Fear not, biotech investors, better times are ahead. Or so we all hope. A string of drug disappointments has biotech investors crying into the test tubes these days, but Robert Toth Jr., senior portfolio manager at San Francisco hedge fund EGM Capital, believes there are opportunities these days to buy oversold biotech companies that have promising drug pipelines.We spent some time with Toth recently, talking about what's going on behind the scenes of the moribund biotech sector, and more importantly, which stocks he's buying. Toth, a former biotech analyst with Prudential Securities, manages the $100 million biotech and specialty pharmaceutical fund under the EGM Capital umbrella, which has about $1 billion in total assets.
Life's been rough for biotech investors this year, with the sector down 30%-40%. Is it still smart to own biotech stocks?
In my view it's time to own if you can be comfortable with a longer-term perspective -- by that I mean already looking out to the end of 2003.
That implies more near-term trouble for the sector. What exactly should investors be looking for?
Strong drug pipelines. A flurry of negative news from key products in late-stage development has led this piece of the biotech puzzle to lose a lot of valuation. Investors should be looking for companies that have a lot of shots on goal and are moving early products into the latter stages of clinical development.
But why should investors have confidence that these new drug candidates will fare any better than those currently in late-stage clinical trials?
I think drugs that are now just moving out of the early stages of development are benefiting much more from advances in drug discovery and information gleaned from human genomics, for instance. This implies to me that the industry has a better chance of developing successful drugs going forward compared to those in the last six months or so, where we've seen somewhat negative news.
So the markets aren't giving the biotech sector credit for coming up with better ways to develop new drugs?
Right. I think the technology value of the group is being undervalued and oversold by people who are reacting to all the bad news today, but they are not taking into consideration the positive impact the technology will have on drug pipelines moving forward.
Let's get to some stock picks. What are you buying?
I am looking for quality names that have been punished and heavily discounted with the industry as a whole in this selloff, especially where I have a chance to buy intriguing technology at 1.5 to 2.5 times cash value, which is the historical floor for biotech valuations.
Names, give me names.
is a real good pick. It's a company that's expected to put nine new drugs into the clinic this year alone. We're finally seeing results from all the early work Medarex has done in preclinical testing come to fruition, and starting to see their pipeline really advance forward. I think this should correlate with the stock moving higher.
. A lot of investors are keyed into the Cor Therapeutics acquisition, wondering whether Integrilin growth will really be there. That's a big part of the story given what Millennium paid for Cor, but I think this company has the best research and development drug-discovery machine in the industry, a fact that has been completely overlooked in my view.
Millennium's cancer drug, MLN341, looked good at the American Society of Clinical Oncology meeting.
MLN341 is a very intriguing drug, and it certainly got nice exposure at ASCO, but the stock is trading lower now than it was prior to all the data coming out.
What else do you like?
is a stock we own in size. It's a $280 million market-cap company with two very promising shots on goal. With Pagoclone
an anti-anxiety drug, we should hear in the next several weeks whether its partner,
, is going to take the drug forward. I try to imagine a scenario where Pfizer gives the compound back to Indevus, but given what we know about the drug right now, that just doesn't make any sense. It seems like a no-brainer for Pfizer to spend $10 million to hold on to Pagoclone and take it into phase III trials. If that happens, it could effectively double Indevus' valuation. Then there's Trospium for urinary incontinence -- phase III data is coming out at the end of the third quarter or in early fourth quarter.
Indevus was making a nice move late last year, but the stock has since deflated.
The problem is small biotech names languish until the big names move. The $64,000 question: If investors can't get interested or comfortable with the current valuations of stocks like
, then does the rest of the group suffer just because the way the sector traditionally moves, big-cap to small-cap?
That takes us back to current troubles in the sector. We've heard about the drug disappointments, but what else is at work here?
I view the biotech group as being in no man's land these days. Many of the growth managers have become increasingly underweight biotech due to the lack of performance. These guys won't get back into the sector until it moves 10%-15%. And I've heard many of the value guys say that despite the index being down 40% for the year, these valuations are still not attractive enough for them to get in. So, you have the value and growth managers both potentially on the sidelines here.
What gets these guys back in the market?
: For the value guys, it may be a further reduction in valuation; the index might need to take another 15% hit, which would be tough. I certainly hope that doesn't happen. The corollary is that the index may need to move another 15% up before money flows into the group from the growth guys.
So let's accentuate the positive. Lay out a scenario for an upside rally.
The key will be fundamentals. If we have a good second quarter of earnings, it could coincide with three catalytic events this summer: The results of Genentech's phase III Avastin study
an experimental cancer drug; Amgen getting FDA approval for an oncology label for Aranesp
its anemia-fighting drug; and the FDA decision on
a new, inhaled flu vaccine.
Biotech investors just need to have patience, I guess.
Laughing Right. Maybe I've done a very verbose job of stating that. Certainly, investors need patience. They should also be kicking the tires of any companies they may want to buy, to make sure there's a quality story there. And investors also need to examine management to make sure they know how to not only control expenses and finances, but also how to put together good clinical studies. I think this is where the industry is being scrutinized most closely right now.