Grab the Right Biotech IPOs

For the last couple of years, the market for initial public offerings of biotechs had been shut tight, locked, and barred. But what started as a small crack last year has grown wider over the last couple of months, as the capital markets have gotten strong enough to support many more entrants.

Let's face it: IPOs are exciting. The idea of getting in on the ground floor of the next Dendreon (Nasdaq: DNDN  ) or Celgene (Nasdaq: CELG  ) is enticing. But finding that winner isn't as easy as hitting the "buy" button on each new ticker. At this point, the post-IPO window has a few companies wondering whether they should have waited a while before heading into the public markets.

Company

IPO Date

IPO price

Yesterday's Closing Price

Increase (Decrease)

Alimera Sciences

4/22/10

$11.00

$10.95

(0.5%)

AVEO Pharmaceuticals

3/12/10

$9.00

$9.31

3.4%

Anthera Pharmaceuticals

3/1/10

$7.00

$7.02

0.3%

Ironwood Pharmaceuticals (Nasdaq: IRWD  )

2/2/10

$11.25

$13.18

17.2%

China Nuokang Bio-Pharmaceutical

12/10/09

$9.00

$6.80

(24.4%)

Omeros

10/8/09

$10.00

$6.15

(38.5%)

Talecris Biotherapeutics

10/1/09

$19.00

$18.59

(2.2%)

Cumberland Pharmaceuticals (Nasdaq: CPIX  )

8/10/09

$17.00

$10.56

(37.9%)

Source: The Burrill Report and Capital IQ, a division of Standard & Poor's.

One of these stocks is not like the others
Do you see it in the table? It's not that hard to miss. Ironwood is the only contender with a decent post-IPO return.

There doesn't seem to be any news to explain the nice return since its IPO in February; investors just appear more interested in Ironwood's lead drug, linaclotide, than they were previously. And with good reason.

The drug, which is partnered with Forest Labs (NYSE: FRX  ) , has already passed two phase 3 clinical trials in patients with chronic constipation. That should give investors confidence that the drug will pass its current tests, for patients with constipation associated with irritable bowel syndrome, and get on the market soon thereafter.

Ironwood is a drug developer, but it's not a particularly risky one, and investors seem to like that.

Another slam dunk … except it wasn't
Cumberland seemed like a safe bet. When the company IPO'd last summer, it already had three FDA approved drugs: an antidote for overdoses of acetaminophen, the active ingredient in Johnson & Johnson's (NYSE: JNJ  ) Tylenol, which is especially noteworthy after J&J had to change its packaging to warn for that risk; an intravenous form of ibuprofen, the active ingredient in Pfizer's Advil; and Kristalose, a laxative.

With Cumberland, no one factor seems responsible for the damage to the share price; investors just haven't been able to get excited about the drug company. With just $0.01 per share in profits in the fourth quarter, down from the year before, who can blame them?

To increase its share price, Cumberland needs to create a buzz. Increasing profits seems like the easiest way to accomplish that.

Let someone else find the homeruns
David Gardner's third sign of a Rule Breaker -- strong past price appreciation -- is especially useful when looking at post-IPO drug companies. Raising money is an integral part of drug development, and it doesn't stop when a company sells shares at its IPO. Unfortunately, secondary offerings are a necessary evil of the business.

It's much easier to raise those funds if your stock has risen. For one thing, investors are more likely to buy the newly-offered shares. More importantly, at a higher price, current shareholders see less dilution from the secondary offering.

Instead of looking to buy on the day a stock debuts, consider putting the stock on your watch list and waiting for shares to increase. Sure, you'll miss some price appreciation, but the increase in value can actually decrease the risk in owning the drugmaker. Avoiding the Cumberlands is just as important as finding the Ironwoods.

Motley Fool Rule Breakers is always on the hunt for hot drug stocks and other cutting-edge picks. Click here to see all of our latest discoveries with a free 30-day trial subscription.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is a recommendation of the Inside Value newsletter. Johnson & Johnson is an Income Investor selection, and the Motley Fool Options recommended buying calls on the stock. The Fool has a disclosure policy.


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