Biotechs the drug of choice ::

Author: Helena Keers
Date: 19 March 2007
Publication: The Financial Review
Section: Market Wrap

Fund managers are revisiting the sector despite its speculative nature, writes Helena Keers.

Biotech stocks are ramping up to report a rush of results from late-stage clinical trials, prompting fund managers and analysts to predict a resurrection of the sector that has been damaged by the shocking clinical failure of Metabolic Pharmaceuticals and the recent falls in the market.

The eG Capital Small-Cap Biotech Index, which is a measure of the performance of listed biotechnology companies that have a market capitalisation of less than $1 billion, was at an 18-month high on February 20.

But that was before Metabolic announced the failure of phase IIb clinical trials for its anti-obesity drug AOD9604. The day after the company hit the headlines, the index lost 2.53 per cent and has fallen another 5 per cent.

Meanwhile Metabolic shares, which had risen 117 per cent in the four-month run-up to the announcement, have since slumped more than 80 per cent to 15¢.

Taylor Collison biotech analyst Tom Duthy says: "The strength of the sector so far this year has been somewhat tempered by the clinical failure of Metabolic, which has reverberated around the sector."

Of course the fall in the global equity market has affected the biotech sector, which is more prone to volatility because it's a risky sector. But with many market experts predicting a return to market strength, it could be the storm has passed us by and now is the time to really take some risk.

eG Capital biotech analyst Ben McCaw certainly thinks this could present a buying opportunity for investors. He says the difference between the recent falls and dips in the past is that there are a number of companies on the cusp of reporting the results to late-stage clinical trials. "This could prop up the index soon," he says.

Companies in this basket include Avexa, Pharmaxis, Chemgenex Pharmaceuticals, Neuren Pharmaceuticals and Progen.

Avexa's shares have more than doubled since the end of December before results of its anti-infective drug ATC. The company is expected to be the next cab off the rank with phase IIb trials for its HIV drug pencilled in for later this month.

Earlier this month, Neuren announced it had secured US Food and Drug Administration approval to begin its phase-three trial using its drug Glypromate to prevent cognitive impairment following major cardiac surgery. The trial is expected to cost $10 million and take 18 months.

Progen recently raised $20 million to partially fund its PI-88 drug's progress in phase III trials.

Pharmaxis is also expected to complete planned phase III clinical trials for its Bronchitol drug in treating cystic fibrosis and bronchiectasis. Shares in the company are up more than 47 per cent in the past year. A few weeks ago it filed a shelf registration statement with the US Securities and Exchange Commission to raise as much as $US250 million ($314 million) in the US within the next three years.

Taylor Collison's Duthy says: "Clearly there is an appetite for biotechs slated to report chemical milestones. A lot of news flow is expected from biotech companies during this quarter and next, but it's a question of how strong these results will be."

The difficulty of investing in biotechs is that it's hard to know how long a company will take to get FDA approval for a drug. Only specialist investors will know what the competition is and if a new drug will get out to the market first.

Clime Capital chairman Roger Montgomery compares biotechs with uranium explorers, saying: "You need to do a great deal of research. You need to subscribe to all the industry journals and become an expert."

Adam Smith Asset Management portfolio manager Michael Glennon agrees, saying: "You've got to be a specialist to understand them and we don't."

A lot of investors are also turned off biotechs because so many are loss-making research and development companies.

Jenkins Investment Management managing director David Aylward says he tends to invest only in companies that have a track record or earnings.

Montgomery says investing in biotechnology is an oxymoron because buying shares in biotechs is actually speculating. "A business with no track record can't be valued," he says.

Before the market falls of last week the sector had had a very strong run because risk appetite was rampant among Australian investors.

Biotech company Phylogica chief executive Stewart Washer admits: "The sector is not a revenue and profit sector. Biotechnology is more speculative.

"Most biotechs have lumpy income because you have to sink more money and more time into the drug to get it fully approved, but there can be substantial incomes."

There are biotech companies that offer less return and less risk, though. Phylogica licenses out its drugs after first pre-clinical trials, before FDA approval. "We have an unlimited supply of drugs in the pipeline because we know how to make drugs from scratch," says Washer.

Of course, the less risky shares offer lower returns.

According to Innovation Dynamics chairman Kelvin Hopper, who recently published his 2007 BioIndustry Review, the lift in revenue in some large companies and the next tier of biotech and devices firms, together with the start of strong international merger and acquisition activity, provides the evidence that the sector is moving away from its highly speculative beginnings.

He says in the report: "The international market appears to be revisiting Australia, slowly. Hopefully, we will see more stability in company management and fewer chief executives changing during 2007 and beyond."

Many fund managers are wary about taking on board even these risks, especially with the market experiencing volatility and falls.

Challenger Financial Services' head of small and micro companies, Michael Courtney, warns: "The risk appetite of investors has increased substantially. If you were a contrarian you'd be wary."

Clime Capital's Montgomery adds: "In our view, biotechs are way too expensive to consider.

"We can't be 90 per cent certain that we're going to get a return of 15 per cent. You can still make very handsome returns without investing in this sector."

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