**This trade is being made under the regular portfolio policy, namely, once The Fool announces an intention to trade, that trade will be made within the next five trading days. For more detail, please read our Trading Policy.**
At some point in the next five market days, the Rule Breaker Portfolio is BUYING approximately $45,000 (about 7.1% of the RB portfolio's current value) of:
Human Genome Sciences, Inc. (Nasdaq: HGSI)
9410 Key West Avenue
Rockville, MD 20850
Phone: (301) 309-8504
Fax: (301) 309-8512
Closing Price (9/21/00): $154.19
Average daily volume: 1.36 million shares
Daily dollar volume: $209.7 million
Market Cap: $ 8.47 billion
12 Month Sales: $23.6 million
Price-to-Sales ratio: 359
On September 22, 2000, the RB Port bought 280 shares at a total cost basis of $160.11 per share, including the $8 commission.
HGS Quote | HGS Snapshot | HGS Chart | HGS Financials | HGS Estimates
Less than two years ago, we added to the Rule Breaker Portfolio the first of what will be many different investments in companies that use biotechnology. We said at the time that we believed the two most significant Rule-Breaking industries over the foreseeable future are the Internet and biotechnology. And we called that investment, Amgen (Nasdaq: AMGN), a "biotech company," the top dog and first-mover in the "biotech industry."
We soon came to regret that phrasing, because biotechnology is not an industry. It is a technology. There is no "biotechnology industry," per se -- just as there is no "Internet industry." There are many, many companies that use biotechnology or the Internet in order to profit, providing products or services that customers find attractive and valuable. But just try to identify a single "top dog" Internet or biotechnology company. It's not really possible. Again, these are technologies that different companies adopt in order to gain a lead in one industry or another.
So it was that we bought Celera Genomics (NYSE: CRA), the leader in genomic information, a year after Amgen. We now buy our third "top dog" in a biotechnology industry, Human Genome Sciences. HGS dominates the vital field of proteomics.
On January 4, 2000, Kevin DeWalt (TMF GetFit of Soapbox.com), Greg Carlin (a best-selling author on Soapbox.com known as ElricSeven) and Jeff Fischer (TMF Jeff) visited the headquarters of HGS in the green hills of Maryland.
We spent a full day with a handful of company executives, including Dr. William Haseltine, Chairman and CEO, Dr. Craig Rosen, Executive Vice President of Research and Development, Steven Mayer, Senior Vice President and CFO, and David Stump, M.D., Senior Vice President of Drug Development. David Stump had recently decided to work at HGS rather than Millennium Pharmaceuticals (Nasdaq: MLNM), another Rule-Breaker candidate. I asked him why, and he replied that he greatly respected both companies, so the choice was partially personal.
Our coffee poured, the morning at HGS began in a conference room with an introduction from Dr. Haseltine. He explained what his company does (it creates medicines using the human body's genes, proteins and antibodies) and provided an outline of the company's history. HGS has been building a protein-centric genomic database since the early 1990s, and it has filed for 7,700 related, specific patents. The company has three promising drugs in human clinical trials, about a half dozen others in preclinical studies, and many other possible candidates in the wings. Dr. Haseltine launched HGS with Dr. Craig Venter, now the chairman of Celera Genomics (NYSE: CRA). Dr. Venter stayed aboard for five years, until 1997.
Following more than an hour of "conversation," which mainly consisted of them explaining to us how HGS's science works (we nodded to keep our brains from melting), they fired up the computers and showed us their extensive database. The company spent much of the 1990s analyzing genes to find those that were involved in relaying signals between cells on the assumption that these genes would have the greatest medical value. In the end, the company focused on the signaling proteins (as they're called -- more on them later) encoded by more than 10,000 genes. HGS ran in-house lab experiments to learn what each protein did for the body and developed a database based on the results of thousands of tests. This massive protein database is now central in the company's drug development program and led to most of the company's patent filings.
On the computer, HGS showed us how it can weed through thousands of proteins in order to find ones that perform different specific functions, such as those that stimulate T-cell (an immunity cell) production. Within a few minutes, they demonstrated how they can zero in on a single protein that stimulates T-cell growth without affecting any other cell types. Most proteins do affect several cell types when stimulating T-cell growth, but you don't want those proteins because they would likely have adverse effects on the patient. By identifying a protein that only affects T-cells and not other cell types (as HGS has done), the company essentially has discovered a potentially powerful and novel drug candidate. So, HGS filed a patent on this protein's function. The key in these protein discoveries is to be first, and apparently HGS has been in most cases.
Following lunch, we learned about the company's drug pipeline and we toured its new drug production facility, which was funded by the government of Maryland.
As dusk fell on this chilly January evening, the three of us finally said good bye and exited to the parking lot and Kevin's old, beat-up Ford Escort. Earlier in the day, Kevin had used his car to drive Dr. Haseltine around HGS's campus -- much to the amusement of Greg and myself, who were in Dr. Stump's shiny SUV. The funnier part of the story is that at first Kevin couldn't even find his car for several minutes, and it was raining. So, there Kevin was that afternoon, wandering the HGS parking lot in a steady rain with world-renown scientist Dr. Haseltine in tow. As Kevin anxiously searched in the rain for his car and apologized to Dr. Haseltine, he was hoping that the car would actually start once he found it.
RB Criterion #1: Top dog and first-mover in an important, emerging industry.
I want to see this company succeed and thrive on a very large scale. Why? Partially because HGS operates in such an important, emerging industry, and partly because I liked everyone that I met at the company. Let's call HGS's industry that of natural or regenerative medicine. HGS's medicines use the body's natural substances -- genes, proteins and antibodies -- to fight or cure human health ailments, including anything from cancer to weakening arteries to deep skin wounds.
The company's genomic database focuses on the messenger RNA in cells, which is responsible for creating protein chains. This makes HGS's database different from Celera's or the Human Genome Project's because HGS did not sequence the DNA of the entire genome -- it focused on sequencing messenger RNA in order to learn about protein functions. So in the field of signaling protein databases and related drug development programs, HGS is undoubtedly the top dog and first mover. About 14,000 genes are thought to exist that produce signaling proteins. HGS has filed patent applications on 7,700.
Although we named Millennium Pharmaceuticals a genomic top dog due to market capitalization, research & development spending, drug pipeline (which was purchased in an acquisition) and contract revenue, Human Genome Sciences is the top dog in related patent filings, in protein-based drug research (which should become a very large part of the biotech industry), and in internally developed drug candidates. HGS's market capitalization is the second-largest among young, drug-less genomic biotechs. It stands at $8 billion versus Millennium's $12 billion. HGS has a goal of having a deeper product pipeline than Amgen (Nasdaq: AMGN), a $74 billion company, and more blockbuster drugs. Amgen has two -- Epogen and Neupogen, both of which are signaling protein drugs.
In the past week, outstanding content has been written about HGS on the Fool discussion boards. That content is where I send you now. As we continue our Break Down and make our purchase decision in the next few weeks, I will assume that you have read the following articles about Human Genome Sciences if you are indeed interested in the company. In other words, the following is your highly-suggested homework if you are considering the company...
Last week, Fool community member and physicist Ricaard Corrado (screen-name rcorrado) wrote a full explanatory analysis of Human Genome Sciences, including RB analysis, and offers many links to related analysis.
Next, Soapbox author ElricSeven (seller of the report, Harvesting the Human Genome) posted his analysis of HGS's top dog and first mover status, which we offer here to flesh out our own analysis of this criterion.
Finally, Fool Mike Paquette (mpaque) compared Millennium vs. HGS on all RB critiera, including top dog and first mover analysis, which further fleshes out this criterion for us.
RB Criterion #2: Sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition.
HGS has potential for vast sustainable advantages. The company's early focus on proteins has led to 8,000 patent filings. Importantly, HGS believes at least 80% of its filed patents are novel, meaning that in most cases other companies will not have prior rights or earlier patents than HGS. (So far, less than 200 of the HGS's filed patents have been reviewed and issued. It takes time, so guessing who was first is a science in itself.)
Human Genome Science's patents could prove very lucrative because drugs created by other companies based on HGS's patents (whether intentional or not) should result in royalty payments. The number of drugs that fall into this category could be large, because the company believes that it has filed patents on about half the signaling proteins in the human body. For more details, patent attorney Greg Carlin (a.k.a. ElricSeven) wrote four pages about HGS patents and biotech patenting in general. He wrote much more about HGS's patents in particular in his Soapbox research report, Harvesting the Human Genome.
Interesting Drugs in the Pipeline
HGS has started to develop its discoveries into drugs in its Functional Genomics Program. Under this end-to-end program, HGS collects data on full length genes, analyzes the data in a lab (not only on computers, as many other companies do) and catalogs results. It puts most promising compounds through more tests. HGS has three drugs in human clinical trials and several more potential drugs in the wings. (Remember, it usually takes a decade or more to develop a preclinical drug, although HGS does believe it can speed the process, partly because its drugs are not "artificial" -- they come from the body -- and should result in fewer side effects.)
HGS's goal is to create drugs that serve very large medical needs that are currently under-served. It has two drugs in phase II (of III) trials. One drug is a growth factor protein that rebuilds cells that make up almost one-third of the body. This drug is targeted to repair layers of skin (including chronic or severe wounds), the mouth and throat lining (including during chemotherapy), and the gastrointestinal tract and other organs. It is called repifermin, or Keratinocyte Growth Factor-2 (KGF-2).
Also in trials is Mirostipen, or Myeloid Progenitor Inhibitory Factor (MPIF) -- try saying that just one time fast. MPIF is also a human protein. In trials, it increases the safety of anti-cancer treatments by (from the website), "reducing their toxic effects on the blood-forming tissues in the bone marrow. Mirostipen may be one of the body's natural signals to stop making additional cells of the blood and immune systems because a sufficient number are present." So, when it is working properly, MPIF may regulate cells in the blood and immune system. Using it may make it possible to turn off blood-cell creation during chemotherapy, so that toxins don't kill the new cells, and then turn it back on soon after treatment. This blood-cell "protection" could significantly increase cancer survival rates.
Also in human clinical tests is Vascular Endothelial Growth Factor-2 (VEGF-2), another natural human protein. VEGF-2 stimulates the growth of blood and lymph vessels, so it may have great potential as a treatment for coronary artery disease or to grow new, life-sustaining blood vessels in otherwise dying limbs. Human trials, being monitored closely by the FDA, should soon resume.
Finally, a new HGS discovery is especially exciting: the identification of a B Lymphocyte Stimulator, or BLyS. From the company website:
"This human protein stimulates the body's immune system to produce antibodies, which are its first line of defense against infection. BLyS has the potential to treat many serious immune deficiency diseases and has moved quickly through pre-clinical testing. Plans are now in place to test BLyS with patients suffering from various forms of immunodeficiency. Our pre-clinical studies suggest that BLyS also may be useful in treating acquired immune deficiency that results from infection with the AIDS virus, as well as immune deficiencies caused by certain cancers, and as a consequence of medical procedures such as organ transplantation. In addition, BLyS may be used to boost function of the immune system of elderly adults."
The company's products (or pipeline) are described in detail on its website. Since these are all protein-based drugs, if you want to learn more about proteomics, consider the Soapbox report: Proteomics - The Coming Revolution?
RB Criterion #3: Good management and smart backing.
Chief Executive Officer Dr. William Haseltine has a doctorate from Harvard, has founded seven biotech companies since 1981 (each one in a different area of medicine and each one a success) and helped launch 20 others. Dr. Haseltine founded the first educational department for research on AIDS in 1984, at the Dana-Farber Cancer Institute, and is world-renown for his research on the virus.
Last week, the L.A. Times published an excellent column about Haseltine and his company. Take five minutes to read the article, titled "An Ego in a Lab Coat." (Upon meeting Haseltine in January, he does display an air of arrogance, as critics complain, but it isn't overly brash. He's just very confident. In fact, I might wish that everyone were that way. I enjoyed the day with him and left with only good impressions.) Also, Fool contributor Mike Paquette (mpaque) took a closer look at Dr. Haseltine in a post.
In January, I also met the VP of research and development, the CFO, and the VP of drug development for a day -- all seemingly kind, smart people. I especially found the VP of drug development, Dr. Stump, to be a smart and sincere individual. He didn't hype the drugs that HGS is working on, although he could have. Instead, he was very realistic. Overall, I'm convinced HGS has strong management. The company's website has profiles of the team.
RB Criteria #s 4, 5, 6: Excellent past share appreciation, measured by relative strength of 90 or higher; the greater the consumer brand, the better; and a significant portion of the financial media has called it overvalued.
This stock has a relative strength of 96 as of August 28; the company doesn't have a consumer brand known by most consumers, so it loses points here; and, unfortunately, we don't have Barron's saying that HGS is worth just $3 per share, nor do we have other media moguls attacking this complex, young company. Another RB point is lost.
Conclusion on HGS
Measured on the most important RB metrics, in my opinion -- top dog and first mover in an important, emerging industry, sustainable advantage and great management and backing -- I believe that Human Genome Sciences is a Rule Breaker.
Note that we did not address risks: HGS has raised over $800 million so it has enough cash for several years. This is vital because profits are nowhere on the radar. HGS will begin to resell its database of information in 2001, and eventual royalties may be considerable. However, the company needs drug sales, too, and all of its current drugs could fail to reach the market. So, the risks are very high.