For Biotech, This Time It's Different

Well, I got the answer to my question. In my last article for RealMoney.com on Sept. 22 , I said:

Biotech has a tough time staying up when Nasdaq is cratering around it. Right now, a lot of new funds have been started in biotech, and every general fund that can own biotech now does so. Meanwhile, the number of lockups that will come off biotech IPOs and secondaries in the next two months will unleash more than $10 billion of stock on the market. Can biotech absorb that and still stay up, let alone continue to rise? ... [Will] the sector blast through what look like double-tops in the American Stock Exchange Biotechnology Index and the Nasdaq Biotech Index?

Two months later, the answer to my question is clear: "Fuggedaboutit. At least until next year." In fact, this market-with-an-attitude broke so far down last week that the biotech indices tested support at their 300-day moving averages.

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Now, biotech was holding up better than just about any other sector until Michael Shaoul's article slagging biotech valuations came out in Barron's two weeks ago. (Bet that made him popular with fund managers!) As one who has enjoyed writing for Barron's in the past, I can attest to the astonishing impact its articles sometimes have -- particularly in the volatile autumn months.

In November 1992, I accidentally caused a "reverse-Shaoul" with a Barron's article about how bombed-out biotech was. Stocks had fallen 60% to 90% over the summer and were starting to float back up, but that article helped launch a minor mania. Investors rushed back into biotech and the secondary market reopened: All kinds of warrants were issued during this period. One happy venture capitalist who got cash for several companies later told me, "It's the best work you've ever done." (Which certainly put my life in perspective!)

Anyway, I've been muttering about biotech brokerage conferences this week like they are some kind of magic spell that can levitate the entire sector. The past three months have been chockablock with biotech conferences that couldn't keep the stocks up. So why should this week be any different? Gary B. Smith says that if last Wednesday was the bottom, "he'll be way past shocked" -- and the man knows his technical analysis.

But biotech doesn't always move with the market and it is end-of-month funding time, when pension funds and 401(k) plans throw more money at the market. Moreover, for all the mutual funds that run on a November fiscal year --- and there are many -- this week is it. Whatever we own in our reports Thursday night is what our shareholders will see in our annual reports. Such year-end considerations naturally make a portfolio manager think about what they want to show. And showing that you own biotech, the best-performing sector this year of the eight Nasdaq groups, is probably good for business.

Furthermore, biotech could care less about a weakening dollar or rising interest rates or recession or even the election. Biotech products are most often used by 40- to 60-year-old patients, so Medicare price fixing of prescription drugs is almost irrelevant to these companies. It doesn't really matter to them who is in the White House.

If biotech companies stop befouling their nests by issuing too much stock --- and the market of the past few weeks has put a real crimp in that behavior --- the whole sector is set to move up again.

Having shrunk its market cap back under $400 billion, I wouldn't be a bit surprised if these stocks gain 25% from now through the end of the year. (Heck, they lost 22% over the past 3 1/2 weeks, so 25% over five weeks isn't much of a stretch.)

And then there's the incitement to riot by the conferences. The annual Robertson Stephens Health Care Conference packs a lot of clout, particularly because its biotech analyst team is highly rated by everyone from TSC to The Wall Street Journal. (Robbie analyst Jay Silverman was ranked No. 1 in biotech by The Wall Street Journal this year.)

Silverman and his buddies have just issued a report called "Why Everybody Should Love Antibodies Even More." This is the companion piece to his original report in November 1998, which pointed out how monoclonal antibody companies were about to take off. How much of it was self-fulfilling prophecy I do not know --- but the numbers say Silverman was right.

Look at these moves over the past two years:

Antibodies Are an Investor's Buddy The stocks of companies producing monoclonal antibodies took off
Company	Price on 11/16/98	Price on 11/24/00	% Change
Abgenix( ABGX)	$2.44	$58.63	2303%
Biogen( BGEN)	$39.44	$56.70	44%
Cambridge Antibody Technology (CAT LN)	2.45	29.3	1096%
Celltech (CCH LN)	4.2	12.5	198%
Genentech( DNA)	$18.20	$73.00	301%
IDEC Pharmaceuticals(IDPH)	$14.88	$177.00	1090%
Medarex(MEDX)	$1.97	$1.97	1816%
MedImmune(MEDI)	$11.20	$61.47	449%
Millennium Pharmaceuticals(MLNM)	$4.80	$54.06	1026%
Protein Design Labs(PDLI)	$12.22	$95.00	677%
AMEX Biotech Index(BTK)	$163.09	$622.78	282%

Why were investors so willing to buy into Silverman's story? Because antibody companies finally figured out how to make monoclonals 90% or more human protein, instead of 65% or more mouse protein. That was a huge achievement, because human bodies don't like mouse protein injections and often react very badly to them. (This is the famous human antimouse antibody that gave monoclonals such a bad name in the 1980s.)

As proof of the importance of their achievement, clever Genentech (DNA:NYSE - news - boards) got the monoclonal Rituxan for non-Hodgkins lymphoma approved (with IDEC Pharmaceuticals (IDEC:Nasdaq - news - boards)) in December 1997, and then Herceptin approved for breast cancer six months later.

Other monoclonals had been approved before, but that really ushered in the age of monoclonals. Of course, Wall Street took notice.

Meanwhile, the confluence of genomics and monoclonals could scarcely have been more perfect in terms of timing. Because when you know the sequence of a gene and the protein it encodes, you can make an antibody to that protein. And monoclonal antibodies can go from concept to market in five to six years. Compare that with a small molecule drug that takes 10 to 12 years to develop. Then multiply the five or six years that are gained by the revenue such a drug might bring in. Heck, Amgen's (AMGN:Nasdaq - news - boards) Epogen grosses more than $2 million a day. At that rate, a monoclonal could bring in $3 billion before a small molecule drug could even hit the pavement.

This is why big pharmaceutical companies bought into biotech more than 20 years ago. They hoped it would shorten their drug development lead times. Now, at last, it has.

Biotech companies are making steady progress -- that's why the stocks will go higher. Nasdaq may rise and fall; Alan Greenspan may pump the economy full of money as he did before Y2K and then drain it as he did all winter. Enthusiasm for monoclonals and genomics and cancer vaccines will wax and wane; individual drugs will succeed or fail.

But accepting the volatility, biotech will keep trending higher. I have said these heretical words softly on this site before, and now I say them again: Truly, for biotech, this time it's different.

Note: I was wrong in thinking the Amgen/Transkaryotic Therapies (TKTX:Nasdaq - news - boards) court decision might come down last week. Wish the judge would rule -- the longer he takes, the bigger a sword of Damocles that ruling may be for biotech.

But otherwise, I'm pretty cheerful about the sector. I know people who were blown out in the past weeks' bloodbath, but most are smart and they'll be back. After all, biotech gives us the wild ride of momentum stocks with the substantive achievements and intellectual challenge of technology stocks. For many of us, that's an addictive combination.

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Lissa Morgenthaler runs the Monterey Murphy New World Biotechnology Fund, and has written on biotech for various publications, including Barron's and Michael Murphy's California Technology Stock Letter for more than 15 years. At time of publication, Morgenthaler was long Transkaryotic Therapies, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Morgenthaler appreciates your feedback and invites you to send it to Lissa Morgenthaler .