Speculating in Biotech

After last week's update on stocks offering dividends and growth, it's time for a walk on the speculative side. If you are at all interested in high-risk investing, it's best to have most of your funds in relatively safe investments. For me, that's 70%-80% in large, dominant companies and small caps chosen according to strict value principles. This allows me the comfort and relative security to take more risks with the third and smaller part.

Biotech spec
Biotech drugmaking is one place where you are sure to find speculations. The drug development process is lengthy and expensive -- 10-15 years and up to $800 million per approved drug (including the cost of failures). Newer biotech drug makers race against limited time and dwindling money to secure FDA approval for a lead drug based on innovative technology. The trouble is that only 10%-20% of the drugs that enter human trials gain FDA approval, and fewer still succeed in the marketplace. If Biotech-in-a-Bottle graced the investor's shelf, it would sport skull and crossbones.

In biotech, things change in a moment. Consider yesterday's terrific news of Regeneron Pharmaceuticals' (Nasdaq: REGN  ) deal with Aventis (NYSE: AVE  ) . Then check out how dark things looked for the company just four months ago in Zeke Ashton's Little Safety in Biotechs. No one should have any illusions that investing in biotechnology is "safe" -- or that one must invest in biotech at all to make money.

Thus forewarned, let's launch today's rank biotech speculation.

Today's speculation
At the start of 2001, Abarelix was Praecis Pharmaceuticals' (Nasdaq: PRCS  ) big prospect, and analysts loved the stock. Abarelix offered hope for the second-largest killer of men: prostate cancer. By reducing the testosterone surge side effect of some treatments that actually stimulate prostate gland and cancer growth, Abarelix looked to do better than Abbott Labs' (NYSE: ABT  ) Lupron in combination with the drug Casodex.

Abarelix also had a star marketing partner. Biotech drug power Amgen (Nasdaq: AMGN  ) was on board, even though a prostate drug would be a marketing departure from its two blockbusters, Epogen and Neupogen, which boosted red and white blood cell production in kidney dialysis and chemotherapy patients.

Here's how it looked in January 2001 to BusinessWeek:

The stock's appeal is no fluke. Praecis has clinical evidence suggesting that its drug now before the Food & Drug Administration, Abarelix, might be a breakthrough for patients with prostate cancer, the second-leading cause of cancer deaths in men. The company has already signed a sweet marketing deal for the drug with Amgen, the biggest biotech company in the world. The analysts who cover Praecis all have buy ratings on the stock. Alex To of Credit Suisse First Boston says Praecis' Abarelix has the 'key appeal of the investment thesis,' a fancy way of saying it meets all the criteria for solid growth.

But the excellent article goes on to cite the numerous real doubts about the drug's benefits and potential market -- doubts apparently dispelled for some large investors when the FDA not only accepted the Abarelix new drug application (NDA) soon thereafter, but granted priority review, which meant a commitment to a decision within six months. Though Praecis had cancelled its 1998 IPO and finally limped out in April 2000, raising $80 million after a 40% price cut, it now easily collected $178 million in a February 2001 secondary offering.

Amgen unhinges
A decision came all right, but not a good one. On June 12, 2001, the FDA ruled that the application was inadequate for approval. Experts interpreted this to mean more follow-up data on patients would be necessary. But that meant more money and time before any possible Abarelix revenues. Praecis stock dropped 30%.

Facing the expense and at least another year delay, if not worse, Amgen apparently determined that the drug's prospects were not worth the continued expense and risk. It returned all rights to Praecis the following September. For Praecis stockholders, the FDA was a setback, but Amgen's lack of confidence dealt the death blow, a 61% cliff fall from $9.45 to $3.67 in five trading days. Praecis shares trended down to a low of $2.20 a year later.

It's all relative
But "not worth it" for Amgen could still be gold for a little drug maker with $250 million in cash, only $33 million in debt, and a burn rate slated to be $55 million in 2001. Praecis could fund perhaps another four years of Plenaxis and the rest of its pipeline's development for the chance at a pot of gold.

In December 2001, the company announced that it would proceed with Plenaxis development and 14 months later, resubmitted the NDA to the FDA. Company execs must have danced the polka when the FDA accepted the NDA in March 2003 and committed to completing review by August 27. They may have stopped dancing in July when they said the FDA extended the Plenaxis "action date" 90 days from August 27, to review new data and "work with the company to arrive at the appropriate risk management program for the drug," but not for long. Praecis said that it expected approval for a "defined sub-population of advanced cancer patients by November 2003" and to launch the drug by the first quarter of 2004.

Since its fall 2002 low of $2.20, the stock has slowly risen with hopes for the renewed application and closed yesterday at $6.98.

Biotech gamble
We are in the realm of speculation here, so I won't -- and can't -- perform a detailed valuation analysis that would pass the straight-face test. Plenaxis is Praecis' only near-term potential for revenue, so this is really an either/or situation. If approved, and even if the wild-eyed former projections of $500 million-$1 billion in Plenaxis sales never materialize, it doesn't take much to boost a company with trailing-12-month cash burn -- negative free cash flow -- of $71 million.

Ron Garren, M.D., editor of biotechInsight and a consultant to New York's InvestBio, thinks the chances of approval are excellent and values the shares 40%-65% higher. I recently took the calculated risk -- all right, gamble -- with a very small 2% of my portfolio, finding the risk of Plenaxis disapproval or marketing failure favorably balanced with the possible reward of a near-term double or more. The downside risk is significant, but despite its burn rate, and with net cash of $2.58 a share, bad news won't send Praecis shares to zero. At least not immediately.

Sure, 20-20 hindsight would say buy at $2.20, but I'm not going to say something stupid, like "for a good speculation, buy any biotech when its stock tanks on bad FDA news." That's ridiculous. Some do well later, some don't, and it's certain doom to ignore a specific drug's prospects, company finances and management, and a litany of other important factors for avoiding investment disaster and determining possibility of success.

Yet, I can't deny that for a huge number of companies, it has been a rewarding speculation to buy biotech drug stocks soon after some setback for a single lead drug candidate obliterates the share price. Think Scios after Natrecor -- later bought out by Johnson & Johnson (NYSE: JNJ  ) , ImClone (Nasdaq: IMCL  ) after Erbitux (though that saga continues), Regeneron, and perhaps now Praecis. Fine. But let's just not pretend it's anything remotely like investing with a margin of safety.

Thanks for reading. I'm always happy to hear from you at TomJ@Fool.com, though I cannot give individual investment advice. For all things biotechnology, enjoy our Biotech discussion board.

Have a most Foolish week!

Writer and Senior AnalystTom Jacobs (TMF Tom9) is the old man of The Motley Fool analyst team (as hisbio reveals), but they still call him "dude." This Tom owns shares of Praecis Pharmaceuticals as well as other companies listed in hisprofile. The Motley Fool has an industry-leadingdisclosure policy.


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