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Biotech Beat Down

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Finding value in troubled sector.

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My apologies for the long stretch between roundups. Neighborhood issues, city politics, and (oh yeah, my job) initiating coverage on a couple of new companies has kept me busy.

This market sucks. First, differential returns between "similarly risky" commodities, emerging markets, and biotech hedge funds saw money being pulled out of the lower performing biotech funds by the big Funds of Funds (FoFs). Then reallocation of illiquid failing debt investments to the "high risk" pool inside FoFs caused more forced biotech selling since the biotech names were liquid and the debt investments are not.

Not a week goes by that I don't hear about another biotech fund failure or significant redemptions. This creates strong selling on news, which causes biotech stocks that hit their milestones to stay flat or go down. This torques independent investors, and we get more selling.

I've written often about what it was like launching a biotech-only research outfit in October 2001, just as the biotech market fell off a cliff into 2002. This is starting to feel like 2002.

A hedge fund manager argues we're actually at worse valuations than 2002, and he has a point. Many of the biotech companies are further along than we saw in 2002, but their valuations are not getting credit for that advancement. I believe the sector isn't as bad as 2002 because we don't have as many companies trading at or below cash.

Can we get there? Oh yeah. I bet we get one more bounce mid-spring – April to May, maybe. Then the regular-as-clockwork seasonality will take over to where you can hedge you bio positions, pitch your tent on a beach somewhere (The Hamptons are out this year, obviously), and relax until August.

Nastech Spin-Off

Nastech (NSTK) CEO Steven Quay… oops, Dr. Steven Quay announced that the planned spin-off of the company's RNAi technology wasn't going to happen. (Read Fleck's good description of this technology as Nastech sees it here) With one partner and product failure after another, there is no way Dr. Quay can jettison probably the only thing left in the company worth the value.

My guess is that sometime before the BIO conference in June, Dr. Quay will announce that a "strategic review" of the company's assets and programs has lead to a cancellation of all programs other than RNAi. The subsequent presentation will be all about Nastech as a pure-play RNAi company, and will have at least as many slides about SiRNA (bought for a billion) and Alnylam (ALNY) (market cap $1.3 billion) as about his own company.

Biotech is the product of technology times management. The failure rate in this industry tends to make anyone critical of any biotech company appear smarter than they actually are, but I continue to think this is one you want to stay away from.

Genentech's Avastin

After some thought, I think the lesson from the approval of Genentech's (DNA) Avastin is the FDA's Office of Oncologic Drugs will approve anything that hits a primary endpoint. It is so stuck on biostatistics it can't see the forest for the trees.

Expect a rush of new trials being launched with progression-free survival (PFS) as an endpoint. Expect companies who achieve PFS then fail on survival, like Avastin did, to expect approval for their drug anyway. While I don't wish such failures on cancer patients or investors, it will be interesting to watch OOD's Rick Pazdur's face as he tries to rationalize turning them down: "Well, Genentech's lawyers are bigger than yours."

Bully for breast cancer patients, by the way. I wasn't against the approval of Avastin, I just find it offensive the way the OOD operates.

Avastin can now be more easily studied to determine which women benefit the most and which women are most likely to experience the side effects. If that can be determined from the data, it will be a good thing. That will happen much quicker with the drug on the market – as we learned when this same Richard Pazdur made essentially the opposite decision, gutting lung cancer patients' hopes and putting the brakes on research into AstraZeneca's (AZN) Iressa.

In a note to my firm's customers that Monday after approval, I said DNA – and the BBH since DNA is such a big part of that ETF – would likely see some lasting gains based upon the fundamentals. But, the rest of biotech would see a short halo effect and then end up back in the toilet. We covered most of the IBB short we had on our model Monday morning. That lasted exactly one week and now it's back.

Amgen Gets FDA'd

Question: Would you invest in a company whose primary product was under attack by government regulators and the largest customer?

Answer: No.

You can see why I am puzzled by the number of folks who want you to buy Amgen (AMGN) shares. As I noted before, the FDA will take another whack at the company on Monday. Johnson & Johnson (JNJ) has exposure to the meeting also, but its ESA is not as big a percentage of its business as Aranesp is for Amgen.

I think it highly likely the FDA panel recommends additional label cautions based upon new data showing increased cancer risk. They could even tell the FDA the label should be altered to remove anemia in cancer patients as an approved indication, but I doubt ODAC will be that aggressive after being slapped down by their boss in the Avastin approval.

And that brings us to the wild card. This ODAC panel was 'overturned' by the FDA in the Avastin vote. Are they going to be looking to aggressively make a point, will they be passive due to uncertainty concerning their opinion, or will it not matter?

If you think passivity is the most likely, then maybe Amgen gets nothing more than a request to run a specific safety trial exploring different target hemoglobin levels in cancer patients. That is not trial data I would want to be long in front of, but the fact is that trial would take until 2H-2008 to start and probably 2011 to see data. Given that, people might think Amgen is a buy with that kind of an outcome.

I would still tend to be leery of the company. I can see it overcompensating and trying to score a prominent biotech acquisition to shore up its sagged revenues. The big price the company paid for Vectibix is on indication of this, another may be the $100 million it coughed up yesterday for a Phase I drug.

With that caveat, the number of e-mails I get indicating people are itching to buy this name indicates a 'push' at the panel meeting could see some gains in the stock. I wouldn't want to be in front of the panel meeting, but you might want to put it on your radar.

Best Values in Biotech?

I get this question often, especially now. It is problematic for me because my firm only covers about 10% of the whole dev-stage biotech field, so there are some out there we're missing. That said, here are three that you should put on your pile of "Things to Research".

ZymoGenetics (ZGEN) saw a drug approved that will dominate a $300 million market and its stock went down. Competitors did a good job of snowing some analysts who should know better, at least one of which hasn't gotten the hint yet that he got took. Solid management, solid cash, solid pipeline, and coming proof of solid sales growth from RecoThrom that launched earlier in the year. And, by the way, it has no need to raise cash in 2008.

Repros Therapeutics (RPRX) could be the poster child for the hedge fund failure issue I wrote about above. Its decline from the mid-teens was brought about by people surprised by a longer regulatory path for its two products. Forced selling from fund redemptions and scared individual investors did the rest. The reaction to a data presentation from Italy was a good example. The data had been discussed at length previously, but scared investors imagined something was wrong. This is true dev-stage biotech, with all the attendant risks of a company with no products on the market, but I like this one a great deal.

Resverlogix (TSE:RVX) is a nearly unknown Calgary company which just might have the perfect pill for cardiovascular disease. It's pill stimulates the genetic pathway that produces HDL – the good cholesterol responsible for clearing your arteries of those $1 McBurgers you've been eating lately to save money. Much of the team and some of their board are from Esperion, the company Pfizer (PFE) bought in a bidding war in 2003 for over $1 billion. The knock on this company is it won't tell anyone how its drug works, which completely turns off (and rightfully so) most professional investors. If I didn't have a good relationship with the Esperion folks, I wouldn't touch this one either.

The company also had a history of being overly promotional, which I think is in the past. Pocket change until it comes clean on their drug's mechanism, for sure, unless you also know the Esperion gang well. This one is at worth getting familiar with in the meantime. If it works, it might be the world's first $20 billion drug.

Keep in mind with all three, though, I think the overall biotech sector will get worse before it gets better.

Positions in RPRX, ZGEN

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