The Biotech Big Picture

Focusing on biotech industries can lead an investor to forget the larger picture. For example, because the big drug makers can provide the cash and marketing muscle to help newer biotechs survive until profitability, biotechs dance to the drug makers' tunes. After analyzing the biotech industries of biomaterials (tissue engineering, regenerative medicine) and genomics tool makers, Tom Jacobs asks Madame Fooliana for a Big Picture reality check.

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By Tom Jacobs (TMF Tom9)
December 8, 2000

A Fool always needs perspective. After months of biotech immersion in order to write articles on biomaterials and genomics tool makers for The Motley Fool's Industry Focus 2001, I worried: Had I focused on the minutiae to the exclusion of the "Big Picture?"

So I raided my change jar and sprang for a session with Madame Fooliana, a noted fortune teller with a biotech consulting business on the side. She plies her trade in a new townhouse on the Potomac, not far from Fool HQ. 

Tom9: Thank you for seeing me, Madame. Whoa, nice crystal ball. Baccarat?

Mme. F: That? [Dismissive wave of hand.] A mere bauble. But biotech consulting has done well this year. Venter and Haseltine pay me anything. Put my three darlings through fortune-telling college -- and that strange one through bioinformatics grad school. 

Tom9: [Considering what he's paying.] Hmmm. Uh, Madame Fooliana, I'm perplexed. This year, almost any stock remotely connected with biotechnology saw its stock price fly to the moon -- and then back. So many biotech IPOs. Help me with the long view here. Can all these biotech companies survive and prosper? 

Mme. F: No, but you hardly need me to tell you how capitalism works. Many contenders, but few ascend to the throne. I mean, ever hear of Internet business-to-consumer commerce? Bye bye, sock puppet! 

Tom9: Yes, yes, of course -- I've read Rule Breaker portfolio's Jeff Fischer on But Madame, biotechnology is rocket science, and Internet retail is not. There's something actually there -- the potential for tremendous patent and intellectual property advantages.

Mme. F: True, and that's why venture capitalists pay Madame Fooliana big bucks for biotech consulting: to sort the better from the best.

[Gazing bug-eyed into the ball.] I see three futures: Big Drug Makers Call the Shots, Big Guns Move In, and a Few Strong Ones Survive to Prosper.    

Big drug makers call the shots
Mme. F:
First, remember that it is the big drug makers that drive biotechnology advances, directly or indirectly. They are the deep-pocket customers for biotech research and development, and without their purses most development-stage biotechnology firms would expire. End of story.

Twelve to fifteen big companies dominate the drug world, with market caps ranging from the mid-$40 billions to Pfizer (NYSE: PFE), at $275 billion. These include a few first-generation biotech drug makers, such as Amgen (Nasdaq: AMGN) and Genentech (NYSE: DNA). To produce the profits necessary to sustain and enhance these valuations, big companies like Schering-Plough (NYSE: SGP), American Home Products (NYSE: AHP), Merck (NYSE: MRK), and Eli Lilly (NYSE: LLY) are under enormous pressure to develop not just successful drugs, but blockbusters that bring in $250-$500 million a year or more. They must stuff their drug development pipelines with promising candidates for large, less-competitive, or underserved patient populations.

No wonder big drug makers jump at the chance to take the billions they spend on research and development and spread them around clever biotechs with the latest technology! The big drug makers gloat, "I can cherry pick and not take on all the overhead."

Tom9: Right. [Trying to impress Mme. F.] They've all formed major strategic alliances. A few are Bayer's investment in Millennium Pharmaceuticals (Nasdaq: MLNM), SmithKline Beecham (NYSE: SBH) in Human Genome Sciences (Nasdaq: HGSI), and American Home Products in Immunex (Nasdaq: IMNX).    

Mme F:  Exactly. These are three excellent examples of fully-integrated genomics-based drug companies which may -- may -- join the exalted ranks of the big drug makers. But their smaller siblings, biotechs founded on a drug or two, are most risky. Great rewards if the drug succeeds, horrible consequences if it fails. If I name any you will receive avalanches of hate email.  

Tom9: You're telling me -- I named names and you should have seen my mailbox. 

Let's move to biomaterials and genomics tool makers.

Mme. F:  Of course. To riskier universe, challenging even my great abilities. The biomaterials companies include many who wish to alleviate the organ transplant shortage through various engineering marvels, such as Advanced Tissue Sciences (Nasdaq: ATIS), Curis (Nasdaq: CRIS), Organogenesis (AMEX: ORG), Alexion Pharmaceuticals (Nasdaq: ALXN), Human Genome Sciences, and Geron Corp. (Nasdaq: GERN).

This is a worthy goal. But I see much promise and little to show yet. Scientific American and other popular magazines make the science seem dazzling and the breakthroughs imminent, but do not be fooled -- never buy biotech because of some neat thing you read. Little Xena or Sparky's college tuition money should not be in biomaterials. Study hard, examine your investing horizon, and be prepared to wait for returns. Don't invest any money you need in three to five years, money you can't afford to lose, and don't buy anything in this volatile sector on margin

Tom9: Very Foolish. But what about the genomics tool makers?

Mme. F: The drug companies and other biotechs are on track to spend billions buying hardware and software tools to carry on their research. Affymetrix (Nasdaq: AFFX), Celera (NYSE: CRA), Gene Logic (Nasdaq: GLGC) -- you interviewed their CEO recently -- CuraGen (Nasdaq: CRGN), Applera/Applied Biosystems (NYSE: ABI) -- these are just a random few. The hard part here is discovering what differentiates one from another and how a company grows really big from this work. I'm not saying it can't happen -- only that it is very early for even biotech consulting whiz Madame Fooliana to know what will happen. 

Big guns move in, but a few strong upstarts survive
Meanwhile, big companies with established technical expertise in materials are either watching on the sidelines, waiting to jump in, or actively entering the spaces. I see Agilent Technologies (NYSE: A), Corning (NYSE: GLW), Motorola (NYSE: MOT), IBM (NYSE: IBM), and DuPont (NYSE: DD) leveraging engineering and computing know-how to move into the biochips (gene chips, DNA microarrays, DNA chips) space, for example, or bioinformatics. They partner with smaller biotechs and will sometimes buy them. A few well-financed, well-patent protected newer companies may survive and prosper, but not the multitude clamoring at the gates today. Beware high valuations and be patient.  

Tom9: Thank you, Madame. Do you see anything else I should know?

Mme. F: [Peers over her glasses.] Other than that you now owe all your knowledge to me? [Claps hands, stands and sweeps up her robes.] Time's up! This way out, and please remember me to those nice Gardner boys, David and -- Tom One? I taught them everything they know.   

Is Madame Fooliana in the know? Share your opinion on the Fool on the Hill discussion board!