Looking for Bargain Biotechs? Consider Small-Cap Vaccine Makers

Growth and value are two words that have completely fallen out of the biotech lexicon of late. The adjectives 'bubble' and 'expensive' have instead taken their place, when investors talk biotech. And with the average biotech price to earnings ratio now topping 37, it's easy to understand why. The S&P 500, for example, is presently garnering a price to earnings ratio of roughly half that of your average biotech company.

Biotech's meteoric rise has thus left many investors asking a simple question: Is there any value left in the sector? I believe the answer is emphatically yes! Small-cap vaccine-makers like Dynavax Technologies Corp. (NASDAQ: DVAX  ) and Novavax  (NASDAQ: NVAX  )  may have some attractive opportunities.

Overview of the vaccine market
Vaccines presently occupy less than 5% of the total pharmaceutical market. Nonetheless, this sub-segment is growing quickly, with an average annual growth rate of 12.5%. To give you a feel for just how rapid this growth is, the remainder of the market averages around 6% per year.

Over the past decade, vaccine sales have more than quadrupled to $24 billion last year, and are projected to grow to $100 billion by 2025. So, it's no wonder industry heavyweights like Pfizer, Johnson & Johnson, and Sanofi, among others, have made vaccines a point of emphasis in their business models. 

Why is the vaccine market growing by leaps and bounds? A couple of factors are at play here. Firstly, Pfizer's Prevnar, and its various iterations that treat different strains of Streptococcus pneumoniae, have demonstrated, unequivocally, that vaccines can be megablockbusters.

Secondly, large pharmas have successfully increased access to their vaccines in large emerging markets, which has been a major source of growth. And finally, new technologies are presenting the possibility of treating and/or preventing infectious diseases that have long plagued humanity. This innovation boon has led to over 120 new vaccine candidates entering clinical trials in the past three years alone. 

Small-cap vaccine-makers with growth potential
What's interesting about the vaccine space is that five large pharmas account for about 80% of the global market. Why? Because they have bought up nearly all the smaller companies developing promising vaccines. From 2005 to 2012, for instance, there were 13 major acquisitions within the vaccine space. The downside to all this M&A activity is that there are only a handful of small-cap vaccine-makers remaining that are publicly traded. Of those left, I believe Dynavax and Novavax should be on investors' watch list.

Dynavax could dominate the hepatitis B market with Heplisav
Dynavax's story begins and ends with its experimental hepatitis B vaccine Heplisav. While Heplisav has been shown to be clinically superior to GlaxoSmithKline's (NYSE: GSK  ) Engerix-B in terms of effectiveness, the U.S. Food and Drug Administration, or FDA, believed there wasn't enough data on the vaccine's safety to approve it last June. Recently, the European Medicines Agency, or EMA, came to the same conclusion, forcing the company to withdraw Heplisav's marketing application in Europe.

The good news is that a late-stage trial has commenced to address the outstanding safety issues, as well as investigate the drug's effectiveness in diabetes patients. The downside is that the study won't be concluded for another year, and there is little in the way of a near-term catalyst. That said, Heplisav is projected to see sales topping $700 million per year if approved in the U.S., and the company currently has a market cap less than $500 million. All told, Dynavax offers investors what I view as a compelling risk to reward ratio.

Novavax breaks through with RSV vaccine
Respiratory syncytial virus, or RSV, is one of the most common infections out there. Yet, there is no vaccine available. Novavax management believes that they have a breakthrough experimental vaccine that could provide immune protection in a wide diversity of patient populations. And with two successful mid-stage trials under their belt already, Novavax is now investigating the vaccine's effectiveness in children, pregnant women, and the elderly. As such, a commercial version of the vaccine could be on the market as early as 2016.

Although I'm optimistic about the RSV program, investors need to understand that Novavax has an exceptionally strong clinical pipeline. Some of their other clinical candidates aim to treat seasonal as well as pandemic flu, which could be blockbusters in their own right. 

Foolish final thoughts
Vaccines are going to be major engines of growth in the pharma industry for the foreseeable future. Developmental stage companies like Dynavax and Novavax offer investors the opportunity to capture some of this growth at reasonable prices, in my opinion. What's particularly interesting is that both companies have shown their flagship vaccines to be effective in large, randomized clinical trials. So while clinical and regulatory risks still remain, there are good reasons to keep an eye on these two companies moving forward.  

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