Don't Lump Biotechs With Big Pharma

Litigation risk, generic competition and pipeline problems are causing investors to just say no to large-cap drug stocks. But should they also steer clear of biotech companies for the same reasons?

As demonstrated last week when Merck(MRK) shares were stung after a judge ruled its first federal Vioxx case a mistrial, large-cap pharmaceutical companies can be stuck trading according to outside factors rather than earnings potential.

But don't lump biotechs in with the big boys just because they both peddle drugs, says Stephan Patten, manager of the $20 million (QBPAX)Quaker Biotech Pharma-Healthcare fund. Patten says the challenges facing big-cap pharma won't rub off on biotechs, which he says don't face the same threat from juries, or, for that matter, generic drugs. And biotechs are gaining strength in the merger world, as evidenced by Amgen's (AMGN) agreement last week to buy Abgenix (ABGX) in a $2.2 billion deal, though buyouts aren't necessarily one of Patten's reasons for investing.

Patten's fund is up 2% year to date and 14.2% annually over the past three years, after taking into account its fairly pricey 2.3% expense ratio.

TheStreet.com chatted with Patten about big-cap pharma's problems and his favorite biotech stocks.

Will the problems afflicting large-cap pharma ever start trickling down to biotech?

Large-cap pharmaceuticals face a number of challenges, in particular patent expirations and challenges, therapeutic substitution by generics, and sparse late-stage pipelines. The vast majority of biotech companies remain unaffected by these issues.

Firstly, biotech companies are generally more immune to generic challenges and, therefore, therapeutic substitution, than are traditional pharmaceutical companies. This stems from the fact that pharmaceutical companies typically develop chemical drugs -- of which generic versions can be made quite easily. While on the other hand, the biotech industry typically makes biologic drugs -- of which generic copies are still extremely difficult to make. At some point in time in the future, the US and Europe will likely allow biologic generics to come, but the requirements for approval will involve a much longer and more costly development path.