Yesterday's article showcased some reasons why the portfolio currently sports consumer businesses and no tech stocks. It's not that we don't think there's tech money to be made. We do! After all, we start our Rule Breaker strategy hunt with important, emerging industries, which "come from invention, reinvention, or adaptation of existing technologies." We like technology.
But here's the rub: If a company's complex new technology creates an important, emerging industry, we may lack the expertise or passion to know when competition appears, in what form, and how well management responds (other than to see revenues evaporate and the stock price tank).
Why so many biotechs?
There's "tech" in "biotechnology." So why three companies whose biotechnology has transformed an existing business (drug making) or created a new one (bioinformatics)? No secret about why we thought Amgen (Nasdaq: AMGN), Human Genome Sciences (Nasdaq: HGSI), and Celera Genomics (NYSE: CRA) were Rule Breakers. We provide you all the reasoning. But isn't biotech just as complex and difficult to follow as any kinds of tech you want to name -- optical networking, wireless communications, computer hardware or software, and the like?
But there's one major reason that biotech may have an advantage over plain old tech. The drug making game is rigged. Pure and simple. And you can understand it.
Why biotech drug makers are easier to keep up with and evaluate than other tech stocks
For our safety, the Food & Drug Administration is gatekeeper for all prescription drugs. Nothing passes the FDA unless its maker provides enough evidence that its use in humans is both safe and effective.
Fight about it, argue, throw pillows at each other, but prescription drug makers like Amgen and (one day, inshallah) Human Genome Sciences make no money unless the FDA approves their applications to market drugs in the U.S. And even then, there's no guarantee that any company will recoup the $500 million in development costs (including the cost of failures along the way) and make a profit in the time left on the drug's patent (drug patents run 20 years from the date of application, which is usually pretty early in the development process).
Without the FDA's OK, you don't get to play
That's why almost every article analyzing a drug maker, from Rule Maker portfolio holding Pfizer (NYSE: PFE) to Amgen, looks at its stable of drug development candidates, invariably referred to as its drug pipeline. The pipeline is future cash. Here's what the drug development and approval process looks like:
time stage 2-3 years research -- labCompanies decide at each stage whether a drug is worth more development or whether money could be better spent on the other drug candidate children begging for resources (like baby birds' open mouths). A drug at phase 1 has about a 20% chance of eventually reaching the market, and if it makes it to phase 3, about a 60% chance, rising to 70% when the company submits its reams of data -- up to 100,000 pages -- to the FDA. Because companies must report drug testing progress publicly, we can see the success of a pipeline much in the way that we may watch a horserace. Losers slip back as the race progresses and the winner passes through FDA approval and on to the marketplace.
1 year pre-clinical -- lab and animal studies
~10 years clinical development -- human trials Phase 1 20-50 healthy human subjects
Phase 2 100-300 patients with the condition
Phase 3 500-5000 patients with the condition 1-2 years FDA review and approval
New Drug Application (NDA)
FDA advisory panel recommendation
FDA decision Commercialization [adapted from BioChem Pharma's 1998 Annual Report and other sources]
Where do Amgen and HGS stand?
Take Amgen, which at the time of our Dec. 1998 purchase deserved the Rule Breaker moniker for using recombinant DNA technology to make its hugely successful treatments for patients who lack red blood cells and white blood cells. It also sports more drug hopefuls in its drug development pipeline, and we can watch their progress.
Part of HGS' Rule Breakerhood is that it has a proprietary database of protein-producing genes that it asserts will lead to more and better drug targets and drug candidates than it could possibly develop and sell on its own, at lower cost and faster. We can validate these claims as we watch how many new drugs enter human trials each year, how they perform, and how many targets or candidates HGS sells to big pharma because it's cherry-picking the best ones for itself.
Because of the FDA's role, drug making presents a world that can be the opposite of cutting edge "tech" investing, where life begins with, "Oh, what a cool idea," matures into, "I hope it overtakes the established order!" and then often turns into, "Why did someone invent a better giga-mousetrap and I lost all my money?" With drugs, the testing and approval process lets you see more. You still need to evaluate the market size, competitors for the drug, and the like, but you have an advantage.
What about Celera?
Celera Genomics is a different biotech beast and may be the riskiest investment in the portfolio. It's not clear how it will make enough money from bioinformation to provide truly Rule Breaking returns, unless it develops significant income through royalties, its own drug development, or both. Each of these is years away, Human Genome Sciences is way ahead, but even HGS' first drugs in the best of all possible world are unlikely to hit the market before 2005. This doesn't deny Celera's potential to reward investors, but asks how much and how long it would take.
Biotech's consumer appeal
The last two days have begged the big question: Where's the consumer appeal for companies using biotechnology? That will have to wait for more thought and another day. Please share on the Rule Breaker Strategies discussion board whether and why you think Amgen, HGS, and Celera Genomics have consumer appeal and brand possibilities.
Tom Jacobs (TMF Tom9) has made public fun of the NCAA tourney and then secretly watched the regional finals. Those boys sure know how to punt! He owns shares of Celera Genomics and Human Genome Sciences. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.