Can Derivatives Cure Drug Stocks?

Securitize

The time has come for the pharmaceutical industry to securitize the options embedded in its product pipeline. Investors already own these options as a portfolio when they own the various stocks, so how much of a stretch is it to separate out each individual drug in the pipeline and sell it as a call warrant or option-embedded structured note to investors? The risk of each individual drug in the pipeline can then be confined to those seeking a portfolio of securities with very high risk but very high returns.

The movie business, and for that matter the oil and gas drilling business, long have sold participations in their wildcat projects. These investments have never been for the faint of heart, but they have allowed both industries to spin their risks off to risk-seekers, provide a steadier and less variable stream of returns to more risk-averse investors and to concentrate on what they do best: conceive of new development projects.

The future economic well-being of the U.S. is going to lie increasingly in the intellectual property industries. Let's face it: We have no competitive advantage with China on manufacturing costs. Our financial services industry has been a pioneer in the development of innovations such as mortgage securitizations (go Fannie (FNM) go) that redound to the benefit of society by distributing risks to -- dare I say -- a coalition of the willing.

It took a long time for various industries to start conceiving of themselves in financial engineering terms. We could argue that the U.S. automotive industry has transformed itself into a business that makes cars in order to make auto loans.

The pharmaceutical industry can achieve the same sort of transformation by viewing itself as an innovation factory that finances itself by monetizing its future cash flows today. The alternative is, what, having three or four Vioxx or Celebrex blowups a year?

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