Finding The Bulls In Biotech The sector is blazing, the science ever more titillating. But with share prices up 214% in three years, can biotech stocks go even higher? The right ones can.
(FORTUNE Magazine) – On Dec. 17, Amgen, the flagship company of the biotechnology world, closed the biggest merger in the sector's history. It agreed to pay $16 billion to buy rival Immunex, primarily for the right to acquire its exciting arthritis drug Enbrel. Two weeks later an up-and-coming biotech named ImClone Systems revealed that approval of its wildly hyped cancer drug Erbitux had been delayed by the FDA, kicking off the biggest stock debacle this side of Enron (assuming a 50%-plus stock plunge and a slew of class-action lawsuits still qualifies as a debacle these days).
On the surface these were two very different events, highlighting both the promise and the risk of investing in ambitious science. But the underlying message to investors is really the same in each: Biotech is becoming more of a business every day. Traditionally, the perception of value in biotechnology has been determined by the strength of ideas. That precept was only reinforced by the hype surrounding the historic mapping of the human genome two years ago. But professional investors are tired of hearing about potential. The new mantra is simple--products, products, products. The more, the better. In short, it's time for biotech to get a job. The companies that can create revenue and grow while limiting risk are going to be favored in the years to come. The sector will no longer rise as one. "Winners are going to start to emerge," says analyst Elise Wang of Salomon Smith Barney.
The spoils should be plentiful enough. The amount of money spent on health care, particularly prescription drugs, continues to rise annually. But increasingly, the big drugmakers are in no position to take advantage of that trend. Empty pipelines and expiring patents are killing their growth.
Biotech companies, on the other hand, now have some 100 drugs in Phase III (final stage) FDA clinical studies, which means that the next few years will likely bring a flood of new products onto the market. Because of the small revenue base of the typical biotech firm, a single major success can have a big impact, kicking earnings growth into overdrive. "One or two drugs can really move the needle," says Tom Wald of the Invesco Health Sciences fund.
But don't go laying all your money down on long shots. To increase stability in an inherently volatile sector, the pros advise buying into companies that are taking more "shots on goal" and therefore have a better chance of scoring big. With that in mind, here are five companies that look like future winners.
At first, no one seemed to understand why Amgen (AMGN, $56) wanted to do the Immunex deal. The biotech heavyweight (Amgen's $58 billion market cap is bigger than those of two major drugmakers) has a solid revenue base, with two billion-dollar drugs in Epogen, which is used to treat anemia, and Neupogen, which stimulates the growth of white blood cells. There was speculation that the company had overpaid. But investors are beginning to understand its reasoning. The success of Epo and Neupo notwithstanding, Amgen had a gap in its drug pipeline. Management saw a way to plug that hole in its revenue stream with Immunex's profitable drug Enbrel. The drug not only gets high marks for the treatment of rheumatoid arthritis but is now being tested for ailments like psoriasis and psoriatic arthritis, which could make it even more lucrative. "Basically, they're going to have three blockbuster drugs instead of two," says Wald.
The company has other near-term growth drivers too, including another would-be blockbuster, Aranesp, the second-generation version of Epogen. Amgen has been bound by a contract not to compete with Johnson & Johnson's Procrit (a rebranded version of Epogen) in many markets, but Aranesp will not be so constrained. That means Amgen will be free to duke it out for a market that could potentially grow to to $15 billion, from $6 billion. After trading down 12% in 2001, the stock may be primed for a nice ride.
If any one product is emblematic of trends in the biotech market, it's Rituxan. This soon-to-be blockbuster is already driving growth for two of the biggest biotechs--IDEC Pharmaceuticals (IDPH, $62), which makes the drug, and Genentech (DNA, $49), which markets it. The two companies split sales of roughly $800 million in 2001. As its adoption spreads, Rituxan, which fights a type of cancer known as non-Hodgkin's lymphoma, is on track to surpass the $1 billion mark this year. And sales are expected to grow by 20% annually over the next five years. Those numbers make it a rarity in a health-care world in which cancer had long been ignored by big drugmakers. "In cancer, there aren't that many billion-dollar drugs around," says Salomon Smith Barney's Wang.
Rituxan is also significant because it heralds the arrival of a new wave of products from an old technology: the monoclonal antibody. Designed to look and act like part of the body's own immune system, monoclonal antibodies fight ailments efficiently by precisely targeting a specific disease or infection. After years of refinement, new antibody drugs are emerging from company pipelines and starting to have a big impact in the market. In a recent report, Banc of America Securities analyst Eric Ende projected sales from monoclonal antibody drugs will rise from $2 billion in 2001 to $8.4 billion in 2005 and $21 billion by the end of the decade. Because they are very specific and relatively fast to develop in the clinic, antibody products could benefit greatly from the infusion of genetic targets coming out of genome research. "It's the approach to developing new drugs we have the most confidence in," says Michael Dauchot, co-manager of the Dresdner RCM Biotechnology fund.
Right now Genentech, the granddaddy of the industry, probably has the premier portfolio of monoclonal antibody products. When FORTUNE picked the stock in our "New Prescription for Your Portfolio" package last summer (see fortune.com), we recommended buying at $50--just above the stock's current price. We believe it looks more attractive now. In addition to Rituxan, the company has a successful antibody product in Herceptin, a breast cancer drug. And Genentech's pipeline is as broad as any in the business. Delays in the approval of Xolair, an allergic asthma drug, and Xanelim, for psoriasis, held the stock down in 2001. But both should get the green light this year. IDEC, the fastest growing of the major biotech companies, is also benefiting from monoclonal antibody technology. Analysts expect Zevalin, a cancer medication, to be approved later this year too. That's scientifically significant because Zevalin uses an antibody to deliver a radioactive dose to kill tumor cells. Early projections don't size it up as a full-scale blockbuster, but IDEC owns 100% of the profits. Having a second big revenue stream should stabilize a sometimes volatile stock and fund more R&D. "IDEC is now one of the big boys in my opinion," says Alidad Mireskandari of the Orbitex Health and Biotechnology fund.
A slightly more speculative way to bet on monoclonal antibodies is to buy Abgenix (ABGX, $26). The Fremont, Calif., company started out primarily focusing on research and has partnerships with bigger biotechs like Amgen, as well as with Big Pharma companies like Pfizer. But now Abgenix is developing its own product pipeline. The company specializes in what's known as "fully human" antibodies, which are developed in special mice (the company's proprietary XenoMouse) that are genetically engineered with human antibody genes. Antibodies can be harvested in the mice and used directly in people with less risk of rejection.
Because Abgenix doesn't have a product on the market yet, profitability is still a few years away. But it has a strong pipeline in the key growth areas of cancer, psoriasis, and arthritis. The company's goal is to have 11 products (either its own or in partnerships) in clinical trials by the end of 2002. "If the platform is successful, it's going to result in multiple hits," says Wald. That potential, combined with the company's strong balance sheet--$540 million in cash and no debt--looks like a good bet.
To gamble on a big return from a small company, try Telik (TELK, $13). The South San Francisco company has a promising pipeline of cancer and diabetes drugs with two--both cancer therapies--in early trials. The newer of the therapies is much like Amgen's blockbuster Neupogen but could potentially be cheaper and easier to administer. After a secondary offering in August led by institutional investors, the company is well fortified with roughly $60 million in cash. Predicts Mireskandari: "Once it proves the efficacy of its lead drug, it will grab a lot of attention on Wall Street."