Sector Spotlight: Bully for Biotechs

Will the biotech rally continue?

Although share prices are riding high compared with year-ago levels, a major correction seems unlikely at this point. That's in part because bullish investors are expecting a spate of good news in the fall, which could push the stocks even higher.

Of course, the stocks have already tumbled once this year, and remain off their highs. They also still carry high valuations, which means bad news, like a disappointment with a product under development, could hurt them. But for now, most signs point toward stronger stock prices.

For investors who bought wisely, the returns have been spectacular over the past year. Top companies in the sector, such as Amgen(AMGN), Immunex (IMNX) and Genentech(DNA), have tripled or more in value over the past year. The S&P Biotech Index surged 70% to peak in February; though it then fell sharply, but it's still up 30% from this time last year.

Two Steps Forward, One Step Back Despite some big dips, some biotechs are still surging ahead.

Share prices "look temporarily a little ahead of themselves, but they're justified by long-term fundamentals," says Sam Isaly, fund manager for the $750 million Eaton Vance Worldwide Health Science Fund, a leading biotech fund.

Isaly says he expects August to be a slower month for the stocks as investors take time off or digest recent IPOs. But he expects them to rise in the fall. "There's a fairly demonstrable seasonality to biotech stock-price action, usually with a fourth-quarter rally," says Isaly.

Reporting Progress

Others agree. Industry heavy-hitters like Genentech, Amgen, Cor Therapeutics (CORR) and other index drivers are likely to push indices higher by reporting on the progress of major drugs in development at a spate of medical and investor conferences in the fall.

Amgen and Immunex, for instance, will likely report progress of arthritis drugs at the American College of Rheumatology in Philadelphia in October, while the American Society of Hematology meeting in December is expected to feature presentations from ILEX Oncology(ILXO), Amgen and a dozen other biotechs, according to CIBC World Markets, which has done underwriting for ILEX but not the others.

In terms of fundamental value-creation, the industry is far from failing, with the number of profitable companies among the 300 or so publicly traded companies expected to grow to 30 next year from 16 this year, according to Banc of America biotech analysts.

And the brokerage projects product revenue will grow an aggregate of 21% a year for the next five years from $18 billion this year to $50 billion by 2005.

IPOs

Meanwhile, investor appetites haven't been whetted, if recent IPO performance is any guide; dozens are waiting in the wings. Some recent IPOs have done very well. For instance, Orchid Biosciences(ORCH), a gene research company, surged as high as 61 from its offering price of 8 in May, although it recently gave back some gains, closing Friday at 38 5/16. Praecis Pharmaceuticals(PRCS), a cancer-drug developer, jumped to 40 from its IPO price of 10 in May, closing Friday at 30 1/2.

Eaton Vance's Isaly says he expects some 20 more biotechs to float in the next few weeks, a factor that could draw funds away from existing investments and lead to a weaker biotech market in coming weeks.

But that's likely to open up new buying opportunities of another sort for some investors -- biotechs that haven't rallied recently. "We're looking at first-quarter hot companies that haven't come back," says Jim Fiore, fund manager with the $36 million Life Sciences Fund in Greenwich, Conn. "We've always had our best successes when people weren't looking."

Fiore says some of these top new holdings include Antigenics(AGEN), a cancer drug company, Genzyme Molecular Oncology (GZMO) and BioTransplant(BTRN). Antigenics, which held its IPO in March, dropped from a high of 71 in April to trade as low at 10 in May and has barely recovered, even after it reported advances in its lead cancer vaccine Oncophage at the American Society of Clinical Oncology in May.

When Good News Goes Bad

But Antigenics wasn't alone. Other companies also suffered share declines after reporting apparently positive news at ASCO, demonstrating that medical meetings don't always bring attendant share gains. SuperGen(SUPG), a California biotech, announced at ASCO that its cancer drug Rubitecan extended the lives of 15 out of 45 patients with pancreatic cancer in a mid-stage clinical trial.

This positive news, albeit with all the usual caveats, might have sent SuperGen's stock surging in another era. Instead, its stock fell 15.5% to 25 3/4 on May 22, the day of the announcement. It dropped further still in subsequent days, falling after an equally inexplicable rally in March, when the stock hit 77.

Still, while the ASCO events demonstrated that positive news at medical meetings isn't a guarantee of share gains, it most often drives stocks higher.

Some say that with share prices often at multiples over last year's, shares are "priced to perfection" and the slightest hint of bad news can send them reeling, especially given that investors seem to travel in packs these days. That has dampened optimism among some investors, who say it's unlikely that autumn will bring a return to hefty March share values. But few say a return to the slump of the mid-1990s is possible, as the industry collectively is much more mature and closer to profitability.

Robert Toth, biotech analyst at Prudential Vector Securities, says ASCO-related share-price declines demonstrated that investors are scrutinizing product development news with more intensity than ever before, particularly with these high valuations. Still, he believes more mature companies are likely to be better able to withstand such scrutiny and impress investors in the fall.

Toth expects good news this fall from cancer drug companies ILEX Oncology, Coulter(CLTR), Imclone (IMCL), OSI Pharmaceuticals (OSIP) and Maxim(MAXM), all of which have new drugs close to market. (He rates all the companies as strong buys except Coulter, which he rates accumulate. His firm has participated in underwriting for each company.)

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