StreetTalk: 2004 Round-Up

The holidays are upon us. It's the time of year that begins with gala parties in December and ends when you finally realize what you spent, usually around April 15 of the next year. Too Scrooge-like? Hope not. I just partook of some bad eggnog.

Brian O'Connell

Just the same, December is a great time to take stock; to assess the year we're leaving behind and try to glean some meaning from the events of the past 12 months. In our biopharmaceutical world, 2004 truly was, as this month's headline suggests, the best of times and the worst of times. It began with high hopes in an industry that was clearly rebounding from the doldrums of 2000-2003. It ended with a historic U.S. presidential election that should shape the industry in favorable ways for years.

LOOKING BACKWARDS

In this momentous year, events of great consequence took place. Among those, here is a short list of my favorites:

The BioPharm Stock Rebound. While the overall stock market struggled in '04, held back by uncertainty over the War in Iraq, the presidential elections, and the plummeting dollar, the Nasdaq Biotech Index (NBI) finished up (through November) up about six percent for the year. Make no mistake, the index was volatile, sinking to 622.01 in late August after skyrocketing to 851.44 in early May (Figure 1). Pharmaceutical stocks held up roughly equally well, giving biopharm investors a leg up on the markets this year. An index fund (PPH) allows tracking.

Figure 1. Nasdaq Biotech Index (November 2003 -November 2004)

Why the gain? Biopharm financing was up by about 250% compared to 2003. Venture capitalists rediscovered the sector turning the life sciences into the "go to" place for big money in 2004 relative to other industries. In the first quarter, venture capitalists fed $1.3 billion into the biopharm sector, according to the North American Venture Capital Association.

Merger activity in the industry was strong, as well. Maybe not at the 80% rate of announced mergers we saw in 2003, but still growing at a respectable 35% in '04.

Best Bets: Stocks and Funds. Making the most noise in the life sciences industry were a handful of key stocks. Some had good years and others did not. Steady performers included biotech mainstays like Amgen (AMGN), Genentech (DNA) and more speculative plays like Atrix (ATRX), which is up about 33% for the year. Valuations are cheapest in the pharmaceutical sector where heavy hitters like Novartis (NVS) have outperformed (up 25%).

What were the best mutual funds in the sector? I told you about the Vanguard Health Care Fund (VGHCX) earlier in the year and was happy to see the fund really pan out for investors in 2004. NAV (net asset value) was up from 110 in January to 127 at year-end. Another decent performer was the Eaton Vance Worldwide Health Sciences (ETHSX). The fund didn't gallop along with the speed of the Vanguard Fund. But it did provide some much-needed stability for investors suffering from losses in other sectors.

Worst Bets: Stocks and Funds. Stocks I thought would do well — but didn't — include Ligand (LGND) and NPS Pharmaceuticals (NPSP), which has fallen about 40% since the beginning of January. Highly anticipated plays like Eli Lilly (LLY) and Pfizer (PFE) disappointed, with both down over 20% for the year.

Big Guys—Little Guys. Another big trend in biopharm circles this year was the consolidation between industry companies, many of which were comprised of big-company-takes-in-little-company in mergers. Charly Trevers, writing in the September 9, 2004 Motley Fool website, says that smaller companies HAVE to sidle up to larger ones because it is the only way they can get their hands on the cash they need to conduct research. The average drug, Travers says, costs anywhere from $800 million to $1.7 billion to develop. Travers surveyed 40 smaller biotech companies and found that, on average, each company had $150 million in cash on hand.

Mergers aren't a luxury to the little guys — they are a necessity. One point of concern for smaller companies looking to piggyback with larger ones: According to the research firm Cutting Edge Information, over 30% of biotech alliances are either cancelled or renegotiated prior to the end of their R&D timelines.

The Rise of Generic Drugs. With drug patent expirations on an upswing in 2004, the market for generic drugs has expanded. Some estimates place the generic drugs market at $12 billion.

The rise in generics has alarmed big pharma companies to the point where many have taken to "evergreening" popular prescription drugs (by doling out "new and improved" versions of those drugs). That trend should continue as an estimated $80 billion worth of prescription drugs face expiration by 2008. The generic drug industry has skyrocketed from $21 billion to $40 billion since 1999.

Amgen, for example, rolled out a second-generation version of its popular drug EPO. AstraZeneca did the same thing with Nexium (a variation from Prilosec), and was rewarded. Patented Nexium has 10% more sales than over-the-counter Prilosec.

Wellness Programs Gaining Strength. Currently, there's a tremendous imbalance between what we pay for treatment-based medical care and preventative-based medical care. According to J. Michael McGinnis, Pamela Williams-Russo, and James R. Knickman, in "The Case For More Active Policy Attention To Health Promotion," which appeared in the March/April, 2002 edition of Health Affairs, approximately 95% of the trillion dollars we spend as a nation on health goes to direct medical care services, while just 5% is allocated to population-wide approaches to health improvement.

Now, wellness programs are looking to fill the void. The impact they are having will certainly have huge ramifications for prescription drug companies. According to the Health Management Research Center (HMRC) at the University of Michigan, companies were first introduced to the concept of investing in health promotion programs in the 1970s. By the 1980s, employers were spending $5 per employee on work-place wellness programs, and today they're shelling out $60 per employee for year-round programs that range from smoking cessation programs to lessons in warding off stress.

The center estimates the cost at about 1-2% of the typical medical care costs. Additional research from HMRC concludes that work-place wellness programs save employers $80 to $225 per employee per year in medical care costs and an equal amount in productivity gains. How drug companies figure out a way to leverage wellness programs to their benefits will have a big impact on their bottom lines down the road.

The Presidential Election. No matter who won in November, the outcome would have been favorable for biopharm investors, although for different reasons. With President Bush back in office, life sciences can count on little government intervention on drug prices. The industry can also count increased revenues stemming from the President's new healthcare prescription drug plan. Spending for stem cell research, despite the $3 billion or so promised in California, will also be tamped down with Bush in office. If Kerry had won, the crystal ball would be a bit cloudier, with healthcare reform in play. That won't happen now.

HAPPY NEW YEAR GREETINGS

All in all, 2004 will go into the books as one of the most interesting years ever for the biopharm industry. After all, it's not every year where so much news happened so fast — and with big-time ramifications for the life sciences industry. In fact, it really makes one wonder what's in store for 2005. Anyway, happy holidays to all.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek, 79 Radcliffe Drive, Doylestown, PA 18901, 267.880.3144, fax 267.880.1939. brian.oco@verizon.net.