12:00 AM
Jul 02, 2012
 |  BioCentury  |  Finance

3Q Financial Markets Preview: Avoiding burnout

Assessing whether biotech stocks can continue to outperform the markets in 2H12

A slew of milestones through year end combined with last quarter's outperformance have investors hopeful that the biotech sector can continue to fend off a dreary macroeconomic environment and weakness in the broader markets.

Buysiders don't expect to see anything catch the imagination of investors and strategic acquirers quite the way HCV has in the last year. But they think positive Alzheimer's Phase III data, as well as another obesity approval, could continue to generate excitement within the sector.

The takeout of Amylin Pharmaceuticals Inc. as 2Q drew to a close also could generate momentum from investors who have been making bets on M&A.

Late last Friday, Bristol-Myers Squibb Co. announced it will acquire the diabetes company for $31 per share in cash, or about $5.3 billion in aggregate after a two-step process involving $3.4 billion cash payment from BMS's diabetes partner AstraZeneca plc.

The real drag on the group is likely to come from forces outside biotech's control: the European crisis, the normal summer doldrums, a renewed U.S. budget debate around mandatory cuts slated for FY13, and the presidential election.

Investors also think these externalities are likely to keep a damper on what had been a strong appetite for follow-ons earlier this year.

Fortunately, many biotechs are now well set for cash, having raised money in 4Q11 and 1Q12. Non-debt financing in 2Q was at its lowest level in three years. Specialist investors remain interested in conducting financings to get promising biotechs to an important milestone. But they are more hesitant about buying shares in small caps without enough cash.

Last quarter was particularly unattractive for IPOs, with neurology play Supernus Pharmaceuticals Inc. and cancer company Tesaro Inc. the only biotechs to make it out. Wall Streeters have mixed views on whether this will change as a result of the Jumpstart Our Business Startups (JOBS) Act (see "IPO Performance").

In terms of stock performance, investors say the larger mid-cap names are likely to remain among the sector's top performers. Large caps have some major milestones in 2H12 and will have a defensive appeal if economies and markets take a turn for the worse.

Micro- and small caps suffered the most last quarter as some investors fled risk on market volatility. Investors expect this will continue to be the case.

While the group has outperformed overall, investors don't anticipate a correction anywhere near the magnitude of the one that occurred last August when Dendreon Corp. removed its annual revenue guidance for prostate cancer immunotherapy Provenge sipuleucel-T and raised fundamental questions for investors about biotech launch plays.

On the up and up

Buysiders were surprised that biotech managed to add to its first quarter gains last quarter. Indeed, the sector outperformed the broader markets and IT in 2Q.

The BioCentury 100 rose 5% on the quarter, while the NASDAQ Biotechnology Index (NBI) and NYSE Arca Biotechnology Index (BTK) each gained 4%.

By contrast, the S&P 500 and Dow Jones indices each shed 3%, while the tech-heavy NASDAQ lost 5% (see "Biotech on Top").

"On a relative basis, biotech did pretty well in the second quarter in a very weak market and a not very good economic environment. That's pretty good, all things considered," said Miller Tabak's Les Funtleyder.

This half, "it will be hard for the sector to have additional gains unless the macro environment is improving. Companies with good products will do well, but they will do better not fighting the headwinds of a weak macro environment," he added.

Overall, Funtleyder expects biotech indices will range from "treading water to up single digits. I'm not looking for double digits on the rest of the year. The best case is maybe high single digits."

Small cap specialist Selena Chaisson of Bailard was slightly more negative.

"Biotech in general has held up surprisingly well - look at the Dow compared to the BTK. It's been surprisingly strong. I was expecting a correction all quarter, given all the volatility around the world," she said.

She added, "I don't think we're out of the woods. Investors have gone to cash where they can. Maybe the third quarter will be worse than the second quarter for small cap biotechs. Sometimes there are catch-up corrections."

Still, Chaisson is among those who don't expect anything on the order of last August.

"Eventually stocks will have to consolidate, but I don't think we're in for a 30% sell-off," she said. "I think a consolidation period will happen in the markets and last three to four months, maybe a little longer. Then the markets will have a stronger rally and take out the old highs."

Medical Strategy's Stefan Kraft also thinks biotech could be in for a pullback.

"Prices have appreciated since August last year; now they are relatively flat. A little correction could come," he said. "Some companies are overvalued - that might make some room for a little correction of about 10%."

Banker Annette Grimaldi of BMO Capital Markets is similarly cautious.

"We don't see any reason for a correction, but it's reasonable to assume that if some of the macro issues remain in the forefront, there will be a correction along with the overall market," she said.

LSP-Life Sciences Partners' Joep Muijrers agreed, but noted the big milestone list could help.

"Macro issues will largely determine what the sector looks like in the back half of the year. But there are quite a few important milestones in the second half. If a...

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