2nd Quarter Stock Preview: Small winners add up

Buysiders have been predicting that 2006 would see a narrowing of the gap between the performance of big and small biotechs. Thus far, that assumption has panned out, with the smaller plays gaining ground on the big group. Now that investors have seen strong returns in every market cap band, the question is whether money will remain in the sector.

Buysiders and bankers think it will. They expect late-stage clinical companies and those on the cusp of commercialization to be the leaders, and they think the big slate of near-term milestones should keep money in the sector. In addition, buysiders say a number of names have been de-risked on the clinical front and offer the chance for significant sales upside.

The Street also expects new money will follow performance. The influx of cash in the waning weeks of March suggests that investors haven't yet had their fill of biotech issues. In addition, Streetwatchers polled by BioCentury expect a healthy increase of paper this quarter, with some bankers predicting PIPEs may be the vehicle of choice.

In Europe, a strong showing by continental biotechs in the first quarter has not translated into a greater appetite for new share issues, with the possible exception of Denmark. The good news is that European investors aren't sitting on the sidelines - they just prefer to buy biotech stocks in the open market instead of IPOs.

The caution is that European biotechs may find themselves competing with Europe's small pharma names for investors.

Setting the small stage

Last year, the only biotech group with an appreciable gain was the cohort valued above $2 billion. That segment added 25% on the year, while most of the other groups showed low single-digit gains or losses. Biotechs that started 2005 valued below $200 million added 13%, but that figure was inflated by the performance of two companies. Backing out the moves of Momenta Pharmaceuticals Inc. (MNTA, Cambridge, Mass.) and ViroPharma Inc. (VPHM, Exton, Penn.), the small companies advanced only 6% last year.

In the first quarter, the tables were turned, as the small and mid-caps outperformed the big names. Indeed, the large caps treaded water (see "Results by Market Cap").

The flight to small caps wasn't endogenous to biotech. The Russell 2000 Index, which measures the small cap segment of the U.S. equity space of companies valued between $270 million and $4.8 billion, surged 14% last quarter (see "Less Is More").

In the macro context, the move to smaller, more speculative companies made sense based on the flow of economic data. Throughout the quarter, investors heard about moderate wage growth, the moderate economy and a not catastrophic slowdown in the housing market. These positive signs prompted speculative capital to enter the market.

The move by small biotech companies also made sense, especially when looking back to the same period last year. In the first quarter of 2005, the picture was grim - multiple sclerosis antibody Tysabri natalizumab from Biogen Idec Inc. (BIIB, Cambridge, Mass.) and Elan Corp. plc (ELN, Dublin, Ireland) had just been taken off the market (see BioCentury, March 7, 2005). Moreover, the Tysabri blowup came on the heels of the COX-2 debacle in the pharma

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