Biotech's Strong Pulse

Nobody ever said investing in biotech is easy, but they do say it can be remarkably rewarding for those who pick the right stocks at the right time. Over the past four months, the sector has rewarded the faithful: the benchmark Intersuisse biotechnology index rose by 17% in the three months to September '” double the 8% rise of the wider ASX over the same period. In the week to 11 October, the biotech sector rose another 4% as the ASX fell by the same amount.

It’s a volatile sector: during 2004-05, as the ASX charged ahead the biotechnology index fell by 20%.

CSL, the blood plasma manufacturer, accounted for almost a third of the recent lift in the biotech index after it announced positive results with cervical cancer treatments. But CSL is a unique company even by biotech standards and its performance can skew results for the sector in the same way News Corporation results once skewed returns on the ASX.

More typically, the sector is represented by dozens of de facto biotech companies; that is, ones that actually develop drugs, such as flu drug company Biota, drug delivery company Norwood Abbey, respiratory drug developer Pharmaxis and nanotechnology specialist Starpharma. These companies have attracted strong investor demand over the past four months.

Why is biotechnology buzzing now? Alison Coutts, a director of EG Capital, a Sydney-based investment bank specialising in biotech, says: "We get strong runs followed by fallow patches; it's a pattern that has marked the sector for a long time.”

How long will the latest biotech bull run last? The consensus among stockbrokers, investment bankers and biotech executives is that the sector will remain strong at least until the end of the year.

There are four related reasons for the latest burst of activity in biotech stocks:

• The sector underperformed a strong ASX for the year to June 2005.
• In the last quarter, positive sentiment returned to the sector after good news from leaders Biota and CSL.
• Retail punters, fresh from success in junior mining stocks, moved across to the biotech sector.
• Australian life science extended its global reputation with another Nobel Prize for Medicine; Barry Marshall and Robin Warren won the prize this year for their discovery that peptic ulcers were caused by infection, not stress. (Australia also won the Nobel Prize for Medicine in 1996 for Peter Doherty’s and Rold Zinkernagel’s work in the immunity area.)

As Jonathan Buckley, a director of stockbroker Intersuisse, suggests: "The Australian biotech sector is unique; there is nothing like it anywhere in the world. There are only a few hundred biotech listings across the globe but at least 100 of them are based here in Australia. We have a well-supported retail base in our biotech sector, coupled with great science; that is most unusual by international standards. This high level of retail activity also characterises the market; there are a lot of early stage listings and there is a lot of capital raising. Investors should know that in many cases they are providing development capital to listed companies; in other markets this service is provided by private equity or big pharma (multinational pharmaceutical companies).

No biotech executive will put it so plainly, but the Australian biotech sector '” despite its top science and often high-minded ideals '” is a punter's market. Coutts of EG Capital gets to the heart of the issue when she says: "It is very hard to select biotech stocks, even when you understand the science; there are so many other factors that can influence the performance of a company."

Stockbroker Marcus Padley of Tolhurst Noall (who is also a columnist with Eureka Report), is more blunt: "This is a highly speculative sector and when some leading stocks start to move, then everything starts to move. There are few fundamentals in this sector, just opportunity."

Although many would argue the sector is not quite as bereft of financial indicators as Padley contends, most investors would find it nerve-racking to invest in companies that don’t report profits, and often don’t even have revenue.

In the absence of these financial fundamentals, the most important indicators for investors are “milestones”, the scientific hurdles that must be met by biotech companies in the development of drugs and devices. Classic milestones include completing trials on time and winning market approval by regulators such as the US Food & Drug Administration. Missing milestones is a big negative for biotech companies whatever the explanation.

The key driver of share prices for most biotech companies is stock exchange announcements. With many stocks having tiny market capitalisations, biotech stocks can be very easy to move on the ASX. Among the most lively stocks on the index are companies such as silicon manufacturer Psivda (market capitalisation $200 million), Norwood Abbey ($96 million) and heart device developer Ventracor ($246 million). Of the leading biotech stocks listed in the table below, most of the improvements relate to announcements or highly relevant news events.

For example, at Biota ($146 million), fears that the Asian bird flu would worsen and transfer to humans has triggered stockpiling of anti-flu drugs. Biota has an anti-flu drug in the market, and the stockpiling has led to Biota's share price tripling in the past month. Similarly, shares in pharmaceutical developer Scigen ($21 million) doubled after an announcement that the company had made a significant distribution deal in China.

However, stock exchange announcements are not alway what they seem. The management at animal health company Imugene ($19 million) were recently caught red-handed exploiting the announcement system. They were issued with a “please explain” directive after Imugene’s shares rose 28% from 16c to 20.5c in a single day's trading. Despite having issued a series of press releases featuring carefully constructed sentences about the negotiations for licensing and its pre-proof of concept for two poultry vaccines, Imugene was forced to announce that it had indeed made no progress and the share price reflected little more than “worldwide attention '¦ on the potential devastating effects of further outbreaks of bird flu.”

With even professional investors being wrong-footed on occasion, hype in the biotech sector a significant problem, especially for retail investors who do not have access to high quality information.

Among the non-performers in the latest biotech bull run are companies that had been market darlings in previous years. Compumedics, a stock that looked as though it could copy the success of sleep device maker ResMed, has fallen 24% since June. Peptech the human and veterinary pharmaceutical developer was one of the best-performing stocks on the ASX in 2001, but it has fallen by nearly 10% since June; and Agenix, a company that is best known for work on deep-vein thrombosis, is down 5%.
It seems biotech companies need to keep up a flow of good news to avoid falling out of favour with investors. As Intersuisse said in a recent biotech report: "The reasons for falls in prices are often hard to foresee or classify."

Eventually '” outside of announcements, hype or roller-coaster index trends '” the success of biotech companies will come down to top science combined with first-class management. The combination of both these forces is very rare. The science comes first. Within the Australian biotech sector are several specialist sub-sectors, one of which is wound healing. If you wish to read about this intriguing area of life sciences, see today's contribution to Eureka Report from David Blake and Mark Pachaz of Bioshares.