The Foolish Biotech Checklist provides a useful framework for investors in both biotech and drug companies. Elan Pharmaceuticals is an intriguing case study, and a Foolish analysis shows that Elan may be an interesting investment idea based upon its Core Clinical Index score, diversified product portfolio, and impressive financials.
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Back in June, I presented a biotech investing framework in a three-part article in the Fool's Den column. Of course, here at The Motley Fool, we are always tinkering and refining and improving. After reviewing the many emails from Fools with comments and suggestions, we developed a new, improved Foolish Biotech Checklist that became the foundation for evaluating biotech stocks in our five-week online Biotech Investing seminar in October. Before investing in biotech stocks, we recommend that investors think about how much risk they are willing to take, and then classify investment candidates into one of three risk classes: Tier 1 biotechs, which are the largest and generally most resilient companies; Tier 2 biotechs, companies that are close to breaking through with successful drugs or are technology leaders in their markets; and Tier 3 biotechs, which are development-stage companies. Here's the Foolish Biotech Checklist, as it was presented in the seminar and, in greater detail, in our new TMF Guide to Biotech Investing: Checkpoint #1: Successful drugs on the market Checkpoint #2: A deep product pipeline Checkpoint #3: Drugs that target large or underserved markets Checkpoint #4: Partnerships and alliances Checkpoint #5: Top dog and first mover Checkpoint #6: Sustainable competitive advantage Checkpoint #7: R&D spending Checkpoint #8: Good management and smart backing One important thing to note is that this list can be applied not only to biotech companies, but any company in the drug businesses, from the major diversified pharmaceutical manufacturers such as Pfizer (NYSE: PFE) or Schering-Plough (NYSE: SGP), to your favorite small specialized drug companies. After applying the criteria in the checklist, you should look at the financial performance. The Biotech Guide offers some different criteria to look at, depending on whether the company is a large and profitable drug maker, a development-stage biotech awash in red ink and research and development expenditures, or somewhere in between. As an example of how to apply the Foolish Biotech Framework, let's take a look at Elan Pharmaceuticals (NYSE: ELN). In the Biotech Guide, we provide case studies on 20 different biotech companies, and Elan is one of them. Here's what I wrote about Elan in the guide: First of all, Ireland-based Elan Pharmaceuticals isn't a biotech company; it's a diversified pharmaceutical company that's moving into biotech in a big way, mostly by buying up any small biotech company that isn't nailed down. I've counted 14 acquisitions since 1996, including The Liposome Company in December 1999, and most recently, drug delivery specialist Dura Pharmaceuticals. The company also owns slices of 10 other companies, including Targeted Genetics (Nasdaq: TGEN), Isis Pharmaceuticals (Nasdaq: ISIP), Ribozyme (Nasdaq: RZYM), and Ligand Pharmaceuticals (Nasdaq: LGND). It wouldn't surprise me to see Elan acquire one or more of these companies in the next couple of years. If Elan isn't pure biotech, you may be wondering why it's being profiled here. The answer is because it is an interesting investment idea. This is a company that had over $1 billion in revenue in 1999, with a net profit margin of over 33% (with an assist from its 2% tax rate in Ireland). I'd consider Elan to be an emerging Rule Maker. With one of the deepest pipelines seen this side of Genentech (NYSE: DNA) as measured by a Core Clinical Index of 6.426, higher than any of our Tier 1 biotechs, and five products either recently approved or filed in the U.S. alone, Elan's market cap of $15 billion certainly compares well to Biogen (Nasdaq: BGEN), Chiron (Nasdaq: CHIR), and Genzyme (Nasdaq: GENZ), and Elan's large portfolio of marketed drugs, drug delivery technology, and pharmaceutical manufacturing services offers a much lower risk profile. Elan will need to watch its debt, which the company has been using to help pay for those acquisitions. With earnings growth expected to exceed 20% for the next five years, Elan looks very enticing at the current price. Just in case you are wondering, here's how Elan stacks up to our Rule Maker criteria. In this case, Elan would be suitable for a more risk-averse investor, due to its large size and diversified product portfolio, and a financial analysis reveals that Elan already exceeds most of our Rule Maker criteria. An interesting way to look at Elan is to compare the number of drugs in the clinical pipeline with some of our Tier 1 biotechs with large market caps. One way to do this is to use the Core Clinical Index, a modification of the Clinical Index developed by Soapbox author and biotech investing enthusiast Greg Carlin in his report on evaluating biotech pipelines. For the seminar, we took his Clinical Index two steps further. One of those "steps" is the Core Clinical Index (CCI), which is the number of drugs in clinical trials multiplied by their percentage chance of making it to market. Elan, with a $15 billion market cap, has a higher CCI than any biotech company on our list. According to our research, as of late October, Elan had a CCI of 6.426, the highest score of any company we looked at in the biotech survey. While the clinical pipeline evaluation is just one part of our biotech checklist, and the CCI is only one part of the evaluating a deep pipeline, the combination of strong financials and successful products on the market with a development pipeline that is busting with drug candidates are two huge pieces of the puzzle. Elan scores well on both counts, and has a market cap of less than $15 billion. Amgen (Nasdaq: AMGN) and Genentech sport market caps that are almost five and three times larger, respectively. Elan passes our Foolish Biotech Checklist with flying colors and must be considered a contender to become a future Rule Maker in the drug and biotech universe. For those of you who didn't take our five-week biotech seminar, our new TMF Guide to Biotech Investing covers all the details of our biotech investing framework and offers Clinical Index scores on 60 companies as well as profiles and opinions on 20 of the most intriguing biotech stocks on the market today. Related Links:
RULE MAKER ELAN (Q2'00)
Sales growth greater than 10% 29.9
Gross margin greater than 50% 78.5
Net margin greater than 10% 35.4%
Foolish Flow Ratio less than 1.25 NA*
Cash / Total Debt greater than 1.5 0.87
Cash King Margin greater than 10% NA*
* Foolish Flow Ratio and Cash King margin not available
In-Depth News on Biotech
TMF Guide to Biotech Investing
A Foolish Checklist for Biotech Investing
Biotechnology Pipeline Evaluation: Harvesting the Human Genome (Soapbox.com report)
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