FOOL ON THE HILL
Biotech Mania Still Isn't Over

Despite their downturn since the bubble burst, biotech stocks have remained popular compared to other sectors of the market. With expectations still running high, one Fool fears biotech mania isn't over yet and the fundamentals indicate it will be more than difficult for most companies to deliver reasonable returns. Investors still seem to be chasing the few profitable players and speculating on the long shots rather confidently. Rick Munarriz would prefer to avoid the sector altogether.

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By Rick Munarriz (TMF Edible)
January 15, 2002

I hope I'm wrong.

I hope that I'm very, very wrong. I hope that the field of life science becomes so practical and commonplace that I'm able to create a clone of myself to eat the crow I will rightfully deserve to wolf down and field the "I told you so" e-mails you will be warranted to send me.

Because, I have to tell you, the biotech investing craze is starting to look far worse than the Internet gold rush. Biotech stocks soared from the third quarter of 1999 to the third quarter of 2000. Like Internet stocks, the biotechs have been deflating ever since, with companies like Millennium Pharmaceuticals (Nasdaq: MLNM) and Human Genome Sciences (Nasdaq: HGSI) down 80% from their highs. But unlike the Internet stocks, many biotech issues still probably have a lot farther to fall.

Last month, the widely followed Nasdaq-100 Index went through its annual ritual of adding big gainers and casting off equity driftwood. Through the "In" door came biotech specialists like Cephalon (Nasdaq: CEPH) and Sepracor (Nasdaq: SEPR). They will now be filling seats warmed by fallen Internet stars like RealNetworks (Nasdaq: REAL) and CMGI (Nasdaq: CMGI). If the revolving door swings familiar, it's because RealNetworks and CMGI were added two years earlier -- just months before the online sector was about to peak and peter out. I've seen doomed bad sitcoms have longer runs than Inktomi's (Nasdaq: INKT) Nasdaq-100 tenure.

It's different with biotech, right? This is a revolution that will transform the way we live, right? I've heard it all before. And the countless number of fledgling biotechs still getting ready to flood the market the way e-commerce and online content wannabes went public in the late 1990s does little to soothe my convictions.

Take BioQuest, please. The Virginia-based company has no operating history or revenues, but that hasn't stopped it from attempting to go public through a self-underwritten direct offering -- according to its website, the first of its kind. BioQuest is hoping to round up enough investors to put up at least 86% of the company's funding for a mere 10% stake in the venture. Before you point out the obvious, that BioQuest is little more than a group of executives looking to fund an alternative medicine center in the island of Antigua, work with me here.

This is not a biotech company. I know. The company is actually earmarking more funds for the development of its online site than the necessary acquisitions one would expect to piggyback onto others' operating history. Still, would this deal stand half a chance if the company organized under the name of its BatOutOfHealth.com alternative medicine portal rather than highlighting the Bio prefix in its moniker? It's playing the Bio the way companies were quick to heat up the branding irons with dot-com endings just 2-3 years ago. If Bio-izing your moniker isn't the froth that lines the bubble, you will surely get what's dot-coming to you.

What's next? Can we expect drkoop.com to reincarnate itself as BioKoop? I'll pass on BioQuest. I'll pass on biotechnology, too. Because the hype is thick for an industry where just a few strike it rich with the Food and Drug Administration lottery. Those who have taken a drug or two to market are priced too dearly and the speculative leftovers are too great in number for anyone's comfort. It's like shooting fish in a barrel -- only without there being any fish in the barrel. While it's easy to look at the sector's flat performance in 2001 as the pause that refreshes, holding its own while the market tanked after years of surges might prove to be little more than a temporary gravity-defying trick.

Yes, folks are still taken with the biotechnology shares. But just inches and a choice of appendages separate a pat on the back from a kick in the rump. While many investors -- including our own Rule Breaker Portfolio -- have healthy gains to be grateful for in the life sciences sector, under what metric other than momentum can one bank the future on? I'm not convinced. Not that the industry needs my blessing.

Biotech fans will be quick to point out that there is no bigger believer in the industry than the industry itself. After all, pharmaceuticals giant Bristol-Myers Squib (NYSE: BMY) announced that it would be investing a cool billion for a 20% stake in ImClone (Nasdaq: IMCL) back in September while MedImmune (Nasdaq: MEDI), Millennium Pharmaceuticals, and Amgen (Nasdaq: AMGN) all announced buyouts in the billions for smaller rivals just last month.

Big mistake.

The same thing was going on with Internet mega-mergers in 1999. Yahoo! (Nasdaq: YHOO) swallowed GeoCities. CMGI chugged a majority stake in AltaVista. And as far as smart money goes, the mighty Softbank had no problem buying into eventual dot-com roadkill like Webvan and Buy.com. If you want bigger tech bellwethers, let's just say that both Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) owned a piece of CMGI. The view from the inside is often too rose-colored, as Chiron's (Nasdaq: CHIR) claim that its nucleic acid blood-testing system would get the FDA thumbs up last year. We're still waiting on that front.

Vernacularly speaking, I can stretch this mirror exercise. I can equate the eventual trend towards falling drug prices domestically to the teetering banner ad market globally. I can hold up shorter drug patent lives and free-spending venture capitalists against the low barrier to entry that commoditized the Web's intellectual capital. I can pit the cobweb-weathered euphemisms of "pipeline" against "path to profitability" and still leave you with two sectors that preach plenty but have delivered few proven producers of bottom line results.

That's a problem. You have investors circling the wagon with buy orders of the few companies that aren't losing money in a talked-up industry group to the point where the share prices are making promises their income streams can't keep. Biogen (Nasdaq: BGEN) is a seasoned player yet that same maturity is calling for earnings to grow by just 3% this year. Do you really want to pay 10 times that growth rate for the stock? Quality names like Amgen and Chrion are poised for healthier profit gains in 2002 but is a year-ahead earnings multiple of 40 worth the risk relative to the upside?

And while Amgen is a Rule Breaker winner (though Tom Jacobs is skeptical), am I the only one surprised to find out that until it got the Food & Drug Administration's head nod a few months ago the company had gone a decade without a major drug being approved?

It's too easy to fall in love with the biotech story. Sure, the sequencing of the human genome is exciting stuff, but researchers were able to find the defective gene that causes cystic fibrosis a dozen years ago and we're still waiting on a cure. When Lehman Brothers singles out some promising biotech upstarts like it did earlier this month, projecting not earnings but revenue through fiscal 2005, isn't it d�j� vu all over again?

A sector at the mercy of what has become a very fickle FDA -- just ask Chiron -- is like trying to play "Mother May I" with a cactus. It's just not worth the risk and you've played this game before, remember? The history of the world is a rerun; are you brave enough to flick the channel? Can you be jaded enough to laugh while everybody sings: Good-bye, Mary Meeker, hello Barry Beaker?

Rick Aristotle Munarriz enjoyed the movie Weird Science but hated Doctor Detroit. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.