ANALYST DOUG ROGERS TAKES ON BIO-TECH

Dear Members,

Once again, we have the good fortune to tap into the expertise of our favorite analyst, Doug Rogers of ManageSource Research. Doug, as our members may recall, has authored numerous pieces for the StockUpTicks membership, providing us with valuable insight and perspective on this crazy market.

As the writers and editors of StockUpTicks sat around the office watching the NASDAQ tank, we began to discuss among ourselves what stocks we really liked now, hoping that as in the past, the market is indeed a cyclical animal who will once again test new levels. 

As you might expect, various ideas crossed the water cooler. Some felt that alternative fuels were worth a deeper look, others thought that Amazon.com (AMZN) and Ebay (EBAY) had proven themselves by weathering the dot-com/dot-bomb storm. Still others embraced new tech deals NetFlix (NFLX) and PayPal (PYPL), two intriguing Internet ventures who debuted recently.

But amid those of us embroiled in this discussion one common denominator shined through: We like Bio-tech.

Hardly a novel concept, some of the brighter stock stories in a morose market have come from the Bio-tech arena. As we mentioned last week, we have been searching for compelling deals to put in front of you and we recognized that the deals we liked the best were those in the Bio-tech sector. Sure, we’ve got others we’re hot after but we found a couple of Bio-techs we really liked.

We recognize that some of them are undoubtedly long-shots, but long-shots with dramatic potential, the kind of stocks we put a few shares of away just in case. Others have more imminent impact, the make-or-break-it point drawing ever near.

But these complicated deals require a complicated profile from us and we’re putting the finishing touches on them even as you read this. In the interim, what better than Doug Rogers’ take on the Bio-tech sector? 

So, sit back and enjoy Doug’s thoughts in this hopefully hot arena. We’ll be back with a profile as soon as possible and Doug’s latest effort may well serve you when those hot little Bio-tech stories hit your inbox.
 
 

BIOTECHNOLOGY STOCK: A PRIMER

Biotechnology and related industries command a very critical corner of the overall marketplace.  There is a tremendous amount of risk involved in biotech stocks due to the lengthy discovery and clinical trials periods that need to occur before a pharmaceutical or device even goes to FDA trials.  The most fascinating aspect, to me at least, is that the biotech industry has really entered its Golden Age.  What we’ve been witnessing in the past ten to fifteen years is the culmination of decades of frustrating research & discovery by the biotech and pharmaceutical industries. 

Prior to the mid 1970s, the amount of truly effective, reliable and available drug therapies was quite limited to vaccines and remedies - hardly an effective arsenal for the multitude of infections, viruses and disease that humans face daily.  But, even then, we didn’t really understand how or why those vaccines and therapies were working at a molecular level.  We lacked the comprehensive knowledge base and functional statistics necessary to manipulate the data in such a way that we could accurately develop and deliver therapies for mental, physical and emotional disease.  From the end of World War II to the early 1970’s, scientific method was a tedious and seemingly endless game of elimination. 

Technology helped to change all of that.

The decades of time and trillions of investment dollars that the biotech, pharmaceutical and healthcare industries have spent in research found its greatest compliment in computing power.  Technology has provided scientists with the predictive and modeling tools necessary to understand how and why drugs and therapeutics work at a biological level.  This has produced an explosion of effective new therapies never before thought possible while substantially cutting time to market, capital requirements and dead ends.  The upshot is that it is a great time to invest in biotechnology and it will remain so for a long time to come.  The downside is that, as investors, it can be very difficult to predict which new drugs, therapies or technologies will actually come to fruition and see commercialization.  Further, the industry is tremendously fragmented and saturated, creating relentless competition and government intervention. 

The biotech and pharmaceutical industries are populated by, at a very basic level, two types of companies.  Large, established players like Abbott Labs (ABT), Genentech (DNA) and Amgen (AMGN) command tremendous market space with existing multiple commercial drugs and a substantial product pipeline.  Despite the disappointing recent results by many of these “blue-chip” biotechs (BCBs), due primarily to increased competition from overseas and domestic generic manufacturers, these companies have tremendous potential and still wield big financial sticks.  The maturity of their businesses, however, makes them susceptible to the market forces that affect all public companies - mainly earnings and investor sentiment.  This is a particularly tenuous time for both.  Valuing the BCBs for inclusion in your portfolio should be relatively straightforward and you can refer to my previous articles for some tips.  Pay fastidious attention to earnings acceleration and product pipeline.  Earnings acceleration means that the company is reporting consistently higher percentage gains Q-Q and Y-Y.  For example, look for companies that are able to grow their earnings by 5%, then 5.2%, then 5.3%, etc. These are completely arbitrary percentages, but you will notice that we’re looking for earnings results that are exponentially better from period-to-period.  It demonstrates the compounding effect of adding new products to the commercial mix and the attainment of economies of scale within the manufacturing process that should be reflecting in lower costs associated with production.  In order to expect this to continue, you want to look for a strong product pipeline with multiple drugs at various states of clinical trials. 

Smaller, development stage companies or others with one or two commercial drugs or health-related products or therapies populate the second camp.  These companies are very difficult to value due to the inconsistency or even nonexistence of revenues.  The small cap biotechnology, pharmaceutical and healthcare industries are littered with companies that have incredibly novel and potentially far-reaching products.  They present investors with tremendous potential, but as with any investment, potential reward is equally offset with greater risk.  The possibilities range from Delcath Systems (Nasdaq SC: DCTH) a development stage company that is attracting attention with their novel chemotherapy delivery technologies, to InKine Pharmaceuticals (NASD: INKP) who has one primary commercial drug, Visicol, but is also engaged in acquisition of late-stage drug candidates and R&D for proprietary drugs and therapies, to Cortex Pharmaceuticals (AMEX: COR), that develops pharmaceuticals for neurological and psychiatric disorders.  The spectrum is much broader and these examples are in no way endorsed, as usual, but you can see that opportunities exist on all of the major markets and with a variety of viable business models. 

Many of the small biotech and pharmaceutical companies have a legitimate chance at survival and future growth.  But, with thousands to choose from, how do you determine the best one(s) for your portfolio?  Unfortunately, valuation here is dictated to a large degree by qualitative factors such as corporate partnerships and joint ventures (do they have relationships with established players?), capital resources (do they have sustainable revenues or a deep well of capital for their R&D?), commercial potential (does their focus have a market?), and management (are they experienced clinicians, medical professionals and healthcare veterans?).  Further, an investor should look for a company that has a solid couple of years of operating history to support their claims and verify that they are making consistent progress relative to their business plan.  Also consider whether they have multiple uses for the drug being developed or future potential for the underlying technology in other areas that could lower the company’s overall market and regulatory risk.

Biotechnology and related industries are volatile and extremely fickle.  Remember the apparent investor feud between Boston Scientific and Arterial Vascular Engineering in ‘97/’98?  Both were great companies with very similar products, but one week’s news dictated that BSX was the high flyer and the next AVEI would take the lead.  It can be a difficult space for investors that are seeking to increase their risk tolerance for greater potential returns, but when you do own stock in a biotech company that receives FDA approval, or gets purchased by Johnson & Johnson, for example, it’s a great rush, and a lucrative one at that!  Remember to keep close tabs on the Company’s progress though, because your payoff could take weeks, months or years. 

Wishing you pragmatic, existential investing,

Douglas Rogers
ManageSource Research
 
 

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