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Feature Articles : 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

Survival of the fittest has governed life on Earth since the beginning of time, but it was first defined only 150 years ago by Charles Darwin. Today, it couldn’t be any more obviously at play, with economic turmoil necessitating a shakedown in the biotechnology sector.

Biotech industry experts agree that financing will be tough in the short term. Smaller companies, in particular, will need to comb through their pipelines and rethink strategies. Additionally, political currents will buoy research and follow-on biologics, but could have an impact on big pharma and drug pricing. 

GEN asked biotech analysts to predict what’s in store for the biotech industry in terms of the new political regime, as well as the current financial distress, and to provide some survival tips. Our respondents were Benjamin J. Conway, managing director with Johnston Blakely & Company, Nola E. Masterson, managing director of Science Futures, Viren Mehta, managing member of Mehta Partners, Jason Napodano, senior biotechnology analyst at Zacks Investment Research, Rod Raynovich, principal at Raygent Associates, and John L. Sullivan, director of research at Leerink Swann.

GEN: What does a company need to do to survive the current economic turmoil?

Conway: Above all else, pragmatic leadership—this plus strategic agility and dexterous implementation capabilities. Companies caught dwelling on scenarios of the past, hoping for a near-term return to the previous status quo will likely be the first to succumb to the current economic maladies.

Masterson: For companies to survive the current recession they should take a tip from Charles Darwin who wrote in The Origin of Species: “It is not the strongest species that survive or the most intelligent, but the ones who are most responsive to change.” Adverse macroeconomic conditions reduce the survival chances of businesses in the same way that bad weather limits biodiversity. Darwin, who cleared a patch of soil to observe its colonization by native plants, wrote: “Periodic seasons of extreme cold or drought seem to be the most effective of all checks on the number of species.”

Biotech companies will be caught up in similar circumstances because many are in a weakened state to begin with. The weakest will succumb first. Many companies that have weak balance sheets, poor patent positions, and few products will be forced to close their doors and sell their assets at fire-sale prices. Government grant money may help some companies maintain their science-based endeavors at a crawl, and a reduced head-count will certainly be seen in many companies.

A conscious strategy will win the day as companies learn to adapt and provide innovations that give them dominance within their environment. In Darwin’s book, he writes of the relative profitability of adaptations while describing habitats as economies.

Darwin’s great insight was that species retain randomly occurring new features that improve their survival—hence, evolution.

The biotech community was birthed in the late 70s on the back of several very important breakthroughs in biological tools. Thirty years later, the tools needed to provide new evolutionary breakthroughs were most likely sitting in the minds of computer scientists who understand genetics. We need a quantum leap now to create products and services that don’t exist.

Traditional sales and marketing approaches will need to be modified to focus on the healthcare consumer.  Personalized medicine is now embraced as significant by pharma, but it does not support the blockbuster model of the last 25 years. If the industry fails to change, it will become history and will be absorbed into the larger companies that have the staying power to withstand the worst markets in several decades. Innovation will be necessary to attract capital, partnerships, and create products.

Novartis (NVS) and Roche (ROG) exemplify the resilience of the European pharmaceutical sector in turbulent times. Pricing, product, and patents remain three very relevant issues, which will be watched carefully by analysts. Their appeal comes from their strong product pipelines, cost controls, and cuts that were necessary. Of course, Novartis has the Chiron pipeline and Roche will likely soon have the Genentech (DNA) cancer franchise—evolution again.

Mehta: Get closer to one’s knitting behind a clear management vision and best people, including a recognition that we will get paid a fair price for the value our products add and no longer just any price that the market has borne to date! 

At the same time, management teams need to develop globally integrated strategies with a more complete and perhaps a bit bolder vision of the way the world may evolve over the horizon when a company’s products mature. For example, a typical collaboration or partnership should not underestimate the potential opportunities outside the U.S., including the emerging markets. Similarly, cost structures should be refined with a fuller understanding of the benefits to be derived from global R&D, as well as manufacturing resources.  Such insights can redefine the company strategy and improve the probability of success. 

Last, but perhaps most important, is the need for a renewed focus on truly new scientific opportunities for sustainable value creation. Though near-term life-cycle management opportunities should not be overlooked, they should be understood as such for their one-time and limited value creation potential and the greater risk they face from external value-police.

Sullivan: Remember, large life science tools companies like lab suppliers have reasonably stable revenue bases and usually carry little financial leverage. For them, survival is not an issue in today’s economy, it’s just a matter of how to best weather this storm. Size is an advantage; customers will often decide to consolidate their business with large vendors who can still afford to develop new products and service their clients.

We’d advise these larger tools companies to stick to their long-term growth plans, but take care to be sufficiently conservative in projecting their business and in  controlling their discretionary costs. We would also encourage these companies to be prepared to take advantage of acquisition opportunities that may present themselves as their smaller competitors are pressured.

Finally, those life science tools companies that sell capital equipment are naturally going to have to be more careful and conservative in their spending than companies that sell consumable products; capital equipment is especially difficult to sell in today’s uncertain environment.

  For small and unprofitable life sciences companies, including those emerging biotechnology companies with their most advanced drug candidates in preclinical or clinical testing, the story is decidedly more challenging. These companies have to cut costs dramatically while looking for opportunities to extend their financial flexibility through licensing or partnering activities.

Management teams from these companies must make decisions to ensure the survival of the company. Cutting early-stage discovery programs to continue to feed development activities closer to monetization is one likely necessity, and partnering attractive drug candidates to cut financial risk is another.

GEN: Are some firms better prepared than others to ride out this crisis based on their technology, products, services, therapeutic focus, or business model?

Conway: In light of current industry dynamics, we believe that the companies best positioned to weather this storm are not so much those with future potential, but those with sound current fundamentals—i.e., strong product franchises in therapeutic areas with well-defined clinical need that are supported by strong balance sheets.

Masterson: Data, data, and more data will drive the successful companies. FDA cannot approve products that do not perform better than what is already on the market. Human data is better than animal data, and data compared with existing approved drugs will convince more rapidly than NCEs that have no side-effect history.

Companies with large capital reserves and multiple products will survive with cost cutting. Innovative ideas with superior management teams may find investment money if it is the perfect storm.

Products that focus on the baby boomers will have a market in the coming years. This includes orthopedic products for hips and knees, and cosmetic lasers and injectable products. Wound-healing products and antivirals will continue to find market acceptance once they clear FDA. Cancer diagnostics and cancer fighting agents will continue to be used, and their market will grow with the boomers.

The orphan drug strategy seems to help, and we continue to like Genomic Health (GHDX) and Genentech (DNA) as long as it stays independent. Women’s health is an area ripe for growth for products such as Merck & Co.’s (MRK) Gardasil and Repros Therapeutics’ (RPRX) Proellex. The better financed the company is, the better chance it has to get the data and get to market. Companies with less than a year in cash will be in a vulnerable position.

Crucell (CRXL) is attractive because it is one of the few remaining independent vaccine makers following takeovers in recent years of some of its competitors. Whether the early-stage negotiations with Wyeth pan out or not, vaccine innovation remains an attractive area of research, globally.

Other areas of M&A activity to look for over the next 12 months include diagnostics and antiaging technologies. We continue to look for consumer medicine plays in the cosmetic market that are not dependent on reimbursement.

Mehta: The attributes noted above are known to most but not consistently practiced by many.  A diverse range of opportunities exist that should enable a number of companies to be successful within their respective therapeutic, product, and service focus. Though not surprisingly, the greatest value will be created by retaining an active role both in innovation, as well as in marketing.  Success of such a broad strategy calls for staying power over the long haul through research, a broad clinical development program, and aggressive, yet prudent (and hopefully globally integrated) marketing—the staying power that will be fully tested during this economic cycle.

Raynovich: We are still in a bear market for biotechnology due to a lack of speculative funding from both VCs and investment banks syndicating IPOs. As a result, we have a more bifurcated market with larger caps stable or growing and smaller caps in a funk. There are no megathemes like genomics or lifestyle drugs that can spur momentum. Nonetheless, there is plenty of money on the sidelines, which will drive companies with compelling products and technology.

 

Sullivan: Large life science tools companies remain well positioned to survive today’s challenging economic and funding environment. For large tools companies, emerging biotech customers often comprise just 10% of revenues, with more reliable NIH-funded labs and pharma companies comprising much larger shares of the revenue base.

Contract research organizations (CROs) also seem to me to be well positioned to ride out today’s difficult economy. Drug companies comprise the largest share of the customer base for large CROs, and pharmas remain well funded. Even their biotechnology company customers likely have to continue to spend on drug development.

GEN: What do you see, if any, as bright spots in the life sciences industry today?

Conway: Industry pundits have long argued that the number of companies populating the biotechnology sector is unsustainable. The sector has too many companies with too little cash that are too light on management, and with too few products to remain viable independent entities.  A sector shakeout, they proclaimed, was all but inevitable. Yet, to this point, consolidation and rationalization has never emerged as a dominant theme directing the industry's future.

That seems poised to change.  Given the magnitude of the current global economic woes, the day of reckoning may be drawing near. We believe this will ultimately be a good thing for the industry, as resources will gravitate toward those companies with the best chances for success, accelerating their achievements.

Accordingly, we believe that 2009 will be dominated by M&A activity not necessarily out of want but out of need—if not sheer desperation. This process will lead to the rationalization needed to bolster industry efficiency and productivity.

Masterson: The use of generics will accelerate, and pharmaceutical companies will have to respond by increasing efficiencies in their workforce and production. Pharmaceutical companies that can bring technological innovation into the R&D process will realize competitive advantage. Big pharma will seek out ways to increase revenues by merging with smaller life science companies.

The area of childhood obesity and diabetes should see innovation and new products this year, because the patient population is growing rapidly.

Research will focus on how genetics can affect pharmaceuticals and enable personalized medicine. Regulations regarding genetics at a state and federal level will continue to develop. Financial distress can be an ideal climate for innovation, as organizations learn to do more with less.

Mehta: Two bright spots offer opportunities:  Science over the longer term and valuations in the near term.

Science: As poor as the new product flow has been, the pot continues to churn in what must be appreciated as the journey of the century—where patience is a virtue and periodic product successes will create large values. Yes, investors must produce better returns sooner, and the bright spots may not yield superior share price performance quickly.  But the new science should produce improving flow of innovative therapeutics that will become palpable over the next three to ten years.

Nearer term, is the usual bottom-fishing opportunity as investors once again have thrown the baby out with the bath water.  There are some promising diamonds in the rough to be found in this valuation free fall.

Raynovich: Negative articles and hand- wringing abound regarding the biotech market, citing clinical trial failures, political concerns, a dearth of funding, and a breakdown of the business model. But, these critics miss the point that the universe of companies and universities in the biomedical sector are trading and investing in R&D programs that result in drugs, diagnostics, and services. Yes, R&D may be becoming less efficient with fewer drug approvals (only 18 in 2008) and cost may be increasing, but the market will always be there because of growing demand from consumers and the core engine—NIH and university research.

Healthcare spending grew at 6% in 2007 for a total of $2.2 trillion, and that is the available market for innovation with improved products and services. And, what always remains as the key driver is the food-chain effect, where licensing and acquisitions make the market.

Sullivan: Even in today’s tough economy, technologies for high-density genetic analysis remain in strong demand. Next-generation DNA sequencing technologies are still seen as offering useful incremental information to disease-state researchers. Technologies for cellular analysis are, likewise, of increasing interest to biomedical researchers.

GEN: What are your predictions in light of the new political regime in relation to follow-on biologics, stem cell research, and healthcare in general?

Conway: Ultimately, politics will have little to do with the industry's future. Greater forces are at work, and the numbers would seem to bear this conclusion out.

As reported by BIO, of the 370 or so public biotech companies, more than one-quarter have less than six months’ cash on hand and 40% have less than 12 months’ cash. Without a dramatic near-term turn in the markets, many of these companies are going to find themselves with limited degrees of freedom. Pragmatic companies are likely being proactive in accelerating discussions with potential acquirors. The shakeout is likely to be as pronounced, if not more so, in the private sector. We believe that there will be significant portfolio prioritizing and pruning, with venture investors ready to jettison all but the best of the lot. And this may be the optimistic scenario.

Masterson: Follow-on biologics are not generics. It is impossible to copy biologics perfectly, and at best, they are similar, hence in Europe they are called biosimilars. The FDA has handled only extremely small biologics like human-made insulin and human growth hormone as if they were conventional generics. They have barred other follow-on biologics from entering the market. This may change, but in the interest of safety and continued innovation, Congress must move forward with care.

Follow-on biologics must have their own distinct names because they could cause unexpected reactions. A biologic can combine several patents, one on the giant molecule itself and numerous others on the process for creating that molecule. Process patents are highly susceptible to challenge in court. Data exclusivity becomes very important for biologics.

President Obama and Democratic leaders have made the repealing of the Bush administration restrictions on embryonic stem cell research a priority. They have yet to determine if Obama should quickly put his stamp on the issue by way of presidential directive or if Congress should write a permanent policy into statute.

The debate is not academic. Democrats who oppose abortion say that such a legislative fight holds the potential to get the year off to a difficult beginning, even though the outcome is certain, given solid majorities in both the House and the Senate for expanded embryonic stem cell research.

Prevention will get a boost from drug makers and regulators in 2009. Pharmaceutical and biotechnology companies that can focus on preventive vaccines and immunizations will be able to capitalize on these public health trends. Pressure to spend more government funding on prevention could reduce availability of dollars for treating diseases.

During 2009, the health industry may prove to be a source of profitable growth during an economic malaise. As new players continue to enter the healthcare market and new technologies develop, the next frontier in healthcare could be hidden from view. In addition, heightened focus by regulators will need to be monitored carefully, as reducing healthcare costs are viewed as a way to stimulate the economy.

Mehta: Perpetual monopoly is incompatible with intellectual property rights.  As tempting as such notions of perpetual monopoly are, which drive some industry managers’ short-sighted actions, biosimilars must become an integral part of the industry’s offerings—as is illustrated by the plans by Merck (MRK), Lilly (LLY), and other global pharma (likely to be joined by some of the mature biotech companies).  All stakeholders have learned a great deal from the small molecule generics journey. 

The only new factor is the need to characterize a biological when made at different manufacturing plants. Rapid progress on this front is under way, especially when one realizes that patented new biologics are usually made at multiple plants and the essential skills are transferrable, and increasingly, not patented. 

In short, biosimilars or follow-on biologics for the first-generation biologics are likely to be widely used around the world by 2014 when the key patents expire, and most of the key monoclonal antibody patents expire around 2019.

Stem cell and such other next-frontier science should also advance noticeably over the next decade, with first-generation products nearing the market, if not already on the market. Here again, we should watch active R&D initiatives from around the world and not just from the industrialized nations. This is the journey for this century, not just this generation, and these innovations are poised to transform the way we live—not just the way medicine is practiced.

In the near term, the healthcare system risks falling victim to the bigger challenge of the turmoil in the financial industry, as many experts fear that there simply are not enough resources to do both. However, the Obama healthcare team certainly has the support and the goodwill to advance healthcare reform in parallel with other serious challenges we face, and we should be prepared for these fundamental changes sooner rather than later. 

From evidence-based reimbursement to ensuring healthcare for everyone means that our industry must redouble its efforts to ensure that access to its products is available to all patients who need them, and it must be prepared to support the pricing versus the value that its products add. 

These challenges of uniform access to cost-effective products and smarter development of the new science are the two fundamental challenges, and therefore, the two key opportunities for managements and investors alike.

Napodano: An issue that biotech investors should be aware of in 2009 is the recent victory and appointment of Rep. Henry Waxman (D-CA) as Chairman of the Energy and Commerce Committee. Waxman’s taking over the leadership position on the Energy and Commerce Committee has potential big implications for the healthcare industry. The Hatch-Waxman bill put into law in 1984 essentially created the generic drug industry as we know it today.

Over the past 20-plus years Waxman has argued aggressively for cheaper drug pricing and nationalized healthcare. Both would be a significant negative headwind for many companies in our universe.

Biotechnology companies now seem squarely in Waxman’s crosshairs with his aggressive push for follow-on biologics. His argument for zero years of patent exclusivity for new biologic applications seems absurd and it has little chance of passing, but it does seem likely that we are heading toward a generic biologic industry much like the generic small molecule industry Waxman helped create back in 1984.

We’ll leave the merits of nationalized healthcare or Waxman’s voting record to Washington, but it is clear that mandating cheaper drug prices for Medicare Part-D and allowing follow-on biologics in as little as zero years after approval is a negative for biotechnology stocks. Additionally, expanding government-run insurance programs with big subsidies, all the while limiting the ability for private insurance from small business and citizens is also a significant headwind for the industry. The money needs to come from somewhere, be it higher taxes, lower prices, or a combination of both.

Raynovich: In my recent Point of View article in the January 1, 2009 GEN, I commented on the political backdrop for healthcare. Follow- on biologics  are coming, but it is a longer-term issue for selected companies and may be an investment opportunity for niche companies focused in this area partnered with larger pharmaceutical companies. National healthcare will be a focus; also expect proposals to try to find money in the 20% share of the insurance companies’ take. The Dems are likely to be tougher on blockbuster drug pricing and big pharma because that is where government spending looms large. The Medicare Drug benefit cost $47.6 billion in 2007. Overall, the political environment should favor biotech, as the NIH’s $28 billion research budget should be expanded with new champions (Eric Lander and Harold Varmus), and stem cell research controls are lessened.

Sullivan: With key Washington leaders marching in lockstep toward legislative reform that aims to make healthcare more available and affordable, we expect that healthcare will grow in terms of its share of the U.S. economy in 2009 and 2010.

Regarding stem cells, it is no secret that the Obama administration will have a more constructive view of such research than its predecessor. As a result, we expect that U.S. disease-state researchers will hurry to integrate stem cell research into their work. Finally, with the legislative father of the generic drug industry, Waxman, holding a much more powerful role in today’s Washington, we expect that follow-on biologics will have a more straightforward path to commercialization.

GEN: Do you have any other comments on biotech investing?

Conway: Of some 61 companies to come (and remain) public since 2000, only seven are currently above their IPO prices.  As such, even if there were a turn in general market sentiment, absent some major change in industry paradigm, it seems highly unlikely that investors will come flocking back to biotechnology en masse any time soon. With the public markets likely to remain all but closed as a funding source, and with big pharma virtually blind to all save marketed or near-to-market products, the vast majority of private companies only have their venture investors to fall back on, and it is unlikely the firms have the funding to support these companies’ product-development efforts through to market.

Napodano: In 2008 we saw a pretty significant split between the performance of large-cap pharmaceutical and biotechnology names versus their small-cap brethren.  It was a horrible second half of the year for any company that released subpar clinical trial results or attempted to raise cash. The capital-raising environment continues to remain extremely difficult given the tight credit markets and low stock prices, so we are recommending investors focus on larger-cap, financially secure names. However, there are a few smaller names that could represent excellent investments in 2009.

Raynovich: Despite one of the worst years for investors since the Depression with market indices down 40%, biotech stocks provided a safe haven from the leveraged credit cowboys in 2008 with major bio ETF’s down only about 10%. My balanced biotech portfolio with 75% in large caps and ETF’s was up 3–9% in 2008 depending upon weighting of mid-cap winners such as Cubist Pharmaceuticals (CBST), Myriad Genetics (MYGN), and ViroPharma (VPHM). If you want to look back to more difficult times, look at 2002 and the early 90s.

As a result of the global meltdown and avoidance of risk, hedge funds, mutual funds, and speculative investors sold biotech and pharma stocks to raise cash. Many high-flying biotech stocks did worse as the hedge funds that created the momentum were forced to take profits as their leverage was cut back.

At the recent Rodman and Renshaw Investment Conference in November, the buzzword was cash runway as smaller-cap companies with weak balance sheets may need to retrench until new money comes back into the market. Nonetheless, Rodman continues to fund PIPES (private investment in public equity) in the biotechnology sector, as technology is progressing, and deals are being done.

Other than the large caps, the market is currently skewed toward traders, so investors should be aware of seasonality and volatility that masks longer-term trends. Despite other opinions, my experience is that Q1 is not the best time to add new positions but Q3 is, because you want to position yourself for a stronger Q4. Moreover an early Q1 rally can be over by February 1.

The retail trade and investment banks are not major participants as in previous years, so hedge funds and institutional investors are the drivers of stock performance. Lately, pundits on financial news channels have been offering positive commentary on the biotech sector, which can be a contrarian indicator.

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.