COMMENT
Looking For Biotech Bargains, Part I

By Ed Bowsher (TMFArkle) (TMF Arkle)
October 21, 2005

Biotech is one of the riskiest sectors on the stock market, perhaps even the riskiest. But sometimes the rewards can be huge. Have a look at this share price chart for US biotech giant Amgen (NASDAQ: AMGN).

Back in January 1990, Amgen shares were available at a split-adjusted $1.07. They're now trading at around $74 that's almost a 70-bagger over 15 years! The shares have also done pretty well over the short-term - climbing 40% over the last year.

Amgen hasn't been the only US biotech winner. Others include Imclone (NASDAQ: IMCL) and Sepracor (NASDAQ: SEPR). Both companies have delivered stunning share price gains over the last ten years.

No UK biotech has delivered similar long-term gains. In fact, few biotechs on this side of the water have even got a drug to market. That said, some British companies are now making solid progress and are arguably undervalued.

So if you're tempted to make some investments in UK biotech, here's a guide to help you make your choice.

Don't put all your eggs in one basket

Investing in biotech is very risky. For every Amgen, there's a company like PPL Therapeutics, which cloned Dolly the sheep. PPL had exciting technology but made very little money, and left the stock market in 2003.

And biotech share prices can be very volatile. If the market as a whole declined over the next six months, I'd expect the biotech sector to fall by more.

What's more, if a drug fails a clinical trial, the share price can crash.. In April 2004, Antisoma (LSE: ASM) announced that a potential blockbuster drug had failed its final clinical trial, and the share price tumbled by more than 50%. The news was especially disappointing as earlier trials had suggested that the drug worked well. Unfortunately, I was an Antisoma shareholder at the time!

One way to reduce the risk a little is to spread your cash around several biotechs.

Pipeline

You also need to look at a company's drug development pipeline. The crucial question is: "How many drugs does the company have in clinical (human) trials?"

More drugs means lower risk.

Another issue is how far advanced are the drugs? Clinical trials for drugs have three main stages. Phase I trials test for safety. Phase II trials establish the best dose and are a first look at efficacy. Phase III trials are longer and larger, and are a more thorough test of efficacy.

I own shares in a small company called Alizyme (LSE: AZM). One of its attractions is that it has two drugs poised to enter Phase III trials. A typical Phase III drug has a 50 to 70% chance of success compared to a 10% chance for a Phase I drug. So a Phase III drug is very attractive.

These late stage products make Alizyme a less risky bet than stem cell player Reneuron (LSE: RENE), which has no products in clinical trials.

After a first glance at the pipeline, you need to figure out how much money a drug might make - assuming it ever gets to market. Say the drug is for breast cancer. How big is the current market for breast cancer treatments? Will the new drug be significantly better than current medicines? How much market share might the new drug gain? Figuring all that out can be tough.

Cash

Cash is a crucial issue for the biotech sector. Clinical trials can be eat up a lot of money. Most biotechs only have two sources of cash. Firstly, they can raise money from the stock market via share issues. Secondly they can out-license the rights to a development drug to a large pharmaceutical company.

If stock market sentiment towards the biotech sector is poor, share issues can be very dilutive and hit existing shareholders hard. Ideally, I'd prefer to invest in a biotech that has sufficient cash to keep the company going for at least 2 years.

In Part II, I look at some of the most interesting biotechs trading on the London market.

Ed owns shares in Antisoma and Alizyme.