Patient route to healthy profits
Despite a sluggish market, shares in biotechnology companies are increasing in value but David Potts warns the sector is complex, and it can take time for investors to see a return.
Despite a sluggish market, shares in biotechnology companies are increasing in value but David Potts warns the sector is complex, and it can take time for investors to see a return. Some mining boom this is. Resource stocks have run out of puff and the smart money is moving on.To where?Well some biotech stocks were posting double-digit gains as the rest of the market was going backwards last year.They're attracting the attention of some of the world's biggest pharmaceutical companies and fund managers.What's good for health is good for wealth, it seems.And judging by the burst of enthusiasm on Wall Street, where the average biotech stock listed on the NASDAQ exchange has soared almost 40 per cent in the past six months, there's still more, er, life in ours.The Bell Potter Life Sciences Index has trailed it by 20 per cent over the past three months.That could be about to change. Even as new floats were being cancelled left, right and centre last year, biotechs managed to raise another $630 million.That came mostly from British and Asian funds, says John Granger, divisional director at Bell Potter, which underwrote six of the last seven new issues by what he calls "life sciences" companies.Do they know something we don't?The stocks doing well have an offshore big brother to produce and market new drugs and applications."The market likes to hear what the partners are saying," he says.The hoopsCertainly a lot of money is going to be made or lost in the next few months on decisions by the FDA, which says a lot for its clout, considering it doesn't have any jurisdiction here.An acronym for US Food and Drug Administration, a bureau somewhere in the American Department of Health and Human Services, it's the be-all and end-all for the success of a new drug or medical appliance.FDA approval is the holy grail for a new drug because then it can be sold in the US, the world's biggest market for medicine."The US is 45 per cent of the global [health] market," healthcare analyst at Nomura Australia, David Stanton, says."FDA approval also means approval in other jurisdictions is more likely," he adds.Such is the degree of difficulty in getting the FDA on side that you need approval to even ask to be considered for approval.No wonder biotech stocks are considered risky.Not only does the cure have to work - some people just want everything, don't they? - but it also needs to get the nod from the FDA.Then the company has to commercialise it, at which point it will almost certainly be bought out by a giant pharmaceutical outfit. And that's where you come in - or preferably a bit before that because a takeover will do wonders for the share price.The best time to buy is after successful phase II clinical trial results, showing it's probably working, and before the final phase III results, by which time if they're successful you won't see the share price for dust.But with a choice of 90 or more, which ones to choose?"Biotechnology is not one big market. There are hundreds of tiny little ones. For each stock you have to look at the competitors - who does what, when and how - and potential patients," David Blake, whose Bioshares newsletter (bioshares.com.au) is the bible of the biotech sector, says."It's a real drill-down exercise. There can appear to be 20 competitors but there aren't because it's carved a new opportunity. But it works in the opposite direction, too."At least you needn't worry about the strong dollar. It's hardly hurting biotech stocks and more often than not it's a distinct help because their main costs are in US dollars, in which case they can afford more.Besides, in potentially billion-dollar-a-year markets, what's a few cents' difference in the exchange rate going to make?But they do burn up cash, which appears to be putting off local investors. Who wants a stock that keeps demanding you put your hand in your pocket to provide more capital?Stocks which are earning revenue - admittedly not necessarily the same thing as earning a profit - and have prominent international partners are preferred by analysts.ACRUX (ACR, $3.65)The testosterone-spray company Acrux set a milestone last year by becoming the first small biotech stock to pay a dividend, but something more distinguishes it from its peers.As a pooled development fund, neither the dividend nor any future capital gains are taxable."It had a 10 per cent market share six months after [its male hormone treatment Axiron's] launch and is likely to end up dominating the whole market," Blake says.Acrux's partner is the giant drug company Eli Lilly, which manufactures the spray and pays a royalty, with Nomura suggesting the big pharma might buy Acrux sometime. In any case, in an ageing population Acrux's product can only be a growing market.Although Acrux is a one-drug wonder, it's working on an animal-health product.In the past year the price has swung between $2.49 and $4.30.MESOBLAST (MSB, $7.56)Of all the new drugs being trialled, Bell Potter biotech analyst Stuart Roberts says stem cell company Mesoblast has the most potential.After all, it seems to be looking at a treatment for everything.Its "lead products will target cardiovascular conditions, diabetes, inflammatory conditions of lungs and joints, eye diseases, bone-marrow cancers, bone fractures, cartilage degeneration and musculoskeletal conditions", it says.The treatments for heart failure and bone-marrow transplants are in phase III trials.It's even working on a cure for bad backs. Bring it on.Mesoblast's share price has soared but there's more where that came from, with Roberts saying the stock is worth $16 a share - about 60 per cent more. Stanton suggests a more sedate $10.15, still a healthy 30 per cent gain.It's a potential takeover target, too, with a multinational shareholder sitting on 19.9 per cent of the shares, a whisker under the compulsory takeover offer threshold.PHOSPHAGENICS (POH, 19?)This is one of Blake's favourite stocks. Phosphagenics is also one for those squeamish about needles because it's just moved to phase III trials for a skin patch that will deliver insulin and other medications. It has $27 million in its kitty that will pay for the trials.It also has a cosmetics line, Elixia, based on its TPM technology that, apparently, makes the anti-ageing skin cream work faster. Bring that on, too.Bell Potter likes it because of its "shorter lead time to market and low cost of clinical development" and values it at 40? a share, more than double its current price.QRxPHARMA (QRX, $1.70)Dr House of the eponymous TV show is always swallowing painkiller Vicodin for his painful leg, but soon he'll be able to switch to something that claims to have fewer side effects, though crankiness could be a challenge.MoxDuo IR is a painkiller combining morphine and oxycodone that, so far, has been found to work better than each individually by reducing side effects by 50 per cent to 75 per cent.The pain-relief market is worth $8 billion a year.Show time for QRxPharma (the odd name comes from its University of Queensland heritage) will be June 24 when the FDA decides whether it can apply for approval of its phase III trial results, in which case it could begin marketing in the second half of this year."If it says yes the stock will be re-rated. If it says no - it's not going to be pleasant," Roberts says.Bell Potter has a target price of $3.30.STARPHARMA (SPL, $1.38)Flushed with funds after a capital raising at the end of last year, with 100 patents and some of the world's biggest drug companies as partners you couldn't pick a better name for Starpharma.But its real beauty is that it doesn't have to invent new drugs - it makes existing ones work better, which also means it's not dependent on a specific one.Making drugs already on the market work better is a boon for pharmaceutical companies. Typically they lose 85 per cent of their sales in the first six to 12 months that a drug goes off patent and faces competition for cheaper generics."They spend 16 to 20 per cent of their revenues on research and development but get few product approvals," Bell Potter's Roberts says.So they either need to extend the life of an existing drug or buy an emerging biotech stock that's had some success.And to cut a long story short, Starpharma has the rights to dendrimers, a special molecule that extends the life of prescription drugs and can reduce their side effects."Our strategy is to generate a series of parallel revenue streams from our technology through commercial licences. We're intentionally diversified," the chief executive, Jackie Fairley, says.It's about to begin a phase III trial of VivaGel, which can be used to treat bacterial vaginosis, as a condom coating (it's already signed up Ansell) and against sexually transmitted infections. It has $49 million in cash, enough to see it through the two phase III and one phase II trials under way since it burns only about $8 million a year.FDA willing, it should turn a profit in another three years. Nomura values it at $1.55.Oh, did I mention one of Britain's biggest funds, M&G Investments, has nabbed a 6.7 per cent stake?Bell Potter values it at $2.30.UNIVERSAL BIOSENSORS (UBI, 73?)A producer of glucose test meters for diabetics this is "a first class company but struggles to get attention from investors. It has the mindset of engineers and professionals rather than salesmen," Blake says."It's come up with a better way, as well as a better way of making it."Despite moving from the lab to commercial production, normally the turning point for a biotech, the share price just drifts down.With no capital raising imminent, $20 million in cash and receivables, plus a low cash burn rate of $5 million a year, chief executive Paul Wright says it's just "general risk aversion" by investors."Our price has halved and we've done nothing wrong," he says.On the contrary, it's done a lot right.Its partnership with Johnson & Johnson is nothing short of lucrative.It gets one cent for every strip it makes for the glucose test kit, plus commission (though it's called a service fee) plus reimbursement for any research and development spending.The cent-a-strip is pure profit and since 16 billion are used each year - well, that adds up to a lot of money.But then there are competitors, though with a different product, so don't get too excited.Blake says its blood-clotting application, with the giant Siemens, will produce even bigger margins. Broker Wilson HTM values the stock at $1.75.