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Feb 1, 2009 (Vol. 29, No. 3)

GEN’s Annual Wall Street Roundup

Experts Agree that Adaptability Is the Key to Long-Term Survival, Especially in Difficult Times

  • GEN: List your top and bottom biotechnology picks for 2009 and provide a brief explanation for each selection. 

  • Conway: Companies that would fit our profile of companies likely to succeed in this environment include large-cap names such as Gilead Sciences (GILD) with an established position in HIV therapeutics, Genzyme (GENZ) as well as its smaller-cap partner Biomarin (BMRN) for a strong orphan drug portfolio, and Celgene with Revlimid and Thalomid providing it with a powerful oncology franchise.

    Other companies we believe may better weather current industry conditions include those involved in products and services for life science research, such as Life Technologies and Sigma Aldrich, because of their broad product base and the likelihood that leadership in biotechnology research will remain of strategic importance.

    In addition to the number of companies with earlier-stage products, we believe many of the larger CRO's including Covance (CVD), Charles River (CRV), and Pharmaceutical Product Development, may find 2009 challenging as many of the larger pharmaceutical companies scale back development agendas.

    Masterson: My picks are:

    • Sequenom (SQNM): This pioneer in DNA analysis had found its killer application in prenatal analysis. We think the stock could go to $32.

    • Isis Pharmaceuticals (ISIS): The  shares of Isis gained 7% after Abbott Laboratories (ABT) exercised its option to purchase the remaining equity ownership in Ibis Biosciences from parent Isis for $175 million. Including Abbott’s $40 million investment earlier this year, the pharmaceutical company said the total cost for the Ibis acquisition is $215 million. In addition, Isis will receive earn-out payments from Abbott.

    • Repros Therapeutics (RPRX): This biopharmaceutical company focuses on the development of new drugs to treat hormonal and reproductive system disorders. The company's lead product candidate, Proellex, is an orally active small molecule that is being developed to alleviate symptoms associated with both uterine fibroids and endometriosis by selectively blocking the progesterone receptor in women. Its second product candidate, Androxal, is an orally active small molecule being developed for the treatment of testosterone deficiency in men. Androxal is a once-a-day oral therapy, which is designed to restore normal testosterone production in males versus competitive treatments that exogenously replace testosterone.

    • Johnson and Johnson (JNJ): This is a safe bet for troubled times; even Cramer likes it.

    • Gilead Sciences: We remain long in this company and expect it to be a winner in the current environment.

    • BioMarin Pharmaceutical: BioMarin Pharmaceutical (BMRN) and La Jolla Pharmaceutical (JLJPC) entered into an agreement to develop and commercialize Riquent, La Jolla's investigational drug for lupus nephritis, in the U.S., Europe, and all other territories of the world, excluding the Asia Pacific region.

    • Celgene (CELG): We like cancer plays this year. Celgene is primarily engaged in the discovery, development, and commercialization of therapies designed to treat cancer and immune- and inflammatory-related diseases. The company’s lead product is Revlimid and Thalomid.

    My Pans are:

    • Orchid Cellmark (ORCH): The company provides DNA testing services that generate genetic profile information by analyzing an organism’s genetic identity. The company’s business focuses on DNA testing for human identity, particularly for forensic and family relationship, as well as security applications. The company provides DNA testing for agricultural applications including for food safety, selective trait breeding, and traceability purposes, all of which are conducted in the U.K. The strength of the pound has hurt this company as well as its lack of cash.

    • PDL BioPharma (PDLI) stock has fallen ahead of the biotechnology company's removal from the S&P MidCap 400 index as it spins off its biotech operations.

    Following the spin-off, PDL will no longer be representative of the U.S. mid-cap sector, Standard & Poor's has said. Shares of companies taken out of indexes can lose value, as mutual funds and other institutional investors that track the indexes rebalance their holdings. The Redwood City, CA-based company is spinning off its biotechnology operations into a separate unit called Facet Biotech.

    Mehta: While we do not publish our bottom picks, our top picks include: 

    • BioMS Medical (MS, Outperform, TP–C$6): Secondary progressive multiple sclerosis (SPMS) is a disease of neuronal degeneration and not inflammation like relapsed refractory multiple sclerosis (RRMS). Currently, approved MS drugs for RRMS drugs are not effective in SPMS. BioMS’ dirucotide’s (formerly MBP-8298) novel approach aims to delay further progression of the disease in SPMS through induction of immunological tolerance with respect to an immunodominant epitope (region 84–106) of the myelin basic protein, the dominant protein target of the MS immune attack.

    • Intercell (ICLL, Outperform, Target Price = €36): Intercell is strengthening its smart innovative  vaccine pipeline and technology platform through judicious deployment of its cash and strategic partnering. The company is ready to launch its first product, a Japanese encephalitis vaccine in 2009 with partners Novartis (NOVN), CSL (CSL), and Boehringer Ingelheim (BE), which targets an unmet need and could command a premium pricing.

    ICLL is poised to capitalize the traveler’s vaccine and nosocomial infection market opportunities. Being on the verge of achieving sustainable profitability within three years of its IPO, the value of its innovative technology platform and novel adjuvants is yet to unfold.

    • Intermune (ITMN, Outperform, TP–$30): The main value driver for these shares is Pirfenidone, a novel treatment for idiopathic pulmonary fibrosis. Intermune has rights to Pirfenidone outside of Japan, where Shionogi has recently received approval to launch. The company’s U.S. and European filings depend on the two Phase III CAPACITY trials. This data should be released in late January or early February. If the CAPACITY trial is negative, Intermune should have some downside protection based on ITMN-191, a protease inhibitor for HCV partnered with Roche.

    • LifeCycle Pharma (LCP, Outperform, TP-DKK26): LCP’s Meltdose technology has the potential to formulate more efficacious drugs with an improved tolerability. With this capability, LCP is poised to target the transplant area with LCP-Tacro (Phase III) and the cardiovascular area with LCP-Fenoglide (Launched) and LCP-AtorFen (PhIII).

    • Myriad Genetics (MYGN,Outperform, TP–$80): Predictive medicine business (PM) provides solid value to the company and is responsible for steering the company toward sustainable profitability. Management intends to use the cash flow of the PM business to acquire complementary diagnostic tests to create further value for the company and its shareholders.

    • NicOx (COX, Outperform, TP–€14): Key driver, naproxcinod (osteoarthritic pain), should become a blockbuster as there exists a large commercial opportunity for naproxcinod in addressing an unmet need.

    Further, 35–50% of patients with osteoarthritis have elevated cardiovascular (CV) risk, suggesting a large opportunity for CV-safe pain killers. Naproxcinod needs to capture just 15% of U.S. patients to generate $720 million in sales. Additional value could come from the hypertension program (partnered with Merck) as well as the ophthalmology program (partnered with Pfizer).

    Napodano: Large-cap names we favor in 2009 include a who’s who of the biotechnology industry. We have buy ratings on both Genentech (DNA) and Biogen Idec (BIIB) and would feel comfortable investing in Amgen (AMGEN) and Gilead,  as well. Roche’s $95 billion bid to acquire Genentech is still on the table but awaits financing. Biogen is also a potential acquisition target in 2009. The company put itself up for sale in late 2007 but found no takers. The progressive multifocal leukoencephalopathy  risk profile for Tysabri remains a concern, but as Biogen’s pipeline moves forward, the name becomes increasingly more attractive to growth-hunting large-cap pharmaceutical names.

    One of our favorite mid-cap biotechnology names for 2009 is antisense play, Isis Pharmaceuticals. The company is in late-stage clinical trials with mipomersen, an antisense compound for high cholesterol. Isis has partnered with Genzyme for the development and commercialization of mipomersen, a product with multibillion-dollar potential. Besides late-stage mipomersen, Isis is also developing mid-stage candidates for cardiovascular disease, cancer, diabetes, inflammation, and viral infections.

    Isis has the best pipeline in biotech outside of the large-cap names, but what’s so attractive about Isis is the financial position. Including the recent $175 million sales price of Isis’ Ibis Bioscience business to Abbott Labs (ABYT) Isis has an estimated $650 million in cash-on-hand. That’s an astonishing amount for a biotech firm with a market value of only $1.3 billion. Add in the huge pipeline, and Isis should outperform in 2009.

    Another top-pick for 2009 is stem cell play Osiris Therapeutics (OSIR). Osiris is currently in three Phase III trials with stem cell product, Prochymal, all under FDA Fast Track, which will offer data in 2009. These programs include steroid refractory graft versus host disease (GvHD), acute GvHD, and Crohn’s disease. Management is also studying the drug in earlier-stage programs for myocardial infarction, chronic obstructive pulmonary disease (COPD), type 1 diabetes, and acute radiation syndrome. We see Prochymal as a blockbuster drug for Osiris and development partner, Genzyme. Similar to Isis, Osiris has a solid cash position and should post positive earnings per share for all of 2009 and forward, assuming Prochymal continues to look as good as it has in its current clinical trials.

    We are big fans of stem cell technology and think that 2009 could be a breakthrough year for the industry. A change in the political landscape should benefit all players. Nevertheless, Osiris’ product utilizes adult stem cells, so they are somewhat sheltered from the ethical issue.

    Another stem cell play we think could be in store for a good 2009 is small-cap Cytori Therapeutics (CYTX). Cytori makes a stem cell purification device called the Celution System. The company is currently selling its product in Europe and Asia, but hopes to enter the U.S. market in the next year.  Cytori’s business could be highly attractive for a larger pharma/ device company looking to break into the stem cell market.

    Another financially sound biotech firm nearing a reign of sustainable profitability is cardiovascular-focused The Medicines Company (MDCO). Sales of the company’s leading product, Angiomax, continue to be strong in the U.S., and management is seeing new growth opportunities with the product as they expand sales around Europe. Management, also, just recently received approval for its second product, Cleviprex, and is in Phase III trials with yet another cardiovascular drug, Cangrelor. Based on our financial model, The Medicines Company should earn near $1.00 in EPS in 2009, putting the name trading at extremely reasonable valuation for the biotech industry. As Cleviprex begins to pick up steam in 2009 and beyond, and if management can gain approval for Cangrelor in 2010, The Medicine Company becomes an attractive takeover target for a larger specialty pharmaceutical organization looking to expand its cardiovascular product offering.

    There are a slew of small-cap biotech names that will have make or break clinical trial data or FDA decisions in 2009. The FDA’s PDUFA action date on Cypress Biosciences’ (CYPB) milnacipran passed in mid October 2008. Cypress and milnacipran development partner, Forest Labs (FRX), recently presented positive data from a third Phase III trial in December 2008. We think approval is coming in early 2009 and would be buyers of Cypress ahead of the decision.

    In March 2009, Arena Pharmaceuticals (ARNA) will release data on its Phase III obesity candidate, lorcaserin. Lorcaserin is the most advanced obesity candidate under our coverage, and the data expected in March 2009 will determine just how successful in signing a development partner Arena will be in 2009. We expect results from the trial to be positive, but we would wait on buying the name until after the data comes out. Based on lorcaserin, Arena has significant upside in its future, but we would rather wait for confirmation from the data.

    Pozen (POZN) is waiting to hear back from the FDA on whether the primary endpoint of its Phase III PN-400 trial remains acceptable for approval. The FDA threw Pozen a curveball in late 2008 when the agency decided to conduct an internal review of the acceptability of using endoscopic gastric ulcers as a primary endpoint in clinical studies for PN-400. PN-400 is a combination of esomeprazole and naproxen, and management should be in position to file for approval during the first half of 2009. That is, unless the FDA asks for another trial with a different endpoint.

    The FDA’s PDUFA action date on Somaxon’s (SOMX) Silenor passed in December 2008. A new date has been set for late February 2009. Silenor is a histamine-receptor blocker under development for the treatment of insomnia. Although Silenor has some differentiating characteristics that make the drug look like a superior option to either sanofi aventis’ Ambien or Sepracor’s Lunesta, we would not look to own Somaxon heading into the FDA decision. The FDA has been tough in the past on approving new sleep medications, and with everything riding on Silenor, Somaxon looks too risky at this point.

    One company that knows all too well how difficult the FDA has been on approving new sleep medications is Neurocrine Bio (NBIX). But Neurocrine is back with a new compound in elagolix, currently in Phase II trials for the treatawment of endometriosis. Data from two Phase II programs should be out during the first half of the year. Neurocrine is looking for a development partner to take elagolix into Phase III trials. Much like all the companies we discussed, Neurocrine has a lot riding on elagolix development. Previous Phase II data on the drug has been encouraging, so we would not be surprised to see Neurocrine outperform in 2009 after additional data on the drug comes out.

    One final make-or-break event in 2009 will be the FDA’s decision on NeurogesX’ (NGSX) NGX-4010, a cutaneous patch designed to treat peripheral neuropathic pain conditions such as post-herpetic neuralgia. The product is designed to provide a high concentration (8%) of a synthetic capsaicin directly to the site of pain via the rapid-delivery patch system.

    Management filed for approval in October 2008 with data from two positive Phase III trials. Normally this would lead us to feel confident in a positive FDA decision in August 2009, but given the novel mechanism and delivery system along with some not-so-good data in another type of neuropathic pain, we are unsure of how the FDA will rule. Approval will be a transformational event for NeurogesX, so it should clearly be on investors’ radar. 

    Raynovich: Despite the current gloom and doom, the forecast for 2009 looks good especially toward Q4 when smaller caps recover due to the usual drivers: M&A, product news, and research breakthroughs. Keep in mind though that the bear market is still intact. As I forecasted last year, biotech and healthcare will outperform other sectors as it is less dependent on the general economy and credit.

    A 10% return should be achievable with a diversified portfolio with a weighting toward large caps and mid caps with strong balance sheets. To balance out the portfolio with niche themes, I would add positions in generics, diagnostics, IT, and tools. Politics will not have a negative impact and in fact should be favorable for life science research. Some overhang is expected from the credit crunch, but there is plenty of money on the sidelines, and little else to do with it.

    My investing model as in previous years is to have a balanced portfolio but to be opportunistic with speculative small caps when momentum returns. Small and mid caps were more beaten up than large caps, so well-funded companies should make a comeback. I have also added more diversification outside biopharma with tools and diagnostics than in previous years to reflect their increasing importance in drug discovery and targeting therapy.

    I would allocate 60% in large-cap biotechs and exchange-traded funds: 25% in XBI, 10% in IBB, 25% in Amgen (AMGN), Biogen Idec (BIIB), Cephalon (CEPH), Genentech (DNA), Gilead Sciences (GILD).

    If there is market strength in biotech the top tier will do well. Moreover there is less risk, as biotech is deemed a defensive growth, replacing large-cap pharma, which is languishing due to slower sales growth and a generic threat for blockbusters.

    25% in Mid Caps:  Auxilium Pharmaceuticals (AUXL), Cubist Pharmaceuticals (CBST), Isis Pharmaceuticals (ISIS), Regeneron (REGN), Seattle Genetics (SGEN), United Therapeutics (UTHR), and Viropharma (VPHM).

    10% in devices, diagnostics, and tools: Pick four out of these six at attractive valuations.

    Abaxis (ABAX)—$100 million plus diagnostic company in human and veterinary IVDs; good balance sheet.

    Celera (CRA)—morphed into personalized disease management; stock is stalled 

    GenProbe (GPRO)—$500 million plus leader in nucleic acid tests for infectious disease

    Hologic (HOLX)—beaten-up, high-flyer due for recovery in 2009; diverse product line Illumina (ILMN)—premier SNP array player in buying range

    Inverness (IMA)—beaten-up, $1.7 billion diagnostic trading at 1X sales

    5% or more in speculative value, with 10% for aggressive position taken out of mid caps: Small-cap companies need to conserve cash, watch headcount, and beef up business development in order to create partnerships. Look for capitulation fourth quarter selling leaving good value for 2009. Ideas that offer value and clinical programs are: Array BioPharma (ARRY), Micromet (MITI), Ardea Biosciences (RDEA), Rigel Pharmaceuticals (RIGL), SuperGen (SUPG), and Targacept (TRGT).

    Niche plays: The following minithemes with large markets merit further research.

    Abiomed (ABMD) and Volcano (VOLC)—small-cap cardiovascular device plays

    Momenta Pharmaceuticals (MNTA) and Teva Pharmaceutical (TEVA)—generic drugs

    Athena Health (ATHN) and Cerner (CERN)—Healthcare IT

    OsirisTherapeutics (OSIR)—stem cells

    For stocks to avoid, look for these signs: less than 15 months of cash, broken down charts with no January recovery, and stock price under a dollar. Also look at retained earnings to see how much investment was made in the company since inception compared to current enterprise value.

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