With a stream of drug approvals going through and M&A activity on the increase, the biotech sector could generate double digit returns in the coming year
Concerns about the uncertainties of the war with Iraq, rising political tension with North Korea and continuing economic uncertainty have caused investors to overlook the positive developments in the biotechnology sector.
Since the sector bottomed in July 2002, biotechnology stocks have generally gone up reflecting more positive fundamentals for the sector. First and foremost, the excesses of the genomics bubble have washed away and valuations are in line with historical norms.
Secondly, the Senate confirmed Dr Mark McClellan as the next FDA commissioner. Already, we have seen a number of drugs either approved, or recommended for approval. Thirdly, many of the large biotechnology companies posted strong earnings growth throughout 2002 and have provided upbeat forecasts for 2003 and beyond.
We are projecting 21% earnings growth for the biotech sector, compared to a figure of about 12% for big pharmaceuticals. On a P/E basis, biotechs trade at a 50% premium to big pharmaceuticals, but much of that is due to incorporating the higher earnings growth rates for biotech. On a P/E to growth basis, biotechs actually trade at a significant discount to the big drug-makers. A biotech stock typically becomes profitable two-to-three years after it launches its flagship drug. As such we expect a whole host of companies, including Trimeris, CV Therapeutics, United Therapeutics Corp, Intermune and Cubist Pharmaceuticals Inc., will reach profitability by 2005.
This year will see an increase in drug applications and approvals, partly because several prominent new drugs were delayed in 2002. Some of the prominent new drugs we expect to come to market in 2003 include Flumist a nasally-administered flu vaccine which MedImmune acquired when they merged with Aviron in early 2002. This drug has been delayed since the summer of 2001, when the FDA expressed concerns about its efficacy and safety. That hurt Aviron's stock price, allowing MedImmune to buy it rather cheaply.
FluMist was again delayed in 2002, due to some more efficacy concerns. Finally, in December 2002, an FDA Advisory Committee recommended approval for Flumist. We have, however, been positive on FluMist all along and we believe it will come to market in a few months. I don't think this will be a blockbuster drug; but I expect it to generate annual sales in the neighbourhood of $400m to $500m.
It will be an important growth driver for MedImmune for several years. MedImmune is now partnering with drug giant Wyeth to market FluMist. MedImmune's lead compound is Synagis, which is used to treat respiratory syncytial virus in infants.
This is a $700 million drug. One of the most intriguing drugs on the horizon is Fuzeon, an HIV drug belonging to Trimeris and its European partner Roche. Fuzeon has had some very good Phase III clinical data, and HIV doctors are excited about it. It will probably be launched in March and Trimeris should start seeing profits on it by 2005. Fuzeon should see annual sales in the $500m to $600m range. However, the company has some problems in manufacturing the drug large-scale, so they may face some capacity constraints for a few years.
Amgen's purchase of Immunex in 2001 garnered some criticisms ' some commentators felt that Amgen overpaid. As a result of the takeover, Amgen launched a new rheumatoid arthritis drug, Enbrel. This is a drug that we are extremely bullish on. In the long-term, we consider that this has the potential to generate annual revenues of several billion dollars. Not only do we think that Enbrel has a great deal of growth left in the rheumatoid arthritis field, we also think it is the long-term winner among biologics for psoriasis. This would make the $16bn price tag for Immunex seem like a bargain.
Another genuine blockbuster is Rituxan, marketed by IDEC Pharmaceuticals. It has just exceeded $1bn in annual sales. We think it will continue to grow. IDEC recently signed collaboration with Biogen to co-develop three cancer drugs from Biogen's early-stage pipeline.
These types of partnerships (that is, between two biotech firms) will become more common. The large biotech companies have the cash and infrastructure to be an attractive partner for smaller biotech firms. Moreover, some of the big biotechs are facing weakening drug pipelines, and they will increasingly need new products.
Another aspect of the biotech sector that we are watching keenly this year is M&A activity.
After the big three biotech mergers were announced at the end of 2001, the most notable being Amgen and Immunex, we thought 2002 would witness a huge wave of M&A. But it didn't happen and that surprised us, since we need to see more consolidation in the industry.
In biotech you basically have two types of company: companies with no products but lots of cash; and companies with no cash but with a product. Therefore, it makes sense for these two types of companies to merge. I expect to see some mergers this year, particularly from the big biotechs, which have large reserves of cash.
Big pharmaceuticals are another matter entirely as they are very sensitive to earnings dilution. If a biotech company is profitable, it will be expensive to buy; if it is not profitable, it will dilute the prospects of the company because they are cash-burners.
So, one way or another, buying a biotech stock will be dilutive to the acquiring big drug company. The one exception to this would be Johnson & Johnson, which I believe will snap up biotech companies this year.
Their subsidiary Cordis is about to launch drug-coated stents, which will accelerate their growth. Thus, it could use the upside to acquire some biotech stocks.
Indeed, February was most notable for the increase in M&A activity in the sector. At least six deals occurred in the month including an acquisition by a pharmaceutical company, two public biotech deals, and a number of public-private combinations. JNJ purchased Scios, one of our holdings, in order to gain rights to the recently launched Natrecor for congestive heart failure as well as a product in Phase II with the potential to treat rheumatoid arthritis.
Two companies announced small acquisitions to boost their portfolios. Cephalon acquired SirTex in a cash deal valued at $161m in order to add a marketed product to its portfolio. The deal brings them SIR-spheres, a treatment for liver cancer recently approved worldwide. OSI Pharmaceuticals acquired Cell Pathways for $32m in stock. The deal adds a couple of oncology products; one in Phase III, one in Phase II and a small, marketed product for the treatment of mucositis associated with chemotherapy.
The most significant deal was the merger of NPS pharmaceuticals and Enzon. The deal was particularly intriguing because it combines a traditional development stage biotechnology firm with a specialty pharmaceutical company providing cashflow from its royalty stream.
The deal provides NPS with the finances to invest in its strong pipeline, and leverage to negotiate a strong marketing partnership with a pharmaceutical partner for its osteoporosis drug in Phase III trials.
For Enzon, the deal provides a source of future growth, as it has become increasingly competitive to acquire marketed products that fit the specialty pharmaceutical business model. The deal has not been well received by the market, as each of the companies had a different shareholder base, yet we feel it will be positive in the long term for NPS.
Another factor that has played against the big pharmaceutical companies entering into deals with biotechs was the Erbitux/ImClone fiasco, but this hesitation has been short-lived. In fact, just recently, we saw Pfizer signing a couple of huge deals, including a $400m agreement with Neurocrine Biosciences (NBIX) to develop Indiplon, Neurocrine's insomnia drug. We expect to see many more similar arrangements between big pharmaceuticals and biotechs as there are numerous un-partnered compounds on deck. Recognising that product pipelines at pharmaceutical companies are still fairly weak, we think the terms of these partnership agreements will become increasingly lucrative for biotech firms.
Overall, we have a very positive outlook for the biotech sector in 2003, after a particularly poor 2002.
Drug applications and approvals will increase this year and will drive growth.
There should be mergers this year from big biotechs with large reserves of cash.
Biotech companies will benefit from the relatively weak product pipelines from pharmaceutical companies.
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