StreetTalk: Stem-Cell Revolution: Big Opportunity for Investors

My editor, Carol Fisher, is one smart cookie. She politely insisted that the first column I wrote for 2005 should be a "trends" piece covering the issues that I thought would most impact the biopharm sector throughout the year.

Brian O'Connell

I moaned and groaned and said that I hate doing prediction pieces. In fact, I wrote those very words in that column.

But now I see the error of my ways. I still hate doing prediction columns but the issues that I cherry-picked for inclusion in the piece turned out to be a template for the columns I'd be writing for the rest of the year.

Take stem-cell research. Most readers of BioPharm International likely already know the stem cell story. For those who don't, stem cells are "unspecialized" cells that can generate healthy new cells, tissues, and organs. Medical researchers believe that stem cells can be used to replace diseased cell populations within patients, effectively reversing the symptoms of many diseases and perhaps even affording a cure. Experts say stem cell research could lead to treatments for diabetes, Alzheimer's, Parkinson's, spinal cord injuries, and over 70 other diseases and conditions affecting more than 128 million Americans.

I wrote in the January trends column that stem cell research — and the stocks of those companies involved in stem cell research — were poised for liftoff in 2005. I said the momentum in the stem cell research — triggered by California's decision to earmark $3 billion for research — should carry over into other states, and could lead to big profits for stem cell research firms. That, in fact, is already coming to pass. New Jersey is committing to $9.5 million for stem cell research, while Wisconsin is promising $750 million in research funding. And in early January, Connecticut jumped on the stem cell bandwagon too, with the governor committing up to $20 million for stem cell research. Expect other states to follow suit. The New York general assembly also is set to vote on a $1 billion, ten-year commitment to stem cell research. Massachusetts, Colorado, Maryland, Delaware, and Nevada all have similar capital funding plans underway. Not all state governments are sold on stem cell research. Initiatives in Illinois and Missouri, for example, have failed in recent weeks however.

Granted, growth in public spending hasn't specifically translated into big stock gains for prominent stem cell companies. Geron (GERN), for example, has fallen 33% since the start of the year, from $9 to $6 per share. But the company's fundamentals are so strong that three leading analysts that follow the stem cell sector — Needham & Co., Rodman and Renshaw, and Landenburg Thalmann have Geron listed as a "hold," "market outperform," and "strong buy," respectively.

The outlook for Geron's stem cell research also is bullish. Geron recently trotted out a litany of studies showing that human embryonic stem cells (hESCs) can be propagated in culture using defined growth factors without the need for feeder cells or media conditioned by feeder cells. That, scientists say, is a major step forward in the development of scalable systems to culture hESCs for the production of therapeutic cell products. Geron also has about 250 existing patents in embryonic stem cell research.

Consequently, the company is drawing some notice among Wall Street types. Jamie Dlugosch, editor of TheRational Investor, a Minneapolis-based growth stock newsletter, calls Geron his "stock of the year." Dlugosch says Geron is poised to take off in stem cell research. "Widespread coverage of the stem-cell debate negated nearly 50% of Geron's market cap in 2004 and offers investors a chance to scoop up shares at a discount," he says. "Earnings are negative, but are expected to show marked improvement in 2005. With large pharmaceuticals struggling mightily, I expect companies such as Geron to benefit greatly. Geron is well capitalized with tremendous market potential. I would buy up to $9 per share. My target is $18."

Another company I mentioned in January was StemCells (STEM), a development, stage biotechnology company focused on the discovery, development and commercialization of stem cell-based therapies, has also seen its stock price fall — from $6 a share to $3 a share.

Wow, Brian, you're really on a roll. But wait, hear me out. Yes, the stock price for both Geron and StemCells have waned so far in 2005. But a closer look reveals both stock prices have ticked upward after news that state governments would be pouring money into stem cell research. Geron rose 7% and StemCells 15%, for example, when news of the New York capital funding effort hit the business pages.

Investors, as they are wont to do, are following the money. And the more news rolling out that shows public funding for stem cell research, the more interest we'll see toward stem cells on Wall Street.

As a result, Geron, StemCells, and another company I mentioned in January, Aastrom Biosciences (ASTM), may not look so grim once you get past the lousy performance we've seen over the past few months. Taking the long view, all three companies combined have a very nice market cap range — about $200 to $300 million. All three are trading around the midpoint of their 52-week ranges, with Geron bringing up the rear. In addition, California's Proposition 71, which opened the spigot for $3 billion in state funding for stem cell research has fueled venture capital action at all three companies. In late 2004, Aastrom raised $10 million in private funding, StemCells raised $22.5 million from similar sources, and Geron announced that it is selling 6.5 million shares to raise $40 million.

A LONG-TERM PLAY

Ideally, stem cell stocks should be a long-term play for interested investors. By that I mean don't expect to reap big gains from a Geron or a StemCells in 2005, although that could happen.

After all, the stem cell industry is a long-term play all by itself. Industry gurus acknowledge that, to date, no diseases or illnesses have been cured by embryonic stem cell research. Many scientists also say we are at least 10 to 15 years away from realizing any of the potential benefits from stem cell research. That could explain why, so far, investors have shied away from embryonic stem cell research companies and focused instead on adult stem cell remedies that are much closer to bearing fruit scientifically, commercially, and financially.

In addition, some investors may still be wrestling with the ethical considerations concerning embryonic stem cell research, which are gathered from human fetal tissue. Their hesitation may cause many investors to avoid stem cell companies until they gather more information and make peace, one way or another, with the idea of using embryonic stem cells in the life sciences arena. "With stem cell research inextricably linked to the controversies surrounding abortion and cloning, many institutional investors are struggling to develop a policy regarding investments in this fast-paced field," says Craig Metrick, director of Corporate Benchmarking Service at the Washington-based Investor Responsibility Research Center (IRRC).

If you want to take a closer look at the stem cell market, the IRRC has a great backgrounder on investing stem cell research called "Stem Cell Research: An Analysis for Investors." The 78-page report covers federal guidelines and legislation influencing stem cell research in the US, and examines legislation under consideration in Congress that could affect advancements in the stem cell sector. It also addresses the history of stem cell research, recent industry developments, and the regulatory future of stem cell research and cloning. Best of all, the $100 report, which shines a spotlight on 25 of the approximately 40 publicly traded companies involved in stem cell research, can be purchased at www.irrc.com.

MOMENTUM ON ITS SIDE

It's going to take a while for stem cell research to really shift into high gear. Political wrestling matches over funding, ethical considerations over embryonic stem cells, and a lack of understanding of exactly where stem cell research is as a life sciences market are all fueling a significant degree of uncertainty among not only investors, but analysts who cover the sector.

This too shall pass. The momentum is shifting in favor of more public funding for stem cell research. With every announcement of $100 million here or $50 million there from a Delaware or a Massachusetts, expect to see stock prices of stem cell companies to ratchet up.

Remember, it's all about following the money. And stem cell companies are starting to see a lot of that.

Editor's Note: See Final Word, for new guidance on stem cell ethics.

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.