16min read
PREVIOUS ARTICLE Search for the best consumer s... NEXT ARTICLE Maximise Your Income On These ...

Some Australians in search of an adrenaline rush travel to the Gold Coast to ride the Cyclone at Dreamworld.  Others invest in biotech stocks.

Biotechnology companies the world over are the playground of investors looking for high rewards.  Unfortunately, some forget that with high reward comes high risk.  Here is a five year share price movement chart for Australian Biotechnology Company Living Cells Technologies (LCT):

The chart says much of what you need to know about biotechs.  They can move up and down with incredible speed.  However, not all companies in the ASX Health Care and Biotechnology Sector share the same high risk profile.  In general, those with the highest risk – and the highest reward – are the drug discovery companies, followed closely by companies whose technology is aimed at new forms of disease treatment.  

LCT is one of many Aussie Biotechs that dramatically point out the risks involved in this kind of investment.  For the reward side, we turn to the company some experts feel is the best biotech investment in Australia – Mesoblast (MSB):

So how does the average retail investor find an MSB while remaining safe from the duds?  Most investors are well aware of the advice to “buy what you know” and very few have the background required to thoroughly understand the medical technologies with which these companies are involved.  So we go off in search of those who seem to know what they are talking about when evaluating biotechs for ideas.  Another option is to buy shares in a Biotechnology investment fund.

For the first option, there are sources like biotechdaily.com.  They have an Australian site and for a hefty subscription fee you can get expert coverage.  Their site maintains a Biotech Daily Index of 40 companies (BDI-40) and a smaller BDI-20.  Inclusion in the index is not fully explained except to say they base their decisions on “interesting technologies, benefit to human health, investment potential, with some attention to market capitalisation.”

On their website we found the following chart which compares the BDI-40 and BDI-20 against the ASX200 for the last twelve months:

It is difficult to interpret the chart since we do not know the composition of the “Second 20” that significantly underperformed the ASX200.  The general conclusion is that the indexes outperformed the ASX, although one needs to remember the rapid capital appreciation of some of these shares inflates the index.  With biotechs, a rising tide does not usually lift all boats.  It is the individual stocks with an exciting story to tell that jump.

As an alternative to researching individual biotech companies, Australian investors can buy into a pure Biotechnology investing fund managed by BioTech Capital Limited (BTC).  In theory, this fund offers the average investor the chance to profit from biotech companies that have yet to be listed on the ASX.  BTC’s asset portfolio includes both listed and unlisted companies.  In practice, it would appear BTC is also hard-pressed to differentiate the winners from the losers.  Here is a ten year share price performance chart, comparing BTC against the ASX200:

The chart shows how difficult it can be even for experts to find the best Australian Biotech companies.  If you have nerves of steel and the time needed to separate the wheat from the chaff, there are at least ten major issues to evaluate.  The great challenge with biotechs, most of whom have yet to show a profit, is determining their value in the absence of the traditional valuation tools investors normally have at their disposal.  Price to earnings ratios, net profit margins, and operating cash flow are simply not available for the majority of these companies.  Much of what you need to know can be found on the company’s websites.  Here then are ten factors you need to consider when investing in biotechs:

1.    Development Stage

2.    Product Pipeline

3.    Cash Reserves

4.    R & D Expertise

5.    Regulatory Issues

6.    Patents

7.    Technology Platform

8.    Market Potential

9.    Management Personnel

10.    Clinical Trials

Development Stage

It can take years to move a drug from a test tube into the marketplace.  While we are looking at Australian biotechs, Americans and Europeans suffer from the same diseases we do and most of our companies have their eyes set on the market that gets everyone’s blood pumping in anticipation – the United States.  As such, Australian biotechs must go through the grueling approval process managed by the USFDA (Food and Drug Administration.)

There are three Phases of clinical testing to pass before the FDA grants approval to market the drug or treatment.  The volatility you see in most biotechs stems from this drawn out approval process.  Once a company gets permission to initiate clinical trials at any stage, share price can rise.  Bad news at any point can send shares tumbling.  Biotech investors who are along for a short-term ride have ample opportunity to get off the boat as the waves crest.  Those with a longer view hold on and see the drops as buying opportunities.  Generally speaking, a company that has no drugs in clinical trials at any Phase may not be as good a target as one that does.

Product Pipeline

Company websites will tell you how many different drugs or treatments are under development.  Obviously, there is less volatility with companies that have several drugs undergoing clinical trials.

Cash Reserves

Biotechs need cash to operate and surprisingly enough not that many rely on debt to raise capital.  Instead stock warrants and outright stock grants are given to large investors.  Think of the life cycle of a biotech company as a race against the clock to generate revenue from drug sales before the available cash runs out.  Another reason for the extreme volatility of these companies is this need to raise additional capital.  In many cases this is done by issuing new shares, which dilutes the value of existing shares and in most cases serves to drive down the share price in the short term.  It is not always easy, but the intelligent biotech investor monitors the burn rate (how fast the company is spending its cash reserves).

Expertise

While it is possible to research the expertise of the doctors and scientists working on the drug or treatment, another indication of solid expertise is evidence of research grants and affiliations with prestigious universities.

Regulatory Issues

Some types of drugs take longer to get through the regulatory approval process than others.  In addition, you should know that while medical device companies do not always yield the astronomical rewards drug developers do, devices and equipment take much less time to get full regulatory approval.

Patents and Technology Platform

Check the company website to ensure whatever technology the company is employing is patented.  Intellectual property rights ensure exclusive rights to market a drug or treatment for as long as twenty years.  In addition, some technologies have the capability to yield multiple drugs or treatments if they work.  

Market Potential

No matter how compelling the story of the potentially breakthrough drug is, you need to have an idea of the size and scope of the market that could be helped by it.  It is a sad fact that drugs targeted at rare diseases suffered by a tiny proportion of the population are not as rewarding to investors as drugs that target diseases afflicting the masses.

Management Personnel

You need to check the credentials of the board of directors as well as company operating personnel.  Somewhere there should be someone with solid business experience with cost control.  Board members with experience with other early stage drug development projects are a must, as is someone experienced in the regulatory approval gauntlet.  The company website and investor presentations should show evidence of a long range plan for marketing the drug.

Clinical Trials

Intelligent investors stay abreast of developments at each stage of clinical trials.  In some cases, although failure to proceed from a Phase 1 to a Phase 2 trial may decimate the stock price, the game may not be over.  The FDA in particular frequently asks companies to redo the trial to look at different issues.  

Now we are going to briefly look at six different biotechs that have generated investor interest over the last decade.  Here are the companies, along with share price information as well as cash on hand and total debt:

CompanyCodeMarket CapShare Price52 Wk Hi52 Wk LoCashTotal Debt
Alchemia LtdACL$136M$.48$.86$.25$5.61M$0
Acrux LtdACR$676M$4.06$4.30$2.83$33.16M$0
Genera BiosystemsGBI$13M$.18$.29$.11$2.75M$0.07M
Living Cell TechnologiesLCT$29M$.08$.14$.04$4.5M$0
Mesoblast LtdMSB$2,159M$7.59$10.04$6.09$263.23M$0
Starpharma HoldingsSPL$440$1.60$1.69$.92$49M$0.07

 

Let’s begin with the only company in the table that has drugs in the market and is generating revenue and profit – Acrux.  Here is how investors have fared with the share price over the last ten years:

ACR is one of the safest biotechs in Australia.  They have a patented platform technology – transdermal (through the skin) drug delivery.  They have a robust pipeline of 9 drugs using the transdermal delivery system, with two already in the market.  American drug giant Eli Lily is one of their marketing partners.  Targeted treatments range from pain relief to smoking cessation to contraception to relief from menopausal symptons, and yes, even to pain relief for dogs!

The next two companies, Alchemia and Genera Biosystems have yet to live up to their promise.  Here is a ten year chart comparing the two:

ACL (Alchema) has six products in the pipeline, with one having received FDA approval in the summer of 2011.  Their drugs have significant target applications – oncology, cardiovascular and respiratory disease, and pain relief.  Think of them as a high-tech chemistry company with a platform technology they call HyAct (patented) that can target multiple disease conditions.  They have solid management and have been at this a long time.

Genera (GBI) has a patented technology for molecular diagnostics.  Their products would be used in laboratories and by physicians around the world.  As you may recall from the table above, they are the only company listed there with debt and their cash position is low.  In a 2011 investor presentation, the company announced a significant cost reduction plan, which is often not a healthy sign.

We have already seen the share price chart for Living Cell Technologies (LCT) and MSB (Mesoblast).  LCT claims to be targeting diseases for which there is no cure and poor treatment options, such as Diabetes and Parkinsons.  They have a patented technology for implanting living cells from pigs into humans.  They have five products in their pipeline with only one in clinical trials.

Mesoblast uses stem cells from bone marrow and their technology has caught the eye of Cephalon, one of the largest biotechs in the United States.  Their stem cell technology has the potential to treat cardiovascular conditions, diabetes, inflammatory conditions of lungs and joints, eye diseases, bone marrow cancers, bone fractures, cartilage degeneration and musculoskeletal conditions.  The company has multiple products in clinical trials, with some nearing Phase 3.  The market potential is staggering but the field of regenerative medicine has many players and the risk posed by competitors is something to consider.  

Our final company, Starpharma has given its investors reason to smile.  Here is their price chart:

The big bump in recent days came about with the beginning of two Phase 3 clinical trials of their claim to fame – a drug called VivaGel for treating bacterial vaginal infections.  It is a topical (applied externally) and the company has plans to introduce a line of condoms coated with the drug.  Apparently, one third of the female population of the United States suffers from bacterial vaginal infections at some point in their lives.

Their platform technology is the exotic sounding dendrimer nanotechnology.  Suffice it to say, there are other potential applications for this technology beyond the treatment and prevention of sexually transmitted infections.  Some of these products are already in the marketplace for diagnostic and laboratory applications.  SPL has a licensing arrangement with Siemens and Merck.

There are plenty of Biotechs to choose from, but the best may be those that already have some successes and some interest from larger global pharmaceutical firms.  One thing for sure, regardless of the company, you are sure to find the word “breakthrough” appearing on their website!

>> Next article – click here to read other articles 

 

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.