StreetTalk: Biopharmaceutical Stocks Shoot and Investors Score

I'm a big basketball fan and, hailing from Boston, grew up watching Larry Bird roam the parquet floor of the old Boston Garden.

While I cheered Larry the basketball legend, my admiration of him went beyond mere hoops and hard courts. He had a folksy, common sense approach. When Bird would go three quarters without a basket, he was able to turn things around with the game on the line in the fourth quarter. He would invariably nail the game winner with seconds left.

Most players, having an off day, would have lost confidence and stopped shooting. Not Bird. As he so often said, "The only shots you know you'll miss are the ones you never take."

So it goes with the biopharmaceutical investment market, where an off year or two doesn’t break an industry that keeps firing away with new ideas, breakthroughs, patents, and life-saving drugs.

After losing roughly 60% of its value from January 2000 through the end of 2002, when terms like burn rates and empty pipelines fueled investor antipathy, the biopharmaceutical market, as measured by the Nasdaq Biotechnology Index was up 40% for the first half of 2003.That's manna from heaven for the biopharm industry, which has seen its coffers rise more than $2.6 billion (in equity financing) so far in 2003. That's a far cry from the $1.5 billion they raised for all of 2002.

Running With the Bulls?

The industry has benefited from a strengthening economy and a revitalized stock market which climbed 17% year-to-date through September 2003 and could post a return of 25% for the year, if current growth trends in the S&P 500 continue through the holidays. Those are numbers much higher than Wall Street forecasters predicted back in January. The sentiment then was that investors should take their 8% annual returns for 2003 and be thankful for that.

But the run-up in the stock market, just like the run-up in the Nasdaq's biotech index, grew legs faster and longer than most insiders had figured. Like freshmen at a college keg party, thirsty investors quickly quenched their thirst on double-digit market gains after three years of flat market brew.

Consequently, fear and timidity, it seems, are giving way to excitement and confidence on the part of investors who know that the last place to be during a market run-up is on the sideline. So, investors are stampeding the market, looking for the best places to park their money and make it work for them. For millions of investors, that means the biopharmaceutical market, where the numbers only begin to tell a rebirth story. Why biopharmaceuticals? Let's have a look:

Follow the Money

Public and private enterprises in the United States poured nearly $70 billion into medical research last year; half will come from the biopharmaceutical sector. Investors, especially seasoned ones, like to follow the money because the money usually leads to significant returns on investment. But higher revenues aren't everything. Job creation in the industry, reduced health care costs due to revolutionary new drugs, and the number of lives saved by the research and products produced by the industry all count too. While you can't put a single price tag on all these elements, they certainly boost the image of an industry that only two years ago was hemorrhaging money on all fronts.

The Rise of the "Hands On" Investor

Investors also can relate to what biopharmaceutical companies are doing to cure their illnesses and ease their pain. Consider a cancer survivor who can point to a new biotech diagnostic that may have saved his life. Or the diabetic who benefits from a new drug that lengthens his. When I worked on Wall Street as a young bond trader I used to hear analysts, traders, and portfolio managers I worked with talk about "hands-on" investors — that is, investors who plowed money into Procter & Gamble because they swore by P&G's toothpastes and shampoos. Or those who loaded up on Gap shares because that's where they bought their blue jeans or sweaters. It's an investment mindset long championed by Wall Street legends like Peter Lynch, the first manager of Fidelity Investments' Magellan Fund. Lynch roamed the shopping malls of Boston and its suburbs examining which stores attracted the most shoppers regularly. Now, hands-on investing has come home to roost in the pharmaceutical sector, where millions of Americans have experienced first hand the lifestyle freedom provided by drugs like Prilosec or Viagra. Why, investors reason, shouldn't millions of other heartburn or erectile dysfunction sufferers enjoy their benefits too? Investors figure that millions benefit from such drugs and are quick to conclude that the companies that make these drugs are worth 100 shares or so in a financial portfolio.

Knowledge is Good

That was the motto of fictional Faber College (from the movie classic

Animal House

) but it fits the biopharm market as well. Professional investors say that there is no substitute for knowledge when investing in a company and that hunches, bar charts, and timing mechanisms are akin to dialing 1-900-PSYCHIC when compared to knowing what a company does and why it does it well. That hurdle seems to have been cleared in the last year or so by a nation of health care consumers who happen to be investors (or, I'm tempted to say, a nation of investors who happen to be health care consumers). Investors have taken notice of the updraft in the economy, have decided to jump back into the market, and have picked out a few sectors — defense, consumer products, housing and construction, as well as biopharmaceuticals — where they feel their money has the best shot for growth.

Results, Results, Results

In the 1970s, Alfred Vellucci, then the mayor of Cambridge, MA, commented on nascent DNA technology. Vellucci said he was worried about what frightening creatures would "crawl out" of the research laboratories. Well, 30 years later the question has been answered on a wide variety of medical fronts. Many biopharmaceutical drugs are available today that have extended the lives and alleviated the suffering of some 300 million people worldwide. As the number of heart disease, rheumatoid arthritis, and pancreatic cancer cases decline and life expectancies rise (six years, on average, in the United States), it's no wonder that, on Wall Street at least, the checkbooks are out and the traders are busy snapping up shares of traditional pharmaceutical companies like Johnson & Johnson (New York Stock Exchange: JNJ), Astra Zeneca (NYSE: AZN), and Bristol-Myers Squibb (NYSE: BMY). Or they're getting in on the ground floor of biotechnology companies like Atrix Laboratories (Nasdaq: ATRX), ICOS (Nasdaq: ICOS), or Human Genome Sciences (Nasdaq: HGSI) which may not see any revenues until 2006 or 2007.

Speed Bumps

That's not to say all the news is good for biopharm companies as 2004 beckons. A raft of high-value patent expirations are hitting, with companies losing their monopoly rights to heavy-hitters like Biogen's Avonex and Schering-Plough's Intron A. All told, $6.7 billion worth of patent expirations were on the docket in 2003, with a dearth of high-profile drug patents coming through the pipeline.

In addition, some investors are beginning to lose patience with long-range industry sectors. In the opinion of Wall Street, genomics companies have taken too long to produce a big winner. Investors are impatient too. And investors get squirrelly if profit timetables take longer than Michelangelo took to paint the Sistine Chapel.

These obstacles aside, the run up in biopharmaceutical stocks — like those of Flamel Technologies (Nasdaq: FLML) and Genentech (NYSE: DNA) — should continue as long as the industry continues to produce headline-making medicines (to get investors' attention) and the economy continues to gather momentum (to ease investors' concerns). While not firing on all cylinders yet, the industry isn't shy about staying on the offensive and taking the shot.

Just like Larry the Legend. BPI