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Columns : Feb 1, 2008 ( )
Web Exclusive: GEN’s Annual Wall Street Roundup
Even with the possibility (some would say it’s already a reality) of a recession in the U.S. this year, the biotech stock analysts we interviewed for our Annual Wall Street Roundup feature express caution yet also optimism about the prospects for the bioindustry in 2008.
Company cash reserves, burn rates, and FDA regulatory oversight raise caution flags with our financial pros. Positive product stories and selective investment opportunities, however, are cause for optimism among potential biotech investors in the year ahead, according to these experts.
Our respondents were Viren Mehta (VM), managing member of Mehta Partners, Jason Napodano (JN), senior biotechnology analyst at Zacks Investment Research, William Tanner, Ph.D. (WT), managing director, biotechnology at Leerink Swann, Rod Raynovich (RR), principal at Raygent Associates, Nola E. Masterson (NM), managing director of Science Futures, and Benjamin J. Conway (BC), managing director of Johnston Blakely & Company.
Managing member, Mehta Partners (www.mpglobal.com)
The themes from recent years promise to continue to shape the opportunities for 2008:
• Upside is most evident in the emerging markets and selected generic companies.
• Mature biotechs are increasingly facing the same challenges of the global pharma companies.
• The specialty pharma model is broken, but selected company managements are cleverly putting some of the pieces together.
• High-priced products, especially in the increasingly crowded oncology class, should be watched with caution.
• New science investments have yet to create the critical mass for predictable productivity and, in fact, accentuate the safety flags with their refined tools. It is likely that this transition period will extend through at least another five years.
Our team’s annual exercise to publish MP Outlook 2008 has led to a significant reduction in our industry revenue growth projections from 6.5% last year to 5% in 2008–09 and gradually down to 2% in 2011–12. In fact, the U.S. may see negative revenue growth trends by 2011.
With about 40% of product sales losing patent protection in the next five years amidst slow R&D productivity and stricter safety regulatory standards, the industry woes are further aggravated by the recent patent rulings such as KSR. The managed-care organizations in the U.S. and payors around the world are smarter in adopting evidence-based reimbursement policies that demand more rational life-cycle management strategies for the older drugs. In short, fewer new product introductions are on the horizon, just when life-cycle opportunities become more limited.
Within this bleak picture there are several bright spots—notably a large opportunity for generics especially in Japan, continuing growth in emerging markets such as India and China as well as a number of smaller markets, new waves of disease-modifying therapies for diabetes and immunologic diseases, and broader use of biologics where serious generic competition is about three years away in Europe and perhaps five years away in the U.S.
Merck & Co. (www.merck.com) is one of the few exceptions among the global pharma companies, as our recommendation through 2007 is likely to be sustained in the new year despite a significant generic threat longer term. Relative performance of most of the other global pharma will be uninspiring, if not downright painful, as also may be the case with some of the larger Japanese pharma companies.
Discussions with industry managers and regulatory authorities suggest that the Japanese pharmaceutical landscape will continue to see dramatic shifts over the next couple of years. Japanese healthcare reforms due April 2008 will finally usher in a more rational generic policy. Physicians will have to check a box to avoid generic substitution and pharmacies will be incentivized in multiple ways to provide generics. The number of hospitals paid by fixed-fee formula will likely triple.
These changes will benefit generic companies such as Sawai (www.sawai.co.jp) and Nippon-Chemiphar (www.chemiphar.co.jp). The patent exposure of major pharmaceutical companies combined with substantial reforms lifted the shares of generic companies in the last few months of 2007.
India and China offer more accessible investment opportunities. Our top pick, Alembic (www.alembic.com), was up over 50% in 2007 on the combination of generic opportunities and booming Indian domestic growth, and it continues to be a top pick in our Indian universe, along with Cadila Healthcare. In China, Wuxi PharmaTech (www.pharmatechs.com) doubled in value since its IPO and is poised to grow with the increased outsourcing of R&D among global pharma players.
On the innovative side, companies focused on orphan diseases or with clearly differentiated drugs offer safer upside. Genzyme (www.genzyme.com) and Biomarin (www.biomarinpharm.com), which both focus on niche populations and have little competition, showed a strong rise in 2007 that should continue. In the pulmonary arterial hypertension market, United Therapeutics (www.unither.com) nearly doubled in 2007. Sales from Remodulin and a launch for Viveta position the company well for 2008.
While R&D appears sluggish overall, the industry pipeline continues to be strong in selected therapeutic areas. We await a new wave of more effective and convenient therapies for diabetes, hepatitis C, multiple sclerosis, and rheumatoid arthritis in late-stage development, and recommend taking selected positions. In addition, biologics for new therapeutic areas, for example Renovo’s (www.renovo.com) Juvista for skin scarring, have no competition and strong early data, and thus long-term growth opportunity.
Perhaps not so surprisingly, yet paradoxically, what little R&D productivity there exists is within the same limited number of targets, creating quite an over-crowding. This will make it challenging to launch new products and expect to recoup R&D investments. For example, Somaxon (www.somaxon.com) has had difficulty finding a partner for its insomnia treatment, Silenor, and will likely have to struggle to gain market share. Similarly, generics as well as a large number of branded alternatives will make it tough for King Pharmaceuticals (www.kingpharm.com) to advance its Altace tablet or H. Lundbeck (www.lundbeck.com) to grow in the antidepressant market, assuming its recent Takeda Pharmaceutical (www.takeda.com) partnership is eventually successful.
While the first disease-modifying drugs for Alzheimer’s are poised to enter late-stage clinical studies, this first-generation crop seems risky and likely to join many earlier attempts that have failed. AAB-001, the antibody-based therapy in development by Elan/Wyeth, targets a risky mechanism of action and deserves a cautious watch. Myriad Genetics’ (www.myriad.com) Flurizan has a more promising mechanism but is still not a sure thing in light of its mixed Phase II data.
A globally diversified positioning of your biopharmaceutical investments is especially timely for 2008. Consider Japanese and other selected generic companies, along with Indian and Chinese firms. On the new science side, exercise special care and focus on the proof-of-concept stage opportunities and underweight large pharma and mature biotech companies.
Senior biotechnology analyst, Zacks Investment Research (www.zacks.com)
Things have been difficult in biotech investing over the past year. Both large-cap and small-cap names struggled throughout 2007. Although we focus primarily on small-cap names for our coverage universe, we can’t help but report on the mishaps of the industry bellwether names such as Amgen (www.amgen.com) and Genentech (www.gene.com).
As of December 2006, Amgen was down 35% in 2007 on safety concerns and labeling changes to its leading drug, Aranesp. Genentech was down 15% in 2007 on the recent ODAC panel recommendation against approving Avastin for the treatment of metastatic breast cancer.
Small-cap biotech performance is determined by three factors: the general positive feeling on the industry, driven by performance of the large-cap names, the potential for M&A activity, and a favorable FDA. All three legs of the stool broke in the second half of 2007.
Leg one has been crumbling for the past 30 months. As noted, Amgen and Genentech both declined in 2007. This was the second year in a row the two biotech giants saw their stocks post negative returns. In fact, both Amgen and Genentech peaked in late 2005 and have been slowly bleeding ever since.
Leg two is looking weak. In December 2007, Biogen Idec (www.biogenidec.com) announced that the company had completed its strategic review and chose to remain independent. The stock dropped nearly 30% on the news. The truth is Biogen got no solid offers. This was a shock to the market considering large-cap pharmaceutical names such as GlaxoSmithKline (www.gks.com), sanofi-aventis (www.sanofi-aventis.us), and Pfizer (www.pfizer.com) were expected to bid heavily on the biotech giant. Biogen has an enormous biologic pipeline and manufacturing capacity among the top in the sector.
The fact that no pharmaceutical company wanted to pay the hefty premium Biogen was looking for does not bode well for future M&A activity in the industry. ImClone (www.imclone.com), Sepracor (www.sepracor.com), and PDL BioPharma (www.pdl.com) all hired bankers to “explore strategic alternatives,” i.e., put themselves up for sale. There are yet no takers.
M&A is extremely important to small-cap biotech stock performance, and right now pharmaceutical stocks seem to be shying away. Big deals in biotech such as Eli Lilly’s (www.lilly.com) acquisition of Icos or AstraZeneca’s (www.astrazeneca.com) buyout of MedImmune are in the minority.
Perhaps the most important factor to drive small-cap biotech stocks higher, though, is a favorable FDA. Nothing could be further from reality at this point. The agency is not taking any chances in this post-Vioxx, post-Bextra, post-Tysabri, post-Avandia world. Leg three is not broken, but it is certainly not inspiring much confidence.
We can site three examples of where the FDA blindsided small-cap biotech stocks in our coverage last year. The first was the rejection of Dendreon’s (www.dendreon.com) Provenge in May. In this decision, the FDA went against the ODAC panel’s recommendation to approve the therapy.
The next was the second approvable letter on Pozen’s (www.pozen.com) trexima in August. In this letter the FDA asked Pozen for preclinical data on trexima, a fixed-dose formulation of two drugs already approved and on the market in naproxen and sumatriptan.
Most recently, Neurocrine Biosciences (www.neurocrine.com) also received a second approvable letter on Indiplon in December 2007, wherein the agency asked the company to do clinical work far above and beyond what sanofi aventis with Ambien or Sepracor with Lunesta were required to do. Perplexing, considering Indiplon is the shortest-acting and safest- looking GABAa drug for insomnia.
So where should biotech investors turn in 2008? We would continue to stay away from the large-cap names. Besides Gilead Sciences (www.gilead.com), the growth is just not there. Small-cap biotechs are where the growth and innovation is emerging. M&A activity has not completely dried up; we just think that the large-cap names will continue to be picky about the deals they do. The FDA as well will start approving drugs again; the agency will just require more proof of safety before it allows new molecules to the market.
This brings us to our investment thesis for 2008: Buy small-cap biotech stocks that are developing one product with multiple potential indications. Such so-called platform drugs like Rituxan, Enbrel, Remicade, or Humira can be approved for three, four, or even five indications.
Genentech’s Rituxan, approved for non-Hodgkin’s lymphoma, also has significant use in other hematological cancers. The firm recently got Rituxan approved for rheumatoid arthritis (RA), and the drug is in clinical testing for multiple sclerosis (MS) and lupus. TNF-alpha drugs like Enbrel, Remicade, and Humira are approved for a slew of indications including RA, psoriatic arthritis, ankylosing spondylitis, juvenile arthritis, and psoriasis. All these drugs are mega-blockbusters.
The beauty of this strategy is that these molecules offer a large-cap name looking for M&A activity, a one-stop pipeline in a product opportunity. They are often cheaper and faster to develop because they only require preclinical, early-stage testing once before multiple pivotal or registration trials can be commenced. Hence, it is significantly more efficient to develop one drug for two indications than one drug for each.
This also allows for significantly more interaction with the FDA around a single agent as opposed to multiple discussions and filings. In the end, we think this improves the chances of approval.
Oncology products lend themselves well to this strategy. Take a look at Celgene’s (www.celgene.com) Revlimid, Millennium’s (www.mlnm.com) Velcade, or Onyx Pharmaceuticals’ (www.onyx-pharm.com) Nexavar for how biotechs leverage one idea into multiple shots on goal.
We see several potential multiple-indication products under development at many small-cap biotech stocks we recommend. The first is Xoma’s (www.xoma.com) IL-1 mAb, Xoma-052, in Phase I trials for type 2 diabetes. Given the significant data around the IL-1 target, Xoma believes that this candidate has potential in a number of other indications including RA, systematic juvenile idiopathic arthritis, and gout.
We expect Xoma to start these programs during the second half of 2008. If the data looks good, expect significant buying interest around this opportunity.
Xoma makes our list twice for pipeline products under development. The company is also collaborating with Novartis (www.novartis.com) on HCD.122. This CD40 target mAb is currently in Phase I studies for chronic lymphocytic leukemia and multiple myeloma (MM). Another Phase I/II trial in lymphoma is expected to begin in 2008. Given HCD.122’s dual mechanism of action around the CD40 target, Xoma believes the drug may have uses in autoimmune diseases such as RA, lupus, or MS. Perhaps Novartis will pattern the development of HCD.122 along the same path Genentech took Rituxan. If so, the duo could be sitting on a potential blockbuster product.
Besides oncology products, compounds under development for pain probably offer the next best pipeline in a product opportunity. Two firms are developing capsaicin-based products for pain indications that target the TRPV1 site. Capsaicin, the active ingredient that makes chili peppers hot, is currently used in several over-the-counter creams at low doses for the management of pain.
Anesiva (www.anesiva.com) is developing a high-dose injectable capsaicin product for postoperative surgical pain. The therapy, Adlea, has been shown in mid-stage trials to knock out noxious pain for as long as 10–12 weeks with site-specific injections during or following surgeries such as hip replacement, knee replacement, shoulder surgery, or bunionectomy. Other potential indications include interdigital neuroma and tendonitis as well as the biggest potential indication, osteoarthritis.
NeurogesX (www.neurogesx.com), on the other hand, is developing NGX-4010, a capsaicin patch for potential neuropathic pain indications such as postherpetic neuralgia (PHN) and painful diabetic neuropathy (PDN). With as little as a one-hour application, the treatment has been shown to knock out PHN and PDN pain for 8–10 weeks. NeurogesX is also developing NGX-4010 for HIV-associated distal sensory polyneuropathy.
The pain therapeutic market has been an area several large pharmaceutical companies are looking to expand into. Both Pfizer and Eli Lilly recently entered into transactions specifically focusing on TRPV1. Adlea and NGX-4010 are the two most advanced products out there. We think these drug candidates represent low FDA risk, considering capsaicin-based creams are already approved over-the-counter, and so far the data looks good.
The final area that offers the best opportunity to develop multiple indication products is in neuropsychiatry. Acadia Pharmaceuticals’ (www.acadia-pharm.com) pimavanserin is the perfect example of this type of platform research. Pimavanserin, a potent and selective 5-HT2A inverse agonist, seems to offer the right balance of dopamine (D2) receptor blockade and 5-HT2A inverse agonism such that Acadia is investigating the drug in a number of indications like in schizophrenia as an adjunctive therapy, for Parkinson’s disease psychosis (PDP), and for sleep maintenance/insomnia. The most advanced of these indications is PDP, currently in a Phase III program.
The biggest potential is in using pimavanserin as an adjunctive therapy with atypical antipsychotic agents for the treatment of schizophrenia. Acadia proved in a Phase II trial that pimavanserin, when added to a low-dose of Johnson and Johnson’s (www.jnj.com) Risperdal, is as effective as high-dose Risperdal with significantly lower side effects and improved tolerability.
This is a big opportunity in our view given the high discontinuation and switching rate among patients on atypical antipsychotics. Poly-pharmacy has become the norm in treating schizophrenia, and adding pimavanserin to any one of the blockbuster drugs on the market could work to enhance efficacy and improve tolerability. Acadia has also amassed early-stage insomnia and PDP data to help convince a large pharmaceutical partner that pimavanserin would be an excellent in-licensing option for a pipeline product.
We would avoid biotech firms that are developing me-too products. The FDA has been steadily increasing the hurdle rate for approval of products that seem to add little value over the existing market—just ask Neurocrine Biosciences.
We would also avoid companies that are developing second-chance products, or drugs that failed for one indication but are being resurrected for another. This is an approach we just don’t have confidence in no matter how much cash they have. Just ask Neurochem (www.neurochem.com) and AtheroGenics (www.atherogenics.com).
We think 2008 could remain difficult for the small-cap biotech area. The three-pronged engine that drives performance of the industry isn’t going to turn around on a dime.
William Tanner, Ph.D.
Managing director, biotechnology, Leerink Swann (www.leerink.com)
We suspect that the bark of changes wrought by the election may be worse than the actual bite. Implementation of healthcare reform measures on which some candidates campaign may be more difficult than is the general perception. That said, many investors with whom we speak generally believe that healthcare stocks, especially those of the drug developers, could struggle in the first part of the year perhaps beginning to lift as the election draws nearer amid the realization that whatever the election outcome, the impact on healthcare will not be significant over the near-to-intermediate term.
We believe the trend suggests that biotech investors have continually become more risk averse, especially since the bursting of the bubble in 2000. We wonder whether such a dynamic actually reflects a narrowing of investor interest in biotech stocks since the beginning of the decade. We recall having numerous conversations in the late 1999 and early 2000 time frame with investors highlighting a relatively poor understanding of what the companies they invested in actually did. At the extreme, we also remember investors seeking biotech stocks that had not yet moved with the thought that they would ultimately be discovered and bid up.
If there has been an exodus of nondedicated healthcare investors from the biotech sector over the past several years, we see no reason that small-cap stocks would perform well in an election year. After all, it seems logical to us that a general avoidance of healthcare stocks in 2008 because of the election may adversely position some small-cap company equities that are more difficult to value and for which a lack of catalysts and liquidity could further dampen interest.
At a pace that is difficult to predict and for targets that may not be readily identifiable, we believe pharma will continue to seek growth through acquisition of biotech companies. There has been extensive discussion about issues facing large-cap pharma companies, especially as it relates to encroaching generic competition from patent expiration and R&D pipelines lacking blockbuster products that fuel future growth.
Recently announced deals that include Eisai’s (www.eisai.com) acquisition of MGI Pharma (www.mgipharma.com) and Celgene’s offer to buy Pharmion (www.pharmion.com) highlight product-focused acquisitions. Additionally, Merck & Co.’s purchase of Sirna Therapeutics suggests that large pharma may have an appetite for promising technologies. It will be of interest to monitor the impact of emerging biotech shareholder activism as a new force that could accelerate the pace of acquisitions by driving some companies into the arms of others.
After an utterly disastrous 2007, we believe Amgen shares could be poised for a rebound in 2008, driven largely by anticipation of positive data from the experimental mAb denosumab for treating bone disorders such as postmenopausal osteoporosis or osteoporosis that is secondary to the treatment of cancer. The lack of investors desiring to show Amgen as a holding as of YE:07 could give way to renewed interest in 2008 based on a relatively compelling valuation, limited downside, and release of data for what could be a blockbuster drug in denosumab.
MEDACorp physicians with whom we speak believe the drug could provide an attractive alternative to bisphosphonate compounds and are of the opinion that denosumab should fare well even in the face of generic alendronate in early 2008.
Concern over safety of erythropoietin-stimulating agents should continue to be an overhang for the stock. It may be possible that further label restrictions could be implemented, especially pursuant to any future ODAC advisory committee meetings. MEDACorp Washington-based consultants do not believe that the Centers for Medicare & Medicaid Services will begin to strictly enforce national coverage determinations until 2Q:08. By that time, there could be better visibility as to whether the policy will be reconsidered.
Back to business as usual for Biogen Idec hopefully entails more active marketing of Tysabri even if it were to mean cannibalization of Avonex. Whether a buyer of Biogen Idec emerges remains to be seen, but we believe Biogen Idec’s MS market presence with the top-selling injectable and infused therapies as well as a pipeline of investigational MS therapies positions the company well to reshape the future MS market either as a stand-alone or as part of a larger organization.
Near term for Biogen Idec and partner Elan (www.elan.com) is the PDUFA date for Tysabri to treat moderate-to-severe Crohn’s disease. Based on the FDA advisory committee recommendation in late July 2007, we believe it likely that the agency will approve the drug. We doubt Tysabri would be used extensively for treating Crohn’s disease notwithstanding the need for alternatives to the anti-TNF agents until there is more clinical experience.
Over the next few quarters, for Biogen Idec stock to perform well, aside from speculation about being acquired, we believe investors will want to see increasing uptake of Tysabri especially as it begins to frame the reasonableness of 100,000 patients being treated with the drug in 2010.
Elan continues to be one of our top biotech picks. We believe 2008 could be a breakout year for the company. The single most important event we foresee for the stock would be release of Phase II data for the antibeta amyloid mAb bapineuzumab (AAB-001) to treat Alzheimer’s disease (AD). We understand that the last patients could go off study toward the end of 1Q:08. If so, it seems reasonable to conclude that top-line data would be released in 2Q:08, with full data presented at a major AD meeting in 2H:08, probably the International Conference on Alzheimer’s Disease.
Given the commercial opportunity that awaits an effective AD treatment, positive data from the Phase II trial would heighten enthusiasm for the drug currently in Phase III testing in the U.S.
Depending upon the robustness of the data, it is possible (although we believe the probability is low) that Elan and partner Wyeth (www.wyeth.com) could file for FDA approval with the Phase II data.
We also note that Elan stock would be impacted by continued commercial success for Tysabri to treat MS as well as the emerging Crohn’s opportunity.
Genzyme could dodge the last obvious bullet with full release of Phase II data of Amicus Therapeutics’ (www.amisuctherapeutics.com) small molecule Plicera for treating Gaucher disease in mid March. Data from the Phase II trial of Amigal, Amicus’ small molecule chaperone for treating Fabry disease, were recently released and the clinical efficacy appears to be modest at best. If those data are proxy for the effectiveness of the chaperone technology, it might not be predicted that the Plicera data would be overly encouraging. Given that Genzyme’s Cerezyme for Gaucher and Fabrazyme for Fabry will account for approximately 40% of revenues in 2007. Thus, any competitive threats to those franchises could have a significant impact.
During 1H:08, Genzyme plans to submit an sNDA for the phosphate binder Renvela for treating patients with chronic kidney disease as well as an NDA for Mozobil for stem cell mobilization. We believe investors will continue to be attracted to Genzyme stock by virtue of the valuation and the company’s financial discipline anticipated to deliver a non-GAAP EPS CAGR of 20% through 2011.
We continue to believe that Gilead Sciences is the best managed large-cap biotech company in the sector. We believe 2008 will be another solid year. The HIV franchise continues to expand and European approval of Atripla should create new commercial opportunities. Dosing convenience and emerging data as to superior clinical outcomes should position the drug well versus Combivir when used with Sustiva.
Beyond the HIV franchise, we suspect that investors will look to evidence of the commercial expansion of other businesses, particularly in the cardiopulmonary area with the continued uptake of pulmonary arterial hypertension drug Letairis and approval of astreonam lysine for treating pulmonary infection in patients with cystic fibrosis. The only negative, a minor one we believe, would be the extent to which sales of Tamiflu decline on a year-over-year basis as the result of less pandemic flu stockpiling.
Principal, Raygent Associates (www.raygent.com)
My biotech forecast of a 10% return was achieved in 2007 simply by purchasing the S&P ETF XBI, which was up more than 25%with big winners such as Biomarin, Alexion Pharmaceuticals (www.alexionpharm.com), and Cepheid (www.cepheid.com).
My specific winners from last year’s GEN Wall St. Roundup were Alnylam Pharmaceuticals (www.alnylam.com), Biogen Idec, Gilead Sciences, Cubist Pharmaceuticals (www.cubist.com), MedImmune, and Myriad Genetics. Among my losers were Amgen, Array Biopharma (www.arraybiopharma.com), and Genentech. Overall, the portfolio mix I recommended with proper weighting would be up more than 10%. My performance significantly improved with August rebalancing by adding stocks such as Biomarin, Isis Pharmaceuticals (www.isispharm.com), and Seattle Genetics (www.seattlegenetics.com).
The biotechnology sector lived up to its reputation in 2007 by being volatile and contrarian. Many of the companies that perennially outperform lagged, like Amgen, Celgene, and Genentech, and new leaders surfaced. It is important to be diversified as stock picking in mid- and small-cap sectors is quite difficult due to clinical and regulatory issues.
My index of 33 widely traded mid-cap biotech stocks was flat for the year with many losers of 35–45% due to poor clinical trial results. Broader-based ETF’s such as IBB and PBE were up only 8–10% due to underperformance of smaller cap names. The BTK was up only 6%.
Among the mutual funds, Fidelity Select Biotech achieved below-average returns of 3% with big losers such as Amgen, Genentech, and Vertex Pharmaceuticals (www.vpharm.com). The broader-based Blackrock Healthcare Fund (MDHCX) was up 20% and the Janus Global Life Sciences Fund (JAGLX) was up over 20% including larger cap, more diversified holdings but with huge biotech winners such as MGI Pharma, Onyx Pharmaceuticals, and OSI Pharmaceuticals (www.osip.com).
In summary a diversified biotechnology portfolio handily beat the S&P return of 3.5% and beat or equalled the NASDAQ return of 10%. The Russell 2000 mirrored the small- and mid-cap biotech risk with a negative return of 2%.
Despite the stock volatility and regulatory issues, I expect that biotech and more broadly healthcare will again beat the S&P 500 in 2008. Stocks will continue to be driven by new products, M&A activity, technological breakthroughs, and overall demand for new treatments. Any economic slowdown or political clouds should not have a significant macro effect on healthcare spending. Biotechnology will always attract capital despite the clinical trial risk because new therapies are in demand and the food-chain effect will drive M&A recombinations.
The outlook for 2008 must be hedged by the regulatory risk. Political activism by patients and industry may actually provoke an attitude adjustment at FDA. Many industry executives feel the agency has become too conservative to the point of discouraging breakthrough therapies particularly in cancer and other life-threatening diseases.
This overly cautious FDA position may have started with the recall of Vioxx and safety issues surrounding diabetes treatment Avandia. It has been extended, though, throughout the regulatory process to include killer diseases like cancer.
For example, recently a setback for Dendreon’s (www.dendreon.com) prostate cancer vaccine means that approval will be delayed another year, as the FDA requested more efficacy data even though the agency’s advisory panel recommended approval. In general, additional data requests and protocol requirements from the FDA will mean more clinical trials and limited growth in new product flow; only 16 NMEs were approved in 2007.
Although the NIH budget was flat for 2007 with $28.6 billion in funding, it will remain a major driver of life science R&D. In future years, with the Democrats in power, the NIH budget should increase or at least keep pace with inflation. When you add up all the NIH funding universities received with the approximately $50 billion spent on drug and diagnostics R&D, you have a perennial core funding model supporting secular growth unlike any other industry.
A hot sector to watch is the diagnostics segment. Beginning with the July 2007 “American Association of Clinical Chemistry Meeting” in San Diego there was a huge rally in diagnostic stocks. Among the winners were:
• Abaxis (www.abaxis.com): Platform blood analysis systems for human and veterinary markets
• Cepheid: Platform system for rapid molecular diagnostics; MRSA test launched
• GenProbe (www.gen-probe.com): Molecular diagnostics
• Idexx (www.idexx.com): Broad-based supplier of veterinary products
• Inverness Medical Innovations: Rapid tests for OTC and professional markets
• Myriad Genetics: Molecular diagnostics for cancer and emerging Rx pipeline
The diagnostics sector should do well again in 2008, although many of these stocks have run up considerably in 2H:08. They represent holds or should be bought on weakness. Drivers continue to be revenue growth and buyouts. Over this past year, Inverness Medical Innovations has been an aggressive buyer, and Roche (www.roche.com) signed a definitive merger agreement to take over Ventana Medical Systems (www.ventanamed.com) for $3.4 billion. Cepheid was the rocket of the group with a 3X appreciation and is a good example of institutional dominance. Celera (www.celera.com) should do well in 2008 after its breakup from Applied Biosystems (www.appliedbiosystems.com).
The life science research tools and reagents market as well has perked up recently. Invitrogen (www.invitrogen.com) is up 50%, and a good value play is Harvard Bioscience (www.harvardbioscience.com) trading at less than 2X sales.
Many biotech companies are evolving the orphan drug model, which Genzyme pioneered, to minimize competition and potential regulatory issues. Development of blockbusters such as Lipitor, Nexium, and EpoGen has become harder than ever, because competition in these large markets means greater FDA scrutiny of potential side effects.
Biomarin is the latest winner in the boutique category with FDA approval in December of Kuvan, its enzyme replacement therapy for phenylketonuria. Pricing for these niche compounds can be aggressive, with revenues of around $50,000 per year per patient. Expect to see more niche drugs for smaller diseases through licensing and M&A.
In terms of therapeutic areas with potential, one must keep an eye on the Alzheimer’s disease segment. AD affects over 5 million Americans and costs about $150 billion a year. The potential market for diagnosis and treatment is thus huge and growing.
Experimental PET scans with a radioactive dye called PIB are being used to detect amyloid plaques in the brain, thought to be a cause of the disease. Genetic tests for apolipoprotein E can also indicate the risk level for Alzheimer’s.
Treatment breakthroughs, however, have not been forthcoming. Most drugs currently on the market only alleviate symptoms without treating underlying disease. There are several companies that could show progress for treating AD. The following companies have a good clinical pipeline:
• Elan: Phase III mAb therapeutic (AAB-001) data is due out this year with Wyeth. The candidate is also in Phase II with ELND005 that breaks down neurototoxic fibrils, with Transition (TTHI) as partner.
• Epix Pharmaceuticals (www.epixmed.com): Phase II trial with PRX-03140, a small molecule 5-HT-4 receptor agonist that stimulates production of acetylcholine, reportedly showed compelling results. The company is partnering with GlaxoSmithKline.
• Myriad Genetics: Flurizan is a selective amyloid beta lowering agent (SALA) in two Phase III trials for mild Alzheimer’s disease. Phase II results had a favorable response rate.
For financing, hedge funds continue to be a driving force for stock performance. They do their homework and control their destiny with small and mid caps. Most biotech stocks have a small float, and that means the big players can move their favorite stocks. Sponsorship is the key element to stock appreciation.
Widespread gloom and doom is forecast for the economy and stocks in general. Healthcare companies, though, are less affected by the housing market and consumer spending. We can expect the healthcare area to capture an increasing share of investor funds. Life science stocks will do as well as if not better than 2007, so a 10% return is achievable with the right mix of stocks. The wild card for 2008 will be trading in stem cell stocks with scientific developments such as the use of skin cells to bypass embryonic stem cells.
My investing model is a balanced portfolio with a core position in ETF’s and large caps. Only 25% of the portfolio should go into small and mid caps.
• 25% in the S&P ETF XBI: I don’t know how S&P does it but they consistently outperform mutual funds and other ETFs.
• 50% in large-cap biotech and pharmaceuticals: I am going with a Dogs of the Dow type of strategy, with these beaten-up large-cap picks, all of which are 2007 losers—Amgen, Celgene, Genentech, and Pfizer. Growth stocks that are core long-term holds are Abbott Laboratories, Becton Dickinson, Biogen Idec, Cephalon, Elan, Genzyme, and Gilead. For greater large pharma weighting add XLV.
• 25% in small and mid-cap life science and diagnostics: Alnylam Pharmaceuticals, Cubist Pharmaceuticals, Celera, Epix Pharmaceuticals, Isis Pharmaceuticals, Martek Biosciences, Seattle Genetics, Sangamo BioSciences, Myriad Genetics, and Viropharma.
• Speculative micro caps: Gene Logic, which is now Ore Pharmaceuticals, Micromet, and Genelabs Technologies.
Biotech stocks can be erratic, so be mindful of seasonality and news hype. January frequently shows a top for small and mid caps, but there are good buying opportunities in August for a Q4 rally. Look at chart patterns especially whether stocks hold up after news.
Nola E. Masterson
Managing director, Science Futures (www.sciencefuturesinc.com)
The biotech stocks underperformed the broader market indices in 2007. The sector had continued volatility led by hedge funds, which now play a major role in the ownership of biotech stocks. The American Stock Exchange’s biotech index, which tracks several bellwether stocks, rose about 5%. The Nasdaq Stock Market’s biotech index, which covers a broader range of small- and mid-cap stocks, rose about 5.6% in 2007.
Historically, pharmaceutical companies have been defensive plays that would have done well in chaotic markets, because their earnings are somewhat immune to economic downturns. Biotech and pharma firms are now indistinguishable as a group, and the path to new molecule approval is just as difficult for big and small companies alike. The American Stock Exchange’s pharmaceutical index slipped 2.4% on the year.
It is accepted wisdom in biotech investing that prices climb as development-stage hurdles are cleared and so does a firm’s value. As risk declines, value increases. Over the last few years, however, this wisdom has been tested by a large number of companies that have not been rewarded by the market until late in the process. FDA approval to market a new drug is now needed to lure backers. In fact, even the agency’s requirement of postmarket data can influence the price of the stock.
The need for financings remains high for biotech companies. Approximately 20% of the firms burning cash in the BioWorld Stock Report universe have less than a year’s worth of operating cash on the balance sheet, and 60% have less than two years cash. Also, approximately 36% of these companies are burning around $2 million per month.
Big pharma, on the other hand, is flush with cash. The 15 companies in the Amex Pharmaceutical Index collectively hold $87 billion. Six other major companies based in Europe and Japan have an additional $58 billion in cash.
Many companies have completed stock offerings this past year, and more will be available in 2008. Introducing new institutional investors, however, did not propel the stock price. U.S.-based institutional and individual investors no longer back public development-stage biotech companies. The remaining European institutional investors are now redeeming from biotech/healthcare funds at an unprecedented rate. This makes it unlikely the current depressed prices in development-stage biotech firms will change significantly in 2008.
Secondary activity will continue to exceed IPO issuance in the coming year. Rule 415 interpretations are likely to slow private investment in public equity activity. Public biotech companies will need to access the capital markets over the next 12 months without regard to market conditions, possibly leading to market terms that deteriorate from current levels.
Strategic activity will be magnified in 2008 by modest public valuations relative to the supply of quality M&A targets having late-stage compounds validated in large clinical trials. In general, M&A-induced demand for equity products will continue. By October 2007, there was over $25 billion in equity removed from U.S. markets through cash acquisitions.
Recommendations for 2008 include:
• Amgen lost 31% during 2007, as the FDA slapped its toughest warning label on Aranesp. Also, Vecitbix failed to show increased survival in colon cancer, and the company laid off 1,500 employees. It may be a good time to accumulate, as sustained earnings will be maintained by cost-cutting measures, and the company posseses a great pipeline of clinical-stage compounds through it recent acquisitions.
The company’s principal products include Aranesp, Neulasta, Neupogen, Epogen, and Enbrel.
• Biogen Idec has four products: Avonex, Rituxan, Tysabri, and Fumaderm. Cell Therapeutics (CTI; www.cticseattle.com) has completed its acquisition of Zevalin® from Biogen Idec, giving CTI sole responsibility for marketing, sales, and development of the drug in the U.S. The drug will continue to be sold outside the United States by Bayer Schering. Zevalin was approved in 2002 to treat patients with relapsed, indolent non-Hodgkin’s lymphoma.
Biogen Idec’s gross margin is more than 91% of other companies in the biotechnology and drugs industry, which means it has more cash to spend on business operations as compared to its peers. As indicated by the operating margins, the company controls its costs and expenses better than 94% of its peers. Tysabri, the firm’s expensive treatment for MS will continue to gain momentum in 2008, and the company expects to have 100,000 patients enrolled by 2010. With the failure of Biogen Idec to find a buyer for itself, the stock has been depressed. Yet it earns over $3 a share. This stock may be a bargin if it continues to slide while looking for a buyer.
• Generex Biotechnology (www.generex.com) is an undercovered gem working in the research, development, and commercialization of drug delivery systems and technologies. It is engaged in the development of technologies and formulations of large molecule drugs delivered to the oral cavity, using a hand-held aerosol applicator. The company has products in development for metabolic and immunological diseases.
The stock has been quite volatile, as the company has made announcements that its Oral-lyn insulin product had been licensed for commercial use in India. In October, a similar license was obtained in South Africa. The company is in the process of securing approvals to market the product in various Middle Eastern countries. The glucose spray products utilizing RapidMist buccal delivery technology have been launched in retail outlets in the U.S. and Canada. Currently Oral-lyn is in Phase III testing in North America.
The number of Indians with diabetes is projected to reach 73.5 million in 2025. The direct and indirect costs of treating such patients are currently about $420 per person per year. If these costs remained the same as they are now, India’s total bill for diabetes would be about $30 billion by 2025.
As its economic wealth grows and standards of care improve, though, treatment costs are likely to rise. The U.S. spends an average $10,844 per year on each patient with diabetes. If India’s per capita expenditure rose to just one-tenth of this level, the total cost of treating all patients with diabetes would be $79.7 billion by 2025.
• Genomic Health (www.genomichealth.com) is focused on the development and commercialization of genomic-based clinical diagnostic tests for cancer. The company’s first instrument, Oncotype DX, is used for early-stage breast cancer patients to predict the likelihood of cancer recurrence, the likelihood of patient survival within 10 years of diagnosis, and the likelihood of chemotherapy benefit.
Government insurance plans, as well as many private insurers, already cover the test for early-stage breast cancer patients. The test became a standard of care this year by ASCO, which means it will be used extensively over the coming years.
Genomic Health developed Oncotype DX using a multistep approach, conducting clinical studies on tumor specimens from more than 2,600 breast cancer patients. Oncotype DX has been clinically validated for node negative (N-), estrogen receptor positive (ER+), tamoxifen-treated breast cancer patients.
Oncotype DX measures the expression of 21 genes of an individual tumor to generate a Recurrence Score result that quantifies the likelihood of recurrence and the magnitude of chemotherapy benefit for a large portion of early-stage breast cancer patients. Its genetic test can help predict when chemotherapy is likely to benefit women with breast cancer that has spread to the lymph nodes.
Researchers ran the test on hundreds of tissue samples from a breast cancer trial that began in the late 1980s. The study also used survival data from the prior trial. Results showed that the test could aid in deciding when to give chemotherapy to tamoxifen-treated, postmenopausal women with so-called estrogen receptor positive breast cancer that has invaded the lymph notes.
The company also reported positive results from a study showing that the Oncotype DX Recurrence Score provides additional prognostic information in patients with early-stage breast cancer beyond that derived from Adjuvant Online, a tool that evaluates clinical variables to help physicians and patients assess the risks and benefits of getting additional therapy after surgery.
• Gilead Sciences is a leading biopharmaceutical company that discovers, develops, and commercializes therapeutics in areas of unmet medical need. The company primarily focuses on the development and commercialization of human therapeutics for life-threatening diseases. Gilead announced European Commission approval of Atripla for treatment of HIV. Commercial launch is expected in early 2008. Gilead had a great run up in 2007 and it could see more upside as the products continue to expand market share.
Gilead’s products include Truvada, Viread, Atripla, Emtriva, Hepsera, AmBisome, Vistide, and Flolan. The company receives royalties from other drugs including Tamiflu, Macugen, and DaunoXome. Gilead has operations in North America, Europe, and Australia. In August 2006, the company acquired Corus Pharma. In November 2006, Gilead acquired Myogen and Raylo Chemicals.
• Illumina (www.illumina.com) develops manufactures and markets next-generation, life-science tools and systems for the large-scale analysis of genetic variation and biological function. The company estimates it will reach a net income between $69 million and $71 million for the year on revenues between $354 million and $358 million. The past five years have seen this stock grow 250%.
Illumina’s products and services are low-cost, high-value with good accuracy, which have, therefore, become the operating system for diagnostic tests in genomic and personalized medicine. The company provides a line of products and services that serve the sequencing, genotyping, and gene expression markets. Its customers include genomic research centers, pharmaceutical companies, academic institutions, clinical research organizations, and biotechnology companies. The company’s tools allow researchers worldwide to perform genetic tests needed to extract valuable medical information from advances in genomics and proteomics. In January 2007, Illumina completed the acquisition of Solexa, which develops and commercializes genetic analysis technologies used to perform a range of analyses including whole genome resequencing, gene expression analysis, and small RNA analysis.
• La Jolla Pharmaceutical (www.ljpc.com) is engaged in the R&D of technology and potential drugs to treat antibody-mediated diseases. The company’s lead product in development, Riquent, is designed to treat lupus renal disease by preventing or delaying renal flares. The FDA has given Riquent orphan drug designation specifically for the treatment of lupus. European regulators have granted Riquent a similar form of protection but for 10 years. The company recently raised $38 million in a secondary offering and has supporters who are willing to hold long.
Riquent was developed based on the company’s Tolerance Technology and comprises a lupus disease-specific epitope attached to a carrier platform. La Jolla Pharmaceutical has designed Riquent to suppress the production of antibodies to double-stranded deoxyribonucleic acid (dsDNA) in lupus patients without suppressing the normal function of the immune system. In March 2007, the company announced positive interim antibody results from its double-blind, placebo-controlled, randomized Phase III trial of Riquent.
• Pharmasset (www.pharmasset.com) is committed to discovering, developing, and commercializing novel drugs to treat viral infections. The company’s primary focus is on the development of oral therapeutics for the treatment of HIV, HBV, and HCV. Its R&D efforts focus on a class of compounds known as nucleoside analogs, which act to inhibit the natural enzymes required for viral replication.
Pharmasset has three product candidates, two of which it is developing alone, and one of which the company is developing with Roche (www.roche.com). The three compounds include clevudine for the treatment of HBV, Racivir for the treatment of HIV in a Phase II trial, and R-4048, a prodrug of PSI-6130 for the treatment of HCV. The company has a small market cap of $300 million, so good news and good data should help propel the stock higher. The company is sitting on approximately #65 million in cash and a big pharma partner to take on the clinical costs. This was one of the best IPOs of 2007.
The analog drug is a small chemical variation of the natural nucleoside that inhibits the activity of the enzyme leading to disruption in replication. This approach has an edge, because the natural nucleoside gives it a great starting point for developing a drug in addition to a potentially low side-effect profile and resistance to mutation. The disadvantages include limited potency and slow metabolism.
The hepatitis C program utilizes a prodrug, which means it gets metabolized into the active drug after it enters the body. The company released data in the fourth quarter showing positive Phase I data, with a 2.7 log reduction of viral load after 14 days in patients that have failed to respond to standard therapy.
• Sirtris Pharmaceuticals (www.sirtrispharma.com) is focused on discovering and developing orally available, small molecule drugs with the potential to treat diseases associated with aging, including metabolic diseases such as type 2 diabetes. The stock has recently been hit with venture selling and the value of the stock is in the low end of its range.
The company’s drug candidates are designed to mimic certain beneficial health effects of calorie restriction, without requiring a change in eating habits. The compounds do this by activating an enzyme called SIRT1, a member of a class of enzymes called sirtuins. SIRT1 activators lowered plasma glucose and improved insulin sensitivity in a preclinical model of type 2 diabetes as well as or better than sitagliptin, a DPP-4 inhibitor. In addition, in an intraperitoneal glucose tolerance test, Sirtris’ SIRT1 activator was shown to control glucose exclusion as well as sitagliptin in this preclinical model of type 2 diabetes. In contrast to DPP-4 inhibitors, which lower glucose, SIRT1 activation appears to both lower glucose in these models and also sensitize them to insulin.
• Repros Therapeutics (www.reprosrx.com) is focused on the development of new drugs to treat hormonal and reproductive system disorders. It addresses the limitations of existing medical/surgical treatments for women in particular. Repors is developing Proellex, a selective blocker of the progesterone receptor in women, for the treatment of uterine fibroids and endometriosis. Its second drug, Androxal, for secondary hypogonadism, has shown data that may extend its use into metabolic syndrome and diabetes. Based on the two drugs with multiple indications this company appears undervalued and looks to be an attractive investment opportunity for small-cap healthcare investors.
The company’s development program has shown promising safety and efficacy data for Proellex. The outcome of its type B meeting held with the FDA in November 2007, put Proellex in Phase III trials for the treatment of uterine fibroids. In addition, Repros also discussed conducting clinical trials for a new indication as a short-course treatment of anemia due to excessive menstrual bleeding associated with uterine fibroids.
During the course of the meeting, FDA agreed that Proellex, indicated as a presurgical treatment for the correction of anemia associated with excessive bleeding due to the presence of uterine fibroids, is acceptable. The agency suggested that this indication would be best considered under a separate IND application. Repros will submit an IND application to commence two Phase III studies for the indication as soon as possible.
The company also reported top-line Phase III results on Androxal demonstrating that the drug increased blood serum testosterone levels to normal physiological levels more effectively than both placebo and the leading marketed competitor, Androgel.
Wyeth is one of my shorts for 2008. The company’s shares are falling on concerns that its blockbuster heartburn drug, Protonix, could face generic competition sooner than expected. Earlier this week, Teva Pharmaceutical Industries (www.tevapharm.com) reported the launch of a generic version of Protonix, even though Wyeth’s patents are not due to expire until July 2010. Wyeth said in December 2007, that it plans to sue Teva for patent infringement. Any lost profits sustained because of the launch would make for unrest in the stock.
Benjamin J. Conway
Managing Director, Johnston Blakely & Company
M&A activity will likely continue to be the overarching market theme for 2008, influenced by an array of considerations. Perhaps the biggest impact on M&A activity in 2007 was the visibility of foreign buyers, an influence unlikely to change in 2008. Taking advantage of the eroding dollar, foreign firms made their presence felt in many of the largest life science deals of 2007: Eisai’s $3.9 billion buyout of MGI Pharma, Royal Philips Electronics’ $5.1 billion offer for Respironics, Siemens’ $7 billion takeover of Dade Behring, and AstraZeneca’s $15.6 billion acquisition of MedImmune.
The presidential election is also certain to influence the industry in 2008. With the Democrats apparently poised to do well, and healthcare reform likely to be central to their platform, companies may reconfigure business models in anticipation of change.
This year’s M&A activity will top out an already frenzied deal-making pace. M&As for 2007 were up 20% over 2006, which itself witnessed a nearly 30% increase in number of completed deals. More significantly, despite the shakeout impacting the broader market, transaction activity for 2007 in the life science sector hit its high for the year in the fourth quarter.
Perhaps equally notable was big pharma’s acquisition focus. Despite headlines lamenting a lack of pipeline depth, completed agreements suggest that broad-based core discovery technologies have the priority. And the numbers bear this out. Of the 20 or so acquisitions by big pharma over the past two years, the majority have involved not late-stage products but rather differentiated technology platforms: witness Glaxo SmithKline’s acquisition of Domantis, Merck & Co.’s buyout of GlycoFi, and Bristol Myers Squibb’s takeover of Adnexus. This deal focus may also be indicative of big pharma’s diminished impression of the intrinsic value of the vast majority of late-stage candidates.
The sector’s performance in the equity market is likely to follow the broader market, remaining tepid in the wake of the real estate downturn and credit crunch. While Q4:07 IPO activity did seem to show some resilience, other indicators suggest a more cautious investment environment. Private financings were down sharply in 2H:07, and dollars committed to life science deals down 50% from 1H:07.
Accordingly, these influences suggest perhaps wise investments might follow these themes. We continue to believe diagnostics will factor prominently in the future of healthcare and so would favor stocks such as Quidel, Inverness Medical Innovations, and Meridian Bioscience. We also like many of the pharma services companies including Covance, Pharmaceutical Product Development, Charles River Laboratories, and ICON Clinical, which we believe will benefit from current industry trends.
We would tend to stay clear of big pharma names as well as certain big biotech firms such as Eli Lilly, Wyeth, Bristol Myers Squibb, Schering Plough, Abbott Laboratories, and Amgen. While we believe these companies’ efforts to retool discovery may ultimately be rewarded, their exposure to the crosshairs of presidential politics likely leaves them vulnerable through this year.
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