The stink at

ImClone Systems

(IMCL)

is wafting over the entire biotech sector, and it's going to take some time before the air clears.

Investors are treating biotechs like five-day-old fish, pushing the American Stock Exchange Biotech Index down 10% since the beginning of the year, compared with about a 2% drop in the

S&P 500

.

And who can blame investors for staying away? Sure, there's been a decent sector rotation back into technology, and biotech is by nature a risky investment because most experimental drugs never make it to market. But revelations that ImClone executives hyped the heck out of their experimental cancer drug Erbitux -- while keeping

mum about serious concerns expressed by U.S. drug regulators -- do not exactly engender a lot of trust in the biotech sector.

Add the fact that ImClone executives like CEO Sam Waksal and his brother and COO Harlan Waksal

sold more than $150 million in ImClone stock before share prices fell by more than 50% -- plus a pending

congressional investigation -- and you've got all the fixings for a biotech hangover of

Enron

-like proportions.

"In this kind of market, the biotech sector depends on positive investor expectations for the future," says Jon Alsenas, biotech fund manager at ING Furman Selz Asset Management.

"But what we have now is ImClone acting like a wet blanket on the entire sector, with new revelations coming out seemingly every few days," he adds. "Then we've seen a series of clinical trial disappointments from other companies. With this kind of pessimistic outlook, biotech valuations are going to contract."

Shares of

Cubist Pharmaceuticals

(CBST)

,

Dendreon

(DNDN)

,

Inspire Pharmaceuticals

(ISPH)

and

Cyberonics

(CYBX)

have been hit hard on news that experimental drugs or medical devices have failed late-stage testing.

But investors need to shoulder some of the blame for disregarding the risky nature of biotech investing. After the Internet bubble popped, wounded investors poured money into biotech and its promise of riches borne from the discovery and development of new drugs. Unfortunately, many of these investors didn't read the section of the biotech handbook that says a majority of experimental drugs fail.

Biotech Can Be Hazardous to Your Wealth

"Every time there is a clinical trial failure or a

Food and Drug Administration letdown, there is a wake-up call that this business is filled with inherent risks," says Ed Fritzky, CEO of

Immunex

(IMNX)

. "Experienced investors understand this situation, but the more casual investor doesn't, and these are the people who are likely to sit on the sidelines for a while."

Fritzky speaks from experience -- he runs one of the largest and most successful biotech firms -- and one that is about to get a whole lot bigger after the $16 billion merger with

Amgen

(AMGN) - Get Report

is completed. And Fritzky warns that ImClone's impact will linger. He's not alone.

"Any biotech with a drug that has some hair on it is going to have a tough time in this market," says one hedge fund manager.

And who's looking a bit hirsute these days?

CV Therapeutics

(CVTX)

,

Corixa

(CRXA)

,

Viropharma

(VPHM)

, Cubist Pharmaceuticals and

Genta

(GNTA)

, to name a few, the hedge fund manager says.

Now, this is not to say that these are bad companies with bad products, or that they're headed for trouble with the FDA. In fact, some or all of these companies could turn out to be real winners. He just means that each of these companies has relatively novel drugs, which for various reasons could require an extra-heavy course of persuasion before the FDA grants approval. (This fund manager is short CV Therapeutics but has no position in the other companies mentioned.)

Merrill Lynch biotech analyst Eric Hecht also is a believer in the big-cap biotechs. In a research note issued Tuesday morning, Hecht called a bottom to the biotech sector's recent selloff, believing that strong balance sheets and reasonable valuations from the large-cap names could push the sector higher by as much as 30% by year-end 2002.

"How should investors pick the top and bottom?" Hecht writes. "We have observed in recent years that

price-to-earnings-to-growth ratios on earnings one year forward bottom in the 1.3 ratio level."

And guess what? A basket of eight big-cap biotechs --

Serono

(SRA)

,

Idec Pharmaceuticals

(IDPH)

, Amgen,

Genzyme General

(GENZ)

,

Genentech

(DNA)

,

MedImmune

(MEDI)

,

Chiron

(CHIR) - Get Report

and

Biogen

(BGEN)

-- are currently trading at a 2003 PEG ratio of 1.3, by Hecht's calculations. (Hecht rates Genentech, Genzyme, Idec, MedImmune and Serono as strong buys; Amgen and Chiron as buys; and Biogen as neutral. His firm has had a banking relationship with Serono, Biogen and Idec within the last three years.)

In fact, the Amex Biotech index rose 1% Tuesday, led by strong gains from the big-cap biotech names, after five straight negative trading sessions.

Guilt by Association

The other big fallout from the ImClone debacle could be felt at the negotiating table between biotechs and their brethren in the pharmaceutical sector. The $1 billion paid by

Bristol-Myers Squibb

(BMY) - Get Report

for a 20% stake in ImClone in September is now worth just $274 million.

The financial hit hurts, but not as much as the blow to the drugmaker's reputation. Bristol-Myers hasn't uttered a single word about ImClone since the bad news broke, leading people to believe the company's business development team was either duped or simply incompetent.

"You're going to see Big Pharma be much more wary about stepping up and paying big dollars for biotech drugs," says John McCamant, editor of the

Medical Technology Stock Letter

.

Drugmakers have been inking partnerships with biotech firms while their drugs are still relatively untested, in part because of pressure to find replacement revenue for blockbuster drugs losing patent expression.

"But while drug companies have become a little more risk-tolerant, the ImClone situation will likely turn more conservative again," McCamant says. "No one wants a repeat of the Bristol-Myers-ImClone fiasco on their books."