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Biotech's bipolar disorder
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October 28, 1998: 1:53 p.m. ET
For smaller biotech stocks, the days of taking without giving may be over
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NEW YORK (CNNfn) - Over the last few years, the biotechnology industry has reaped the rewards of the bull market stampede with abandon, appealing to the entrepreneurial spirit of Wall Street with its progress reports on the esoteric world of genetics and drug development.
Many firms have brought products to market that treat life threatening diseases, posting first-time profits and record stock price gains.
But for all its progress, the still largely misunderstood industry has been unable to develop a cure for the bipolar effect that recent stock market volatility has had on the business.
For start-up biotechs, it seems, the party may be over.
"Even the small cap biotechs that are getting products on the market are not recovering the way they use to," said Sharon Doering, an analyst with Madison Securities. "They are very out of favor and we could get a lot of selling at the end of the year yet because people have had such big losses. I don't think it's necessarily over."
In the last three months, mid- to large-cap biotechs have outperformed the overall market by a wide margin, climbing 14.7 percent, along side the relatively strong performance of health-care and tech stocks, according to the Standard & Poor's sector score card.
(The overall S&P 500 index is down 10.3 percent for the period.)
At the same time, the stock prices of small-cap biotechs have fallen to new lows since the Dow Jones industrial average plunged 512 points in late August, sending risk-averse investors running for cover. Some of those stocks, including Cor Therapeutics, have lost more than half their value.
"This (market volatility) has had a pretty dramatic impact on the industry's ability to raise capital in the public markets, and that's the source of funding for most smaller companies that don't (have income from) corporate partnerships," said Cor Therapeutics President and Chief Executive Vaughn Kailain, adding the market downturn also has made it difficult for would-be merger partners to assess a target company's valuation.
Cor Therapeutics has seen its stock (CORR) tumble to less than $11 per share from a high of $25 per share this time last year. In the last month, its stock has twice dipped below $7 per share.
The company won approval from the Food and Drug Administration in the second quarter for its new cardiovascular drug that treats chest pain.
"We know we can ride out this storm, which for us should be over within the next one or two quarters as we show sales results to the Street," he said. "But I am not nearly as optimistic for the overall market. I think it is going to begin a phase of consolidation and I think it has to. There are far too many companies out there chasing capital."
Likewise, BioChem Pharma (BCHE) plummeted to around $14 per share in early September from its high of about $28 set back in December. The company's stock has since pared some of its losses but remained down at around $22 per share on the Nasdaq.
Analysts say many investors are trading in their riskier biotech start-up stocks -- and the potential for staggering returns that goes with them -- in favor of blue chip drug companies and others of their ilk that have successful products on the market, a well-established client base and a revenue stream rolling in.
"(Large-cap) stocks provide the same relative safety and advantages that large-cap drug stocks provide," said Sharon Doering, an analyst with Madison Securities. "Despite the economic environment, people do need their drugs. Large-cap drug stocks are seen as a safe haven with relatively inelastic demand."
To name just a few of the industry's high-flying big-cap stocks, Biogen, Genzyme Corp.(GENZ), Amgen (AMGN), and Genentech (GNE) all are up around their 52-week highs.
Biogen (BGEN) stock is trading this week at around $78 per share, up from around $30 per share this time last year.
Shares of Amgen Inc., the world's largest biotechnology company, also rocketed up to around $77 per share Wednesday on the Nasdaq, a day after beating Wall Street's third-quarter expectations by 4 cents a share. According to the company, results were buoyed by a 23-percent jump in sales of its Epogen kidney dialysis drug.
(Click here for a chart of Amgen's stock activity)
It's worse for the biotechs
To be sure, the disparity between underperforming small-cap stocks and their larger-cap counterparts of late is not unusual.
The S&P 500 index, a broad barometer of overall large-cap stock activity, has pared much of its losses since the stock market plunge in August. The index now stands at around 1,063.21, down from its peak of 1,186 this summer, but still much higher from its low of about 900 this time last year.
Year-to-date, the S&P's large-cap biotech sector index is up around 24.8 percent.
By comparison, the Russell 2000, which tracks the activity of smaller companies, has declined steadily since August. The index Wednesday stood at 369.51, down from its high of around 491 this spring and its year-ago level of around 450.
But those following the markets say the stock divergence between large- and small-cap stock activity is more pronounced in the biotech sector.
More importantly, they say, it poses a greater threat for the cash-poor industry, since many smaller companies were already struggling to stay afloat.
The irony of it all
"The irony is that this industry took a hit at a time when nearly 300 biotech drugs and vaccines are in human clinical trials," said Carl Feldbaum, president of the Biotechnology Industry Organization in Washington. "The pipelines have never been fuller. I think it'll take investors a little more time to recognize that before small-cap stocks will come back."
Feldbaum added he expects Big Pharma, the large, deep-pocket pharmaceutical firms, to begin cherry picking the biotech industry, buying up smaller, promising companies for a song.
That, in turn, he added, will force investors to sit up and take notice.
"That's the first thing that is going to happen and that will likely be a signal to Wall Street that they are missing the point," Feldbaum said. "These companies are extremely healthy in terms of their product development. The small-cap companies are very much undervalued right now and it's going to be somebody's opportunity."
Feldbaum said he expects the industry small caps to be shunned by investors for at least the next few months.
In the meantime, their stunted ability to raise financing through public offerings and venture capitalists could wreak havoc on their R&D efforts.
"Many of these companies are running short of cash," he said. "Some of them are still perhaps a year or two or more away from product introduction and what could be tragic in some cases is that some of these companies may have to cut back on critical research. That would be an outcome socially and economically that we don't want to see."
When will it end?
The lure of risky small-cap biotechs -- most of which are still in the early stages of research and development, are millions of dollars in debt and offer no promises of ever bringing a product to the market -- has always been their high reward potential.
But with larger biotech and pharmaceutical stocks churning out 30 percent to 60 percent appreciation rates, Doering said investors are choosing instead to put their money where the profits are. Not until those growth rates subside, she said, will biotech reclaim its status as a darling of Wall Street.
"In order for the small caps to really come back into favor, I think some of the valuations of these drug stocks will have to either remain where they are or come down a bit," Doering said, adding she believes drug stocks will continue to perform well but slow their growth.
"I think once the economic environment improves and once our market starts to feel more confident, they'll be willing to take a higher risk," he said.
Going forward, Kailain of Cor Therapeutics says he believes small cap biotechs will be judged against a more reasonable investor benchmark. Those that meet their milestones and maintain a promising pipeline of drug products, he said, should again reap the rewards of investor optimism.
Which companies will survive, however, remains an unanswered question.
"I think everyone's expectations in this industry were set a little too high," he said. "Now that they've reset those expectations and they begin benchmarking (biotech companies) against those expectations, the long-term opportunities will be there." 
-- by staff writer Shelly K. Schwartz
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