Biotech to the Rescue of Recombinant QQQ

The world's bellwether technology index turned resolutely away from networking in its latest reincarnation Monday, putting itself instead in the hands of a technology that is by comparison mature: biotechnology.

Each December the Nasdaq 100 is reranked, and the changes take effect this year on Dec. 24. The event holds significance, because some $30 billion is indexed against it. There are 30 mutual funds linked to the Nasdaq 100, and shares of each company in the index are included in the Nasdaq 100 tracking stock, the QQQ (QQQ Quote).

Eight of the 13 index additions this year are related to health care, six of them biotech firms. "This is a significant event, something everyone should watch over the next week to 10 days," said John Jacobs, chief executive of Nasdaq Financial Products, of the rerankings. "The drop of telecom stocks shouldn't come as a surprise to anyone, nor should the addition of biotech names, which reflects the general strength of that sector."

Misspent Youth

Techs being removed from the index include former B2B highfliers Ariba (ARBA Quote) and BroadVision (BVSN Quote), as well as onetime PDA darlings Palm (PALM Quote) and 3Com (COMS Quote) and telecom services provider Level 3 Communications (LVLT Quote)

Internet stocks CMGI (CMGI Quote), CNET Networks (CNET Quote), Inktomi (INKT Quote) and RealNetworks (RNWK Quote) will be subtracted from the index.

Novell (NOVL Quote), Parametric (PMTC Quote) and McLeod (MCLD Quote) will get the boot, too.

"The story in growth investing is that technology companies have unsustainable business models," said John McCamant, editor of the Medical Technology Stock Letter. "But when focused on drugs, they are sustainable."

Deep Pockets

Among McCamant's favorites in the group of biotechs being added are ImClone Systems (IMCL Quote), which is developing treatments for cancer patients, and ICOS (ICOS Quote).

Both companies are currently involved in deals with Big Pharma -- Bristol-Myers(BMY Quote) agreed to pay $1 billion to ImClone in three stages for the development of its colon cancer drug. The deal gives Bristol Myers the exclusive right to sell the drug, but it will give ImClone 60% of the profits, net of certain costs.

Separately, Eli Lilly (LLY Quote) has collaborated with ICOS to market the firm's anti-impotence drug Cialis, which is still waiting FDA approval. According to McMamant, the drug will eclipse Viagra's sales of $1.3 billion.

According to a recent report from Ernst & Young, biotech companies are "in the best financial shape of their 25-year history, with strong capital reserves and significant investment in research and development."

The report said the $33 billion raised by biotechnology companies last year eclipsed the amount invested in the previous five years combined, noting that the market cap for 339 publicly traded biotechs, as calculated at the end of June 2001, declined only a modest 6% to $330.8 billion, from its record level of $353.5 billion in 2000.

In trading today, the Nasdaq 100 rose 2.2%. So far this year, it is off 30%, while the Nasdaq Composite is lower by 19.6%.

Not-as-Fast Company

The ranking change gives the new members more visibility and broader ownership, which is key. "The fact that there are more funds picking up these stocks may help to buffer the volatility," said McCamant. Trading in these stocks can be very volatile, as a lot of short-sellers bet heavily on whether or not biotech products will make it to market.

"Working with the FDA is a nightmare. But once a drug is approved, people can't go and make it their garages," said McCamant. "The barriers of entry limit the number of competitors in the field."

"What gets us excited is these stocks can double again and again, if products make it to market," said McCamant. "I wouldn't expect any of these names to drop out very quickly."

The remainder of the biotechs being added are Cephalon (CEPH Quote), Protein Design Labs (PDLI Quote), Sepracor (SEPR Quote) and Invitrogen (IVGN Quote).

Medical device manufacturer Cytyc (CYTC Quote) and pharmacy benefit manager Express Scripts (ESRX Quote) are also joining.

Charter Communications (CHTR Quote), CDW Computer (CDWC Quote) and Integrated Device Technology (IDTI Quote) will be added as well.

The Nasdaq 100 is composed of the 100 largest nonfinancial Nasdaq stocks, with the rankings based on market caps. Two companies, Symantec (SYMC Quote) and Synopsys (SNPS Quote), are actually rejoining the index this year.