Playing The Biotech Boom Picking biotech stocks is not a game for novices

Hal Plotkin, Special to SF Gate
Monday, December 31, 2001

URL: sfgate.com/cgi-bin/article.cgi?file=/gate/archive/2001/12/31/biotch.DTL

The year 2002 is expected to be a banner one for the biotech sector, with more innovative research under way and more new drugs set to reach the market than ever before. That’s welcome news not only for the sick and the dying but also for investors smart enough to cash in on all that progress. Unfortunately, though, despite the biotech industry’s overall upward trajectory, many of the same people who got charred buying tech stocks last year could just as easily get burned to a crisp by biotech stocks next year.

The reason for that is pretty simple: Most people usually don’t have access to the information they need to make smart and timely decisions about investments in the rapidly accelerating biotech industry.

During the entire 10-year period between 1976 and 1985, the FDA approved just 198 new drugs. Last year alone, the number of new drug approvals skyrocketed to 160. Experts predict that figure will climb even higher in 2002. At present, an astonishing 643 new pharmaceuticals are nearing the final stages of the FDA’s testing and approval process, according to a recent report prepared for the US Department of Health and Human Services.

Many investors are already well aware of the coming biotech boom. It’s what they don’t know, however, that could hurt them.

The customary sharing of data between scientists and researchers often provides biotech insiders with some very big advantages over members of the general public. Industry insiders frequently get hold of the latest research data weeks or even months before such news trickles down to the public through the mainstream media or the general business press.

That can put the average investor in a very precarious position.

Nonetheless, judging from the recent rise in key biotech stock indexes (the AMEX Biotech index, for example, is up roughly 20 percent over the last three months), it seems many investors are banking on biotechs, hoping they’ll generate whopping returns similar to those investors pocketed from once red-hot tech stocks such as Cisco and Intel.

Such hopes are not entirely misplaced. But cashing in on that opportunity will require more painstaking research than many investors are accustomed to performing.

Developing new pharmaceutical compounds is costly and time consuming. Yet the rewards can be enormous, both for the companies involved and for their investors. New drugs such as Lipitor and Viagra, for example, have created entirely new multibillion-dollar markets.

Before new pharmaceuticals can be sold, they must successfully complete three phases of testing. The process can take as long as 15 years, although expedited procedures enacted during the Clinton administration have reduced the testing period in some cases to less than five years.

The earlier a new drug is located in the development process, the higher the risk. More than 90 percent of all new biopharmaceuticals under development never even make it to the first part of phase III trials, according to Tricia Nagle, managing editor of the newsletter Drug and Market Development, based in Southborough, Mass.

But nearing the end of that process is no sure guarantee of success, either. Roughly 40 percent of potential new drugs fail their final phase III tests. “The farther along you are, the lower the risks, but we have had some spectacular failures in phase III trials,” warns Jim McCamant, editor and publisher of the well-respected, Berkeley-based Medical Technology Stock Letter. McCamant is an expert on the risks and rewards of biotech investing, and, as a newsletter publisher — not an analyst working for a securities firm — he’s also something of a rarity among professional biotech-industry watchers.

To remind you, analysts at securities firms usually make their money working for companies that underwrite stock offerings for the biotech firms they cover, or by selling merger-and-acquisition-related services to those same operations. Not surprisingly, investment advice coming from those quarters has often proven to be less than reliable. McCamant, by contrast, is a veteran biotech stock picker who makes his money by making real investments in carefully selected biotech firms, and by sharing his recommendations, which can change quite rapidly, with clients.

He’s got a pretty impressive track record. His model biotech stock portfolio has increased 746 percent since he started covering biotech securities in 1987. Meanwhile, his aggressive biotech portfolio (which entails more risk) has fared even better, up a staggering 2,474 percent since 1987. (The Dow Jones Industrial Average, by contrast, is up 453 percent over the same period).

McCamant does what most individual investors can’t do, which is to constantly monitor individual firms, science meetings and research publications for developments that will move specific biotech-company stock prices. McCamant says small biotech firms are probably better bets right now than some of the bigger biotech names such as Amgen, Chiron or Biogen, which have already been big beneficiaries of the recent rotation out of tech stocks and into biotechs. He says that could leave very little room on the upside, at least over the near term, for the biggest, most popular biotech brand names.

That’s one of the reasons McCamant recommends the stocks of three less well-known biotech firms, Avant Immunotherapeutics, Valentis and Ligand Pharmaceuticals — all of which, he says, are expected to announce news over the coming months about progress that could double or even triple their stock prices. (Full disclosure: He owns all three stocks, in addition to others.)

The first two firms have stock prices in the low single digits and, he says, are flying under the radar screens of most big biotech mutual funds, which usually prefer better-known names.

What’s really caught his attention, though, is the fact that both firms appear to be making good progress as they near the final phases of the testing process. Assuming the companies manage to keep things on track (which is always a big “if”), they could soon attract more attention from big institutional buyers, says McCamant. (Ligand also makes the cut, even though that stock has already more than doubled in value in recent months as the company nears profitability.)

There are, however, some significant caveats to even the best biotech investment advice.

Common sense is often a critical factor when it comes to picking tech stocks. It didn’t take a rocket scientist, for example, to notice that personal computers weren’t exactly jumping off store shelves last year, or that e-commerce was running into a wee bit of trouble.

Unfortunately, when it comes to biotech investing, common sense is often of very little value, unless it serves to warn people about the dangers of diving into waters that might be too deep for them.

Did you know, for example, that partial GABA-A selective receptor agonists indicate that subtle differences in receptor selectivity can have significant clinical effects? (And now that I have told you, do you have any idea whatsoever what that may mean for any biotech stocks that might be in your portfolio?)

The most successful biotech investors routinely track vast amounts of detailed science-related research or are willing to pay competent experts to do it for them. Without that effort, the only returns they would see from the biotech industry are better drugs to treat stress-related illnesses produced by their own self-inflicted financial wounds.

Understanding what really moves biotech stocks up and down is a case in point. Unsophisticated investors are often swayed by news stories that come out of heavily promoted biotech and health-care conferences sponsored by well-known securities firms. These meetings, such as the big annual SF-based J.P. Morgan H&Q Healthcare Conference, are designed primarily to influence public and institutional investors. Biotech-company CEOs make presentations, and reporters go rushing for the phones.

But the real action usually takes place in the trenches, at far more obscure gatherings attended primarily by biotech professionals. These include annual meetings of key medical-research groups and associations such as the American Society of Clinical Oncologists, the International Psoriasis Symposium or the always fun International Colorectal Disease Symposium. Not surprisingly, very few mainstream business or finance reporters ever cover such events.

Nonetheless, it’s at these and other similar meetings where scientists working with or for biotech companies frequently announce the first results of their most recent experiments in the lab or with human subjects, such as the percentage of patients who have responded to a new compound. The conferences frequently include expert panel discussions where information is presented, often in an almost off-handed way, which can make a once-promising approach appear worthless, or at least far less worthwhile.

What’s more, the scientists (and the very few savvy investors and journalists) who attend these events often receive abstracts of the presentations well in advance, usually after they’ve paid to register. That longstanding practice can provide attendees with key data on current research developments days, weeks or sometimes even months before the general public becomes aware of the information.

In the biotech industry, knowledge is not only power, it’s money.

If, for example, you own a biotech stock that suddenly drops like a rock without apparent warning, you can bet that someone just released details about research that in some way undercuts the market position of the firm whose stock you hold. Likewise, if a biotech stock suddenly shoots up, it often means someone, somewhere, has gotten his or her hands on positive clinical data before it has been widely circulated.

The Securities and Exchange Commission has rules that are supposed to prevent selective disclosure of critical information about corporate performance. Unfortunately, the SEC hasn’t yet figured out how to fully apply those rules to scientific gatherings.

Complicating matters, we’re also talking about information that many members of the general public would not fully grasp even if they could get their hands on it.

A tidal wave of new drugs will almost certainly lead biotech firms to their best year ever in 2002. The most hopeful news is that new pharmaceuticals may soon emerge to help prevent or better treat devastating ailments such as heart disease, cancer, diabetes and Alzheimer’s.

But investors might want to think twice about trying to ride the biotech wave by themselves unless they know those waters well.

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