to both sides of the story. If you pick theright company, developing the right drug, at the right time, the stockwill soar and you may easily see 500-100% gains. In contrast, bad newsabout pivotal clinical trials can easily evaporate 50-90% of yourinvestment overnight.
Given the level of risk, you may not choose to own individualbiotech stocks. If chasing down and babysitting volatile biotechnologystocks is overwhelming to you, there is a way you can still participatein the 1999 party: Biotechnology exchange traded funds (ETFs).
There are currently six biotech ETFs. Each differs in their stockholdings and indexes they follow. They all have different advantagesand disadvantages, you cannot simply choose one and hope for the best.However, with the small number of ETFs available, it requires lesteffort to determine which one you feel may perform best and it iseasier to diversify your portfolio by perhaps owning a collection ofbiotech ETFs. Most importantly, these ETFs allow you to participate inthe 1999 party while keeping off the dance floor.
These funds are:
- First Trust Amex Biotechnology Fund (FBT)
- SPDR S&P Biotech (XBI)
- iShares NASDAQ Biotechnology (IBB)
- Powershares Dynamic Biotech and Genome Portfolio (PBE)
- HOLDRS Biotech ETF (BBH)
- First Trust Amex Biotechnology Trust (FBT)
- PowerShares Global Biotech Portfolio (PBTQ)
But whatever your approach to biotech and pharmaceutical investing you choose, keep these four major concepts in your mind:
- Big pharma is under a lot of stress and as investors sentiment reflects changes in the healthcare system you can expect their share price to reflect that as well.
- Look for small biotech companies that have technology or drugs which will help big pharmaceutical companies overcome the current stresses.
- Biotech is extremely bullish right now due to the flurry of partnerships and deals expected this year; speculation about such things is likely to drive stocks.
- Individual stocks could soar as a result of new coverage which points investors towards these concepts, keep an eye out for these events.
I hope to follow this article with specific mention of stocks whichmay benefit the most from the concepts I discussed here. In themeantime, happy trading, and party like it’s 1999! (hear the famousPrince song in your head)
Disclosure: I currently have no positions in any of the companies or ETFs mentioned.