1 Biotech Investment for Every Type of Investor

Investing in the biotech industry can lead to big gains, but it can be oh-so-complicated. Drug A has an advantage over Drug B because it works in a different way in the body, but it works in only X% of the patient population and ... you get the point. If you want to tap into the potentially massive gains but get a headache from the thought of reading a biotech press release, don't worry. There's a company with a simple business model any level of investor can understand that will still allow you to tap into the biotech market.

So simple it just might work
Ligand Pharmaceuticals (LGND 1.62%) develops or acquires assets -- in this case, pharmaceutical compounds from research labs, small companies, or academia -- and licenses them to pharmaceutical companies. Most compounds are still works-in-progress (a.k.a. in the pipeline), but some have run the gantlet of necessary clinical trials and are ready to hit the market with a partner. The company generates revenue from milestone payments when drugs reach the next level of development and royalties on sales of approved drugs. That's it. Acquire. License. Collect revenue. Repeat.

To illustrate the simplicity of the business model, consider that Ligand has 21 employees and a portfolio of 85 partnered projects with companies from all over the industry. Here's how the list of disclosed projects stacks up:

Source: Ligand Pharmaceuticals.

The seven disclosed programs with Merck include three mid- to late-stage trials covering its novel BACE inhibitor Alzheimer's drug and dinaciclib, a small molecule for chronic lymphocytic leukemia. The latter triggered a $2 million milestone payment last year just for entering a phase 2/3 trial. Consistent revenue streams are created when drugs gain approval and hit the market, but milestone payments can make contributions to the top line as well -- especially considering that 91% of Ligand's portfolio is still in the pipeline.  

Upcoming catalysts
Ligand's business will mature as programs leave the pipeline and head to the market. That will also help insulate investors against volatility caused by early growing pains. There is a lot of buzz surrounding a few late-stage programs at the moment, which means success or failure will have a major impact on shares. Buckle up!

For instance, Ligand and Pfizer are awaiting a decision in October on Aprela, a drug used to treat hot flashes in menopausal women. The FDA has been tough on non-hormonal treatments in the past, but enthusiasm is high after a competitor's drug recently gained approval. The drug has had multiple developmental delays over the past six years, so I would take a cautious approach going into the decision.

Aside from approvals, Ligand also gets a boost when marketed drugs hit the next tier of royalty payments. While these developments attract far less attention, they are key drivers to the business. Consider Ligand's royalty table on multiple myeloma drug Kyprolis from Amgen (AMGN 0.26%), which was recently the centerpiece of a $9.7 billion acquisition of Onyx.

Source: Ligand Pharmaceuticals.

The drug soared to $125 million in sales in the first half of 2013. Given its incredible growth trajectory, full-year 2013 sales should eclipse $250 million and trigger the next level of royalty payments to Ligand. Some analysts believe Kyprolis could generate peak sales of more than $2 billion per year if it proves successful in ongoing trials aimed at expanding its use and patient population. In case you're wondering, Ligand would generate $52.5 million in royalties the year Kyprolis notches $2 billion in annual sales.

Don't forget about risks!
Ligand may have a silky smooth business model and ridiculously low corporate cost structure, but it also has to endure developmental risks. If pharmaceutical compounds fail to make it to market, then the company is about as valuable as a paperweight. The advantage is that all developmental costs are absorbed by partners. So while a drug failure equates to no future royalties for Ligand, it's the partner that has to write off hundreds of millions of dollars in research and development.

Unfortunately, a lot of future growth is being factored into shares right now, which have more than doubled this year. The company is pricey with a market cap over $800 million, especially when you consider first-half 2013 sales tallied just $21 million. There is a lot of potential for growth in the future -- 85 programs in one portfolio! -- but I'll be waiting for a pullback before I add shares to my portfolio.