The Hazards in Bioterror Plays

Certainly, the biochemical warfare scare will bring billions of dollars to biochemical, pharmaceutical and medical equipment manufacturers over the coming years.

But that doesn't mean all of them will be good investments. Which companies benefit, of course, depends on what kind of infectious diseases or toxins the terrorists try to use. Anthrax is only one possible scenario.

Other possibilities include outbreaks of E.coli, dengue fever or tuberculosis. The first large-scale use of biochemical warfare by terrorists in the U.S. was an outbreak of salmonella in Oregon salad bars in 1984, according to Germs: Biological Weapons and America's Secret War, a new book written by Judith Miller, The New York Times bioterrorism expert who last Friday opened a letter suspected of containing anthrax, but which tested negative. In another example, terrorists killed 12 people and injured hundreds of others by releasing nerve gas in a Tokyo subway in 1995.

Few tools presently exist to combat such warfare. After three years of working on an anthrax vaccine for the U.S. military, Bioport still awaits Food and Drug Administration approval. It is clear, however, that the U.S. must produce vaccines and antibiotics, while simultaneously upgrading the nation's public health and epidemiological surveillance systems.

But Sven Borho, a partner with OrbiMed Advisors, a health care fund manager with $3.5 billion of assets under management, warns against investing too heavily in biochemical or pharmaceutical companies because the current bioterrorism threat may recede, and with it, the interest in investing in this sector.

Since anthrax hit the headlines last week, Borho has pulled his money from some of the most logical antiterrorism plays, such as Cepheid(CPHD Quote), which makes a testing kit that can detect chemical or biological pathogens within minutes. He also has become cautious about Hadron(HDRN Quote), even though the government just awarded the company $800,000 to produce a vaccine to resist anthrax.

Further, Borho says that many of these companies, which haven't even made a profit yet, have such high valuations that their prices likely will not rise any higher.

"The biotechnology subsector is very fashionable right now and creating a lot of excitement, but like stem cell biochem companies, many of these stocks are likely to fizzle," Borho says. He prefers companies with strong fundamentals, which likely will win private or Defense Department contracts.

In fact, the companies that Borho likes best aren't even traded in U.S. markets: U.K's Acambis, which has a smallpox vaccine, and Germany's Bayer AG, the maker of Cipro antibiotic, which NBC news anchor Tom Brokaw and other staffers there are taking. And although these companies are not yet profitable, Borho is keeping his eye on IGEN(IGEN Quote), which makes diagnostic systems to detect biological substances, and Luminex(LMNX Quote), which makes a device that can perform up to 100 biological tests simultaneously on one drop of fluid.

Meanwhile, even though some U.S. stocks saw some good short-term runs, the jury is still out on whether they will climb any further. Cepheid, which makes a testing kit that detects chemical or biological pathogens, has soared 408.5% from $1.53 on Sept. 10 to $7.78 as of Friday's close. Not yet profitable, the stock trades at 19 times sales, based on 2001 revenue estimates of $10.95 million.

Bruker Daltonics(BDAL Quote), which makes a spectrometer device that tests air, also had seen a short-term run, increasing 43.3% since the attack to close Friday at $20.49. The stock is profitable, trading at a 2001 price-to-earnings ratio of 333 and a 1.2 price-to-sales ratio, based on 2001 revenue estimates of $92.75 million.

Applied Biosystems(ABI Quote), a company that specializes in genomics and drug interaction, has increased 27% since Sept. 10 to $30.07 on Oct. 12. It trades at a 2001 P/E ratio of 32, and a prices-to-sales ratio of 3.9, based on 2001 revenues of $1.62 billion.

Nanogen(NGEN Quote), which won a $1.5 million grant from the Army to make miniature electronic devices that can identify agents of biological warfare in human blood samples, has risen 81.6% from $4.74 to $8.61 as of last Friday. The stock is not yet profitable, but trades at 14 times sales, based on 2001 revenue estimates of $12.97 million.

But once momentum investors exit these hot stocks, serious investors will return to companies that will likely receive government funding. For example, Howard Horn, an analyst with UBS Warburg, put a hold on Cepheid. "The stock performed very well early the week of Oct. 7 due to the overbuying, but we couldn't justify the price targets," Horn says. "It is prudent to leave the model unchanged until we know where the government spending is going."

The government is considering spending $1.5 billion to develop 60-days worth of antianthrax vaccine for 12 million people. But that's only one, small solution. The government and private investors already spend more than $3 billion a year on biodefense, says Aaron Lindberg, a research analyst with Dougherty.

"These companies are just getting started," Lindberg says. "They've got a lot of opportunity in front of them. [But] this is going to be a tricky area to invest in. There are a lot of unknowns here."

But one certainty exists. "Biological terrorism and domestic defense will be an area where additional funds will have to be put," UBS' Horn says, adding that he hasn't seen any "firm figures," but knows they will be substantial.

As a result, investors could do very well from this grim new world.