Genentech's Stuck in the Morass for Now

Genentech(DNA Quote) has a management team I like and trust -- heck, the mutual fund I run owned the stock until two days ago. But I can tell you the bear rap on the company. My biotech hedge buddies say, "Genentech's pipeline stinks. There's no there there. It's not an exciting story."

Now, after the last two weeks, many of us are pining for a lack of excitement. The prospect of a steady 25% earnings-grower has suddenly become quite tolerable. But a more objective description of Genentech would be that it's temporarily stuck in the data swamp. That's the marshy place most biotech companies wade through when clinical trials are under way and no exciting data are due any time soon.

You wouldn't think a company such as Genentech would find itself in the "data swamp." After all, it's the granddaddy of all biotech firms, having been founded 25 years ago, and now with $1.7 billion in revenues, multiple approved products and 19 projects in development.

But the bears want excitement and they can't see any on the horizon.

The fact that sales of Genentech/Idec's(IDPH Quote) blockbuster non-Hodgkin's lymphoma drug Rituxan were up 83% last quarter to $188 million wasn't enough. That's because the expectation was that sales would more than double to $200 million to $220 million for the quarter. This foul-up was largely because the prescription count reported by industry expert IMS Health(RX Quote) was way off.

Because IMS subscribers pay a lot of money for that data, you could hear the hissing up and down Wall Street after Genentech reported in the second quarter. (By the by, I heard sales of Rituxan might have been a little soft this quarter even before the World Trade Center disaster disrupted shipping, but I really can't tell at this point. I'm one of those who believes Rituxan sales may ultimately top $3 billion. But the bears figure it's a $1 billion product, period.)

Meanwhile, sales of breast cancer drug Herceptin also were below analyst estimates in the second quarter, and the combined sales of Genentech's clot-buster drugs Activase and TNKase fell 9% to $51.6 million. Sales of Genentech's four growth hormone drugs rose 25% to $62.5 million, but they don't get much respect because other companies also sell those drugs. And sales of Pulmozyme, Genentech's cystic fibrosis drug, fell 13% to $51.6 million.

Mind you, Genentech made its expected earnings in the second quarter, partly because the company cut research spending by $13 million. But the picture that emerged was of a company whose growth appeared to be slowing, and at a time when the oncology community is experiencing enormous change.

Until recently, cancer treatment has been an appallingly hit-or-miss proposition: You throw a drug at a cancer and if the tumor dies before the patient, it's a hit. But now we've entered a glorious new age with drugs like Gleevec, which specifically target molecular pathways in cancer. The oncology community is deeply excited because it can see a time coming when its patients don't die. This "molecular targeting" sea change ultimately will result in far better patient outcomes, but like all transformations, it will take time.

And you know, bears hate to wait.

Genentech's stock actually took its hardest one-day hit -- from $52 to $43 -- on July 10 when approval for its experimental asthma drug Xolair was delayed by the FDA's request for more data. Some analysts -- and I'm not one of them -- projected sales of Xolair would start next year and ultimately top $1 billion.

I don't see these numbers happening for Xolair because all but the most severe asthma patients can be managed using existing drugs. Doctors say the real problem is compliance -- i.e., patients don't take their drugs as religiously as they should. I'm also skeptical about Xolair because I'm not yet clear on the pricing. To be competitive in this market, a drug probably needs to sell in the $2,000 price range. But Xolair sounds like it'll be priced at $5,000 to $6,000.

Suffice it to say that everybody wants more data on Xolair before we're comfortable with it.

Because of this progression of negative news, Genentech's stock is down nearly 48% year to date. Investors have probably started to feel like a prizefighter who's reeling after too many hits. They trusted Genentech to get them through this tumultuous market unscathed, and with the best will in the world, Genentech couldn't do it.

But even the bears admit all the likely disappointments are now reflected in Genentech's stock price. Before the WTC disaster, there was a general feeling that Genentech's stock wasn't going anywhere soon. But what a difference two weeks can make. The stock sold off only 10% in the waterfall selling last week, and since has rebounded as folks weigh the value of a steady 25% grower in a world filled with uncertainty.

I argued the bear case with Adam on Genentech partially for fun. But I'll tell you the truth -- Genentech's a powerhouse in waiting. The real question is, do you want to wait?