1 Number All Biotech Investors Need to Watch

In the world of biotech investing, stocks can either soar or plummet depending on clinical trial results. This industry is filled with small-cap companies working toward approval from the Food and Drug Administration and spending millions of dollars on clinical development. Sadly, many run out of cash before they get the chance to commercialize their potentially lucrative drugs.

It's not easy to know when to buy and when to sell in this sector, but investors can avoid losing out by closely monitoring one number: the cash burn rate.

Before we get into how to calculate burn rate and how it relates to five up-and-coming biotech stocks -- including MannKind (Nasdaq: MNKD  ) , Amarin  (Nasdaq: AMRN  ) , Dynavax  (Nasdaq: DVAX  ) , Geron (Nasdaq: GERN  ) , Sarepta  (Nasdaq: SRPT  )  -- let's take a quick look at a case study.

A cautionary tale
EPIX Pharmaceuticals had all the trappings of an ideal growth stock in 2006. It had just merged with Predix Pharmaceuticals and enriched its pipeline with a slew of late-stage developmental drugs for the treatment of hypertension, depression, and Alzheimer's disease.

Three years -- and millions of dollars in R&D expenses -- later, EPIX sent investors a frightening SOS in what would be its final quarterly earnings report:

To continue operations beyond August 2009, we must raise additional capital. If we are unable to obtain such additional funds, we will not be able to sustain our operations and would be required to cease operations and/or seek bankruptcy protection.

Despite getting a product to market and having three drugs in clinical trials, EPIX struggled to generate revenue and build up enough cash to keep the company going. It extinguished its Bunsen burners, auctioned off its intellectual property, and liquidated its remaining assets in 2009.

Unfortunately, the pharmaceutical and biotechnology industries are littered with stories like that of EPIX. This should be a reminder that all health care investors need to keep an eye on how much money the companies in their portfolio are spending each quarter.

How to calculate burn rate
The burn rate, sometimes referred to as negative cash flow, tells you how much money a company is spending. Companies with a high burn rate, like biotechs that don't yet have a drug on the market, typically aren't generating any revenue to offset expenses.

There are different ways to determine a company's burn rate, but a simple back-of-the-envelope approach is to add capital expenditures to the negative cash flow from operating activities. You can readily find both numbers for free on websites like Yahoo! Finance or in the financial statements of a company's SEC filings.

As an example, let's calculate the burn rate for MannKind, which is developing an inhalable insulin drug called Afrezza. Its negative cash flow was around $25 million last quarter, and it had $125,000 in capital expenditures. Given these numbers, the company's burn rate during the last quarter was about $25.1 million, or $8.4 million per month.

How much gas is left in the tank?
EPIX went bust because it didn't have enough cash left in the bank to cover its operating expenses. It looks like MannKind could be heading down the same road; it reported a total of $32 million in cash, cash equivalents, and short-term investments on its balance sheet last quarter. At this rate, the company should theoretically run low on money by the third or fourth quarter of this year.

Trying not to get burned
Cash burn is a quick way to feel the pulse of your stock, but it doesn't tell the whole story. In the case of MannKind, for instance, the company can borrow several million dollars as part of a loan agreement it has with The Mann Group. It may also issue $500 million in a variety of securities, and, while this could dilute current shareholders, this should enable the company to finish its Afrezza trials.

Let's take a look at the burn rates of some other prominent biotech companies that have drugs that have either been approved or are in clinical development:

Company

Monthly Burn Rate in millions (MRQ)

Cash on hand in millions (MRQ)

Expenses coverage (months)

Amarin

$7.2

$250.3

~35

Dynavax

$5.4

$160.2

~30

Geron

$4.7

$119.0

~25

Sarepta

$1.9

$24.5

~13

Source: Yahoo! Finance. Cash on hand = cash, cash equivalents, and short-term investments. MRQ = most recent quarter.

Amarin seems to be in the best shape here. Its hypertriglyceridemia drug, Vascepa, was recently approved by the FDA. Amarin is still unsure if it'll market the drug independently or link up with a larger pharmaceutical company, but it has plenty of cash to keep operations going while it sorts out its commercial approach.

Dynavax's Hepatitis B vaccine is currently under review at the FDA, and the company has enough money available to carry on well past the decision date in late February. In fact, it can operate for another two and a half years at the current burn rate. If the vaccine is approved, its money can be used for commercialization. If the FDA issues a rejection, however, Dynavax may have to invest in more clinical development.

Geron can carry on for another two years based on the financial information from last quarter, but it took a massive blow when one of its four imetelstat cancer drug trials was canceled in September. The company also stated that a second trial won't progress to phase 3 trials. Shares plunged on this news, and we'll have to wait and see the results from the company's other studies to determine the future of this stock.

Sarepta seems to be the most vulnerable of the bunch in terms of cash burn, but the stock jumped almost 200% in a single day after releasing positive data from its eteplirsen Duchenne muscular dystrophy drug trial. The company has about a year of cash left based on last quarter's data, but this week's promising results may attract more investors.

Foolish roundup
Unfortunately, there is no magic formula for biotech investors to follow. A company that has a low burn rate could tank in the long term if its clinical trials fail, while a company with a high burn rate can recover with promising drug results or by triggering a milestone payment from a strategic partner. However, as part of your investment analysis, it's essential to monitor cash burn every quarter, watch for any moves that could dilute your holdings, and avoid companies that could end up in the same unfortunate situation as EPIX.

Biotech companies, while some of the riskiest investments on the market, can also be exciting to watch. These companies are working at the cutting-edge of science and pioneering new drugs that can change the face of medicine. The Motley Fool's analysts have been watching other technological breakthroughs, and have identified a stock they think will jumpstart The Next Trillion-Dollar Revolution. Read our analysts' free report today by clicking here now.

Max Macaluso, Ph.D. has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend MannKind. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (11)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 06, 2012, at 12:16 PM, ProfessorBrains wrote:

    A quick check of Sarepta's recent 8k's will reveal that their cash position is more likely $78+million.

    Prior to the most recent run-up, they filed for a $40M ATM. If they did not exercise it in the $15/shr range, they most assuredly have done so in the $40 range. In addition, there are over $14million in deep-in-the-money ($14 or less strike) outstanding warrants due to expire before the end of the year. It is reasonable to assume that if these have not already been exercised, they will be shortly.

    So with a small effort of Due Diligence, we can see that Sarepta has not 13, but 41 months of cash burn, moving it from "the most vulnerable in the bunch" to the healthiest, having "plenty of cash to keep operations going while it sorts out its" choice of partner (to estimate the potential size of a big-pharma partnership, look at GSK's deal with competitor Prosensa for a drug that now appears to be inferior to SRPT's - $680M + double digit royalties).

  • Report this Comment On October 06, 2012, at 3:40 PM, ctownballer03 wrote:

    How do you guys find out how much they are spending? Was trying to do this on my own, and I couldn't figure out, how much each company is spending? Thanks for any help!

  • Report this Comment On October 08, 2012, at 9:29 AM, TMFMassimo wrote:

    Thanks for the comments!

    @ProfessorBrains

    You make a great point. The goal of this article was to introduce investors specifically to cash burn and quickly “feel the pulse” of the company’s financial situation. The cash on hand calculated from the balance sheet doesn’t always tell the full story, so you’re right in looking at 8k filings and examining other sources of capital.

    @ctownballer03

    Start with the cash flow statement from last quarter and look for “total cash flow from operating activities.” If this number is negative, then the company spent that money. We also have to consider money spent on capital expenditures, and this will also be listed on the cash flow statement. Add these two numbers together and it gives you a rough estimate of how much money the company spent that quarter. You can find this on the company’s quarterly earnings report, 10-Q filing, or a number of free websites. Does that help?

  • Report this Comment On October 08, 2012, at 3:41 PM, dwmcgrat wrote:

    Opexa is a bio-tech that has a MS drug called Tcelna. The company has 23 MM common shares outstanding with aprox 20 MM in non institutional hands, a 17 MM market cap. It has on hand $4MM (up to $8MM) for ongoing operations. AND the monthly burn rate is well in check...the cash flow problem isn't related to on-going operations it is specifically related to the time that it will take the trial to be completed (e.g. 18 months) So what do you do if they run out money before they can complete their Phase IIb trial? Opexa needs a min of $7MM (up to a max of $30MM) just to complete their Tcelna trials to ultimately serve a 12 Billion dollar MS secondary progressive MS market place with a brand new treatment method that is already in place and tested over the last two years.

    Just like J.P. Morgan during the times of the railroads, isn't it a fact the BEST time to buy stock is BEFORE the deal has started?

    For a stock that was $147 dollars and is now .80 cents is a partnership their ONLY 'real' chance of survival long term?

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