The U.S. government's announcement this week that it would fund human embryo stem cell research led to strong biotech gains across the board. Many biotech stocks have fought back from April lows to prior or new dizzying highs, the biotech IPO market is hot, and companies have raised record cash this year. Is this a bubble? The Foolish investor shouldn't care, remaining focused instead on the company's cash horde, market for products, and top-rank scientific talent.
Leaders such as Millennium Pharmaceuticals (Nasdaq: MLNM), Human Genome Sciences (Nasdaq: HGSI), Celera Genomics (NYSE: CRA), and Incyte Genomics (Nasdaq: INCY) have seen their share prices double or more since their March-April lows. Newbies have scored as well: Thirty biotech IPOs have raised $2.5 billion since July 1 -- and there are 16 to go, according to Recombinant Capital.
In this volatile market, it's no wonder that even biotech experts such as Jeffrey Casdin of New York's Cooper Hill Partners say, "Who's who? Who does what? Who are the good ones? Who are the bad ones? It's all coming in a rush."
What's a Foolish investor to do? Take a deep breath and review Motley Fool Research Analyst Zeke Ashton's Foolish Biotech Checklist. Zeke presents eight criteria for evaluating both established and up-and-coming biotech companies. Three of them -- slightly paraphrased -- are particularly relevant today.
Enough cash to fund operations for two years?
Most biotech drug companies are in the early stages of drug development and don't have enough cash to remain afloat until the FDA approves their drugs and the market buys them. Many companies raise capital via another of Zeke's criteria -- partnerships and marketing agreements with blue-chip drug manufacturers.
But when biotechs are stock market darlings -- such as during this year, 1996, or 1991 -- some companies can raise a lot of capital through IPOs, issuing new stock, or offering debt convertible to stock. For example, earlier this year, Celera issued stock raising $1 billion; Abgenix (Nasdaq: ABGX) and Medarex (Nasdaq: MEDX) raised $400 million each in secondary offerings; and Millennium and Human Genome Sciences raised $400 million and $600 million, respectively, in convertible debt offerings.
But even smaller, newer companies are doing well this year. The president and CEO of Denver's Allos Therapeutics (Nasdaq: ALTH), whose March IPO raised $90 million, had this to say: "There's now no need, at least for financial reasons, to seek a corporate partner in North America," he told the New York Times. The money "has really given us control of our own destiny."
Hmm. Maybe a hot market can give a young company some cash and independence, but the long-term question is still pesky: another of Zeke's criteria is whether a company's drug candidates serve a large or underserved market.
Market for drugs?
Newly IPO'd Allos Therapeutics has development-stage drugs that seek to increase the amount of oxygen released from red blood cells, making cancer tumors more susceptible to radiation treatment. When I looked at this, it seemed to me -- an absolute nonscientist -- like a niche market. Yes, cancer is big, but in the long run -- which could be 10 years or longer for all I know -- maybe other advances will move us from radiation to gene treatment.
My colleague Brian Graney (TMF Panic) pointed out that there may be more semiconductor companies today than in the industry's infancy because so many have found small but profitable niches. The question is whether this can happen in biotech. I know a drug for Type I diabetes will serve a huge market, but when I look at a company like Allos, I need to know more to evaluate the market for its potential cancer treatment. Maybe even in the gene era, some patients will still need radiation. I wouldn't invest without researching this criterion further.
Does the biotech have the best scientists? Management guru Peter Drucker believes that the Internet explosion has made software developers as fought over, rare, and highly paid as printers in the 20 years after Gutenberg invented the printing press.
Graney seized on this point for biotech: There are only so many brilliant bioresearchers. He reminded me that when Amgen (Nasdaq: AMGN) started, it raided California universities; Biogen (Nasdaq: BGEN) raided and still cherry-picks from Harvard and MIT. Outside of biotech, think of JDS Uniphase (NYSE: JDSU), which has been on an acquisition binge to gain first-rank fiber-optics researchers for a target's products. Biotech firms will rise and fall and consolidate in large part due to success or failure at raising capital and making and selling drugs, but they will have to employ the best brains in their fields.
In a sky-high biotech market like today's, a biotech firm may be able to raise money more easily to stay alive during its early growth. But it's the cash you can raise -- not whether the market itself is hot, high, or in a bubble -- that should influence a long-term investor. Screaming biotech markets come and go -- witness 1991 and 1996, and the early days of Genentech (NYSE: DNA), Amgen, and Biogen. But, bubble or not, three ways to evaluate a biotech drug company investment -- money, markets, and talent -- don't change.