12:00 AM
Oct 03, 2011
 |  BioCentury  |  Finance

Cost averaging down

4Q biotech stock preview: Investors looking to find good bargains

Even the best fundamentals may not be able to overcome the negative effects of the broader economy on the stock market this quarter. As a result, specialists have little hope of major gains and instead are using price weakness to strengthen portfolios.

Some are focusing mainly on clinical milestones, given the unpredictability of the launch landscape. But others are picking over beaten-up launch stories even though they expect generalist investors will think twice about plunging back into biotech after the thrashing they took in new commercialization stories like Dendreon Corp.

No market cap segment was spared last quarter, as the sector was hit by a slew of macroeconomic and fundamental issues that seem unlikely to go away near term. Deficit-cutting in the U.S. and European austerity measures weighed on the large caps; mid-caps got burned with the launch debacle for Dendreon's Provenge prostate cancer treatment; and small caps suffered from worries about undercapitalization and the broader flight from risk.

The NASDAQ Biotechnology Index (NBI) fell 13% in 3Q, while the BioCentury 100 lost 17% and the NYSE Arca Biotechnology Index (BTK) shed 25%. Among the broader market benchmarks, the NASDAQ dropped 13%, while the Dow Jones Industrial Average and S&P 500 were down 12% and 14%, respectively (see "Few Cinderellas," A15).

The Chicago Board Options Exchange Volatility Index (VIX) hit a high of 48 in early August and ended the quarter at 43. That's nowhere near mid-teen lows in 1H11.

Only $2.8 billion was raised by public biotechs last quarter, with $1.8 billion - almost two-thirds - coming from debt. 3Q was smallest public fundraising quarter since the meltdown of 4Q08, when only $719 million was raised.

Still, so much money was raised in 1H11 that the total for the year is already $23.4 billion. That's compared to $30.7 billion in 2010, which was the largest public financing year since 2000.

Discount shopping

Biotech specialists surveyed by BioCentury are doing the best they can to control their losses while selectively picking up bargains. None of them are convinced the market has hit bottom. As a result, they expect to continue to cost-average by buying into the downside of the market slide.

Some are opting to invest in front of Phase II and III milestones, viewing them as largely sheltered from the taint of launch issues. Others are focusing on value buying among commercial biotechs - including big caps - that do not have all their market cap tied up in any particular launch. Very selective buying by specialists also occurred among the beaten-down launch stories, some of which have rebounded already (see "Launches Stratified," A7, & "Value Verification," A8).

David Pinniger of International Biotechnology Trust is actively buying on two fronts - large-cap and small-cap. He's looking at biotech companies worth less than $1 billion "with potentially transformative drugs coming through that aren't yet at a point where investors are getting excited about launch" and "big caps with deep, durable value and potential for consolidation."

Pinniger said he's been using some leverage, plus cash from trade sales. In the latter M&A space, he took profits from investments in Axis Shield plc which announced a $379 million hostile bid from Alere Inc. in early July, and from Caliper Life Sciences Inc. which announced its acquisition by PerkinElmer Inc. for $600 million in early September.

"When I'm looking at companies now, I look for drugs that are going to be great. Full stop. Not drugs that, while interesting and novel, are only marginally efficacious and very expensive. The majority of the current launch-stage mid-cap names just don't meet that criteria," he said.

Along with Dendreon, Pinniger also has no confidence in the launch of lupus drug Benlysta by Human Genome Sciences Inc. "These companies are toast," he said. "They both need to get to around $500 million in annual sales just to break even. They're not going to get there."

Pinniger added that he expects comparative effectiveness and cost-effectiveness to become an increasingly important driver.

"Cost-effectiveness may not come with PDUFA V, but at some point it will arrive -- it has to be a fundamental part of the risk-benefit equation of making drugs available to a healthcare system characterized by constrained financial resources," he said.

Fidelity's Rajiv Kaul is focused on novelty as the antidote to cost-cutting risk. "Innovation can trump reimbursement headwinds. Not in all situations, but I'm still innovation-focused and feel like society will reward innovation," he said.

Kaul's sweet spot right now is companies in...

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