Why Ben Graham Might Be Wary of Biotechhttp://www.fool.com/investing/general/2013/10/07/why-ben-graham-might-be-wary-of-biotech.aspx Bob Chandler
October 7, 2013
Ben Graham, sometimes known as the father of value investing, often cautions against paying too much for a stock. In his famous work, The Intelligent Investor, he notes that stock prices tend to get unreasonably high when investors get overly enthusiastic. The biotech area seems to be showing some signs of excessive exuberance. Would Graham be wary of the sector? I think so, here's why.
Excessive enthusiasm means increased risk
Dendreon is a good example. This company made news with the 2010 approval of cancer-fighting product Provenge. Analysts at the time believed that the drug would generate sales of more than $1 billion a year by 2013. Unfortunately, the limited acceptance of Provenge and the advent of competitive products dashed those expectations. With a current run-rate of around $300 million in annualized sales, Dendreon shares fell from a high of more than $40 to less than $3 a share.
Merger fever might imply overexuberance
Onyx Pharmaceuticals, a company with a highly regarded cancer treatment drug called Kyprolis, started merger fever when it confirmed a $120 per share offer from large drug company Amgen in July. Thoughts of a potential bidding war pushed Onyx shares to more than $130 with analysts issuing possible buyout prices ranging up to $180 per share.
Shortly after, acquisition mania intensified with rumors that Swiss drug leader Roche was going to make a bid for Alexion Pharmaceuticals (NASDAQ: ALXN). Alexion, a biotech company with an orphan-drug product called Soliris, saw its shares jump. The idea that someone might look to purchase the company made some sense. It did have the approved orphan drug -- one that is highly lucrative with limited competition -- and an ongoing development program focusing on ultra-rare diseases. However, the deal fervor overshadowed legitimate concerns over the $20-plus billion price tag, European patent issues and developmental effectiveness questions. (More about factors related to an Alexion deal can be found here.)
Then, in mid-September, merger expectations erupted again as reports indicated that Roche was going to make a play for BioMarin Pharmaceutical (NASDAQ: BMRN). BioMarin shares rose about 10% on that rumor.
The idea also had some logic behind it. BioMarin has successfully developed and commercialized drugs for rare but serious medical conditions. The company also seemed to have a stronger pipeline than Alexion with a portfolio of four approved products and multiple clinical and pre-clinical product candidates. The cost of a possible deal, still a hefty $10-plus billion, was less extravagant than an Alexion bid, and in association with the company's current sales and future possibilities might seem to make a transaction more likely.
But the resolution of some of these stories was more subdued than investor expectations. Roche, seemingly tired of being named a wanton biotech suitor, had come out quickly and publicly denied any interest in BioMarin. Onyx, after a lack of new bidders, ended up going to Amgen for $125 a share, a minor 4% premium over the initial offer.
One might think the ardor toward biotechs would have cooled given the misses by Onyx and BioMarin. But the continued eagerness to "get in on" the next big deal indicates there still might be some excessive enthusiasm for the sector.
A torrent of IPOs could be a confirming sign
Graham notes that an increase in IPOs should be viewed cautiously. He writes:
The froth in biotech stock offerings looks to still be going strong with four smaller-cap companies all announcing IPO intentions just in the week ended Oct. 4.