The Real Winners of Drug Experimentation

Drug industry executives often point out that it costs more than $800 million to bring a compound from the laboratory to the marketplace. And of every 5,000 to 10,000 screened compounds, the industry's top trade group says, only five will make it to clinical testing, and only one will be approved by regulators.

Those are daunting figures for drug and biotech companies, whose stocks can bounce around depending on whether an experimental compound is a blockbuster or a bust. However, for companies that provide R&D goods and services to drugmakers, nothing succeeds like trial and error.

These companies, such as Sigma-Aldrich (SIAL Quote) and Invitrogen (IVGN Quote), can do quite well whether a drugmaker such as Pfizer (PFE Quote) produces a hit like Lipitor or a failure like torcetrapib, a cholesterol drug that never made it to market.

These companies make chemicals, reagents, bioassays, cell cultures, test tubes, diagnostic kits and other so-called life-sciences tools. As long as R&D budgets grow, so should sales for companies like Applied Biosystems (ABI Quote) and Qiagen (QGEN Quote).

Among drug industry executives and analysts, pharmaceutical companies like Merck (MRK Quote) and Genentech (DNA Quote) often have been likened to miners during the California Gold Rush. In following that mining analogy, life-science tool firms are akin to the Gold Rush merchants who sold picks, shovels and assay equipment.

The mining analogy has become a cliche, but truth is a foundation for cliches. Many Gold Rush merchants fared better than the miners they supplied, and many of today's pick-and-shovel firms have fared better than their clients.

Sigma-Aldrich's stock gained 40% for the 12 months ended March 20, while the Amex pharmaceutical index, which represents large drug companies, was off 13%. The Amex biotechnology index was down 5%, and the S&P 500 fell 6% over the same period.

Over the past five years, St. Louis-based Sigma-Aldrich's shares gained 167% on a split-adjusted basis, while the S&P 500 rose 52%, the biotechnology index climbed 102%, and the big-drug stock index barely broke even during the same time frame.

Other picks-and-shovels players have done well, too. Over the past 12 months, shares of Qiagen, Applied Biosystems, Invitrogen and Thermo Fisher Scientific (TMO Quote) each outpaced the biotech, drug and broader stock indices. Over five years, shares of these companies are up between 109% and 220%.

However, these stocks aren't slam-dunks for consistent returns. On a split-adjusted basis, Qiagen climbed to $57 by mid-2000, then lost more than 90% of its value in just over two years. It has rebounded to trade in the high teens or low $20s. Shares of Millipore (MIL Quote), were down 7% for the 12 months ended March 20, although the stock has doubled over five years.

Aside from company-specific problems, analysts say the major hurdles to picks-and-shovels firms maintaining solid growth rates are extensive drug-industry consolidation, cutbacks in pharmaceutical R&D and slowdowns in government research activities.

Wall Street's worries will be reduced for companies that can expand their products and services in foreign markets, especially developing countries. Survival of the fittest also may mean survival of the biggest in an industry for which consolidation continues.