FDA's Safety Push Raises Drug Stocks' Risk Profile

Drug safety is making drug stocks riskier.

When it comes to treating nonterminal illnesses, the Food and Drug Administration drug-approval process is increasingly focusing on safety, observers say. In practice, that means that treatments for nonfatal diseases are more likely to be rejected than, say, cancer drugs. While that makes sense from a medical perspective, the agency's agenda only adds to the risk for investors betting on companies entering the approval process.

Now, with the FDA preparing to judge scores of new treatments in 2002 for ailments ranging from psoriasis and diabetes to impotence and the flu, investors must consider which new drug candidates face the steepest course for approval, and hedge their bets accordingly.

"The FDA has a zero-tolerance policy when it comes to drug safety," says Jim Fiore, fund manager at Life Sciences Group.

Big Slate

In the next nine months or so, about a dozen biotech and drug companies, including Biogen(BGEN Quote), Eli Lilly(LLY Quote), Amylin Pharmaceuticals(AMLN Quote), Medimmune(MEDI Quote) and Genentech(DNA Quote), will go before the agency with promising new products.

As promising as all the new drugs may appear to be, woe is the investor who fails to heed the safety trend. Witness the case of ViroPharma(VPHM Quote), whose shares plunged more than 60% last month after an FDA advisory panel savaged the company's common-cold drug, citing safety concerns. Weeks earlier, the FDA rejected Sepracor's(SEPR Quote) new allergy drug for the same reasons, pushing the stock down more than 70%.

Clearly, the experience of ViroPharma and Sepracor shows the agency's efforts to stamp out safety risks. But the approval game isn't so simple, analysts and investors warn: The FDA might approve a drug with marginal efficacy if it proves to be very safe. On the other hand, a drug could work so well that regulators might overlook some potentially scary side effects.

"It's become more difficult to predict how the FDA will rule on some of these drugs," adds a hedge fund manager who asked not to be named.

Perhaps most important is to set this risk/benefit analysis in a real-world setting. Drugs that will be prescribed broadly will require a much larger safety database than drugs used to treat rare diseases. The FDA's worst nightmare, observers say, is to approve a drug based on limited safety testing, only to have that drug later yanked off the market because problems cropped up after patients used it.

In that sense, size matters, and not in the way you might think.

"Investors too often get fooled by what I call marquee treatments," Fiore says. "An investor will say, 'Wow, a cure for the common cold, I have to get into that,' but then they get screwed up because they don't understand that the risks are much greater than the rewards."

Common Sense

All this sounds like common sense, right? It is, but some experts believe investors have been slow to consider the FDA's increasingly risk-averse nature. Not to pick on ViroPharma too much, but all but one analyst covering the company predicted success last month.

"There are a lot of companies who do good work in trying to deal with safety concerns," says the hedge fund manager, who -- thankfully, he says -- steered clear of ViroPharma. "But it's getting to the point where you have to really think about just staying on the sidelines because there's too much risk."

For those who don't mind testing the waters, there will be plenty of chances to test out the new risk thesis. On May 23, an FDA advisory panel will review an experimental psoriasis drug from Biogen, dubbed Amevive -- the first of a new crop of drugs aimed at treating the painful inflammatory skin disorder without the long-term health risks associated with current regimens. Amevive has proven to be moderately effective, yet doubts linger about its long-term safety profile.

Genentech and partner Xoma(XOMA Quote) will confront the same issues for their new psoriasis drug, Xanelim. An approval application is expected to be filed with the FDA this summer.

Lilly and partner Icos(ICOS Quote) are expecting to hear soon from the FDA on the approvability of their new erectile dysfunction drug, Cialis. Tests show the drug works, but again, a decision will likely come down to its safety, especially since members of the drug's target audience -- middle-aged men -- often suffer from heart disease and high blood pressure that can be exacerbated by drugs of this type.

Medimmune is hoping to get FDA approval for its new inhaled flu vaccine, FluMist, in time for next winter's flu season. The FDA decision will probably come down to FluMist's safety, because the vaccine could potentially be used by millions of people, including the elderly and small children.

Other drugs facing similar burdens include Amylin's diabetes drug, Symlin, and the asthma drug Xolair, which is under development by Genentech, Tanox(TNOX Quote) and Novartis(NVS Quote).