Biotech Investors Hampered By Naivety About The Science

Researchers as well as analysts maintain that the industry's idiosyncrasies make Wall Street unnecessarily cautious After two years of a bear market, biotechnology analysts, industry officials, and researchers say they have learned some painful lessons about biotech investment, the lifeblood of the young industry. While theories vary on the reasons for what has been an erratic, often-wildly unpredictable market, many veteran industry observers cite two important and related factors: Investors really don't understand the science on which biotech is based or the nature of the regulation process it must go through; and the biotech industry itself does not conform to the rules and customs of Wall Street. Given the millions of dollars required for research and development of a single drug, many industry observers feel it is imperative for biotech scientists and research administrators to educate the investing public about their work and the nuances of Food and Drug Administration approval. Tim Cost, senior vice president of investor relations and strategic planning at Malvern, Pa.-based Centocor Inc., whose share price fell from $60 to $5 after FDA failed to approve its lead drug candidate, Centoxin, in 1993, stresses that investor knowledge is key: "The best thing we can do to limit wild fluctuations is educate the investors. We want to be measured by our real prospects, and not by one adverse event, or the psychology of the sector." Equally important, analysts say, is the need for management to resist the urge to reduce scientific staff to balance the books. The science, they emphasize, is these firms' greatest product. While there is some variation in assessing investor knowledge, virtually everyone interviewed for this article agrees that the setbacks in the biotech market have forced investors to learn more about the industry in which they are sinking their money. In the high-flying '80s, a time of stunning advances, analysts observe, it seemed that even the most unsophisticated investor could make money in biotech stocks. This was true for individual and institutional investors alike, who may not have fully understood the steps needed to, for example, complete a Phase III clinical trial, and a new drug application or product license application. When the tide turned, industry observers note, many investors discovered they had simply been riding a wave, with little understanding of why it crashed. Ray Cummings, vice president of business development at Celtrix Pharmaceuticals in Santa Clara, Calif., gives a personal example. His company's stock was trading near $12 per share in early 1994 but slid to the $6 range at mid-year when, along with the rest of the biotech market, Celtrix investors started selling off their shares. Cummings points out that in June, Celtrix announced an $80 million collaboration with Cambridge, Mass.-based Genzyme Corp., yet this positive development had virtually no impact on the stock. However, in late October, when Celtrix announced an early Phase III clinical setback with Betakine, an ophthalmic drug for macular holes, the stock plummeted immediately to the $2 1/2 range, and remains there. "Betakine represents our smallest business opportunity," Cummings complains. "We have other exciting technologies unrelated to Betakine with much greater commercial potential. If investors understood this, they wouldn't have sold immediately. Their actions resulted in a 65 percent drop in our capitalization." Cummings's experience not-withstanding, many biotech ob- servers feel that today, investors -- especially institutional ones -- are quite aware of the difference between Phase I and Phase III trials. Nowadays, they point out, positive Phase I announcements have little or no impact on a company's stock price, while negative Phase III results do move the share price. "By the time the product gets to Phase III [now]," Stone explains, "the expectation is much higher, so there may be more of a downturn in the stock if there is bad news." One example analysts cite is the case of Gensia Pharmaceuticals Inc. of San Diego, which saw its stock price plummet from an annual high of $253/4 almost a year ago down to its current $4 range after it announced Phase III disappointment with Protara, a cardiovascular drug. Carl Feldbaum, president of the Biotechnology Industry Organization (BIO), also contends that investors have become more refined in their reactions to biotech announcements, especially in the past six months. "Bad news is increasingly confined to the particular company or to the specific therapy it represents. Also, there is more realism about future successes." However, this newfound understanding does not always work out well for companies. San Diego-based Ligand Pharmaceuticals' stock price has not significantly increased, despite a series of positive announcements, including a new $100 million collaboration with Allergan Inc. on retinoid-based drugs; ongoing collaborations with Pfizer Inc. of Southport, N.C., Glaxo Inc. in Research Triangle Park, N.C., and German firm E. Merck; and significant investment by Abbott Laboratories of North Chicago, Ill. While Ligand's pipeline is filling with several FDA investigational new drug applications (INDs) and Phase I-II clinical trials, investors may understand that these compounds are a long way from market. Paradox On Wall Street Analysts say the erratic performance of the biotech market seems to reflect a basic incongruity of biotech and the stock market. For instance, good news in a specific biotech stock affects only that stock, while bad news for a specific firm seems to affect the broader market. David Stone, managing director and biotechnology analyst for the investment firm Cowen and Co. in Boston, goes one step further, suggesting that "sometimes even good news [for a company] does not affect its own stock. This is partially due to negative dominant psychology now in the biotech sector. In fact, just a few years ago, the reverse was actually true." Stone says that understanding this phenomenon requires some knowledge of the different types of investors driving the market. Today, there are "momentum investors," who make buying and selling decisions based on the performance of the stock, and not the company. In addition, there are short sellers, who, according to Robert McNeil, general partner of Sanderling Ventures, a venture capital firm in Menlo Park, Calif., "attempt to manipulate the media like crazy, especially if there is bad news. While this is a general Wall Street phenomenon, it is particularly exaggerated in this sector." Analysts contend that methods of evaluating biotech stocks are different from those used for the rest of the market. This, they say, is due primarily to three factors: First, investment decisions in biotech are often emotional ones. According to Stone, "Some people simply like to invest in potential cures, such as for AIDS or cancer. These types of investment decisions are more than purely economic. People are investing in hope." Second, biotech products are often in development for nearly a decade, meaning that many publicly traded companies have no sales. They are referred to as "development-stage companies," and classic Wall Street methods of evaluation cannot be applied to them. This has significant ramifications for investors, because they cannot turn to established ratios or sales history to make investment decisions. They often cannot even turn to their stockbrokers, who have no established models on which to base recommendations. Finally, the entire industry is new, less than 20 years old. Many biotech firms are less than 10 years old, meaning that analysts and investors do not know enough about the cycles and idiosyncrasies to do accurate forecasting in a business often driven by hope and fear. Ironically, because biotech is out of synch with more standard Wall Street investments, bad news can become good news, notes Enid Miller Alexander, a retail investment broker with A.G. Edwards & Sons Inc. in Atlanta. She points to a recent announcement by Upjohn Co. of Kalamazoo, Mich., to suspend a clinical trial for tirilazad mesylate_a candidate drug for head injury, stroke, and brain hemorrhaging -- owing to an unexpectedly high death rate. Share price fell $13/8 on the day of the announcement, only to rebound the next day by 7/8 because of renewed speculation that Upjohn could be a possible takeover candidate. Alexander says: "Because of the volatility in the sector, many of my clients are uncomfortable investing in biotech. At the first hint of bad news, investors will move their money to what they perceive to be safer investments, typically well-known, blue-chip names. Some biotech stock prices are so low right now that this is actually a good time to buy." In trying to explain market behavior, G. Steven Burrill, managing director of the investment bank Burrill and Craves in San Francisco, notes, "There are 265 publicly held biotech companies today, totaling approximately $40 billion in capitalization. Roughly half of this volume is contained in about 10 companies. About 100 of the 265 have less than $25 million in capitalization." Therefore, he says, it is difficult to speculate about upside potential and volatility, because one cannot paint a $20 million company with the same brush as one capitalized at more than $2 billion. Clearly, fluctuations and downward trends in the sector force companies to make decisions about how to stay in the game, but what part do scientists play in this effort? "When things go badly, you must look at your core competencies," Centocor's Cost says. "If your core competency isn't science, you're dead. When we began to rebuild Centocor, we determined that our core was R&D, clinical development, and manufacturing. Good science was critical to our turnaround, and will be critical in the long term." Karen Hedine, vice president of business development at ProCyte Corp. in Kirkland, Wash., echoes much of what Cost says. "Investors must get beyond the moment of the stock price, and look at a company's [science], and its long-term value," she maintains. "To help them do this, we've made a real commitment to communicating with our stockholders. We want them to know we have a seasoned management coupled with outstanding science. Also, we hold 33 patents, seek niche opportunities, and we study the uniqueness of technologies we develop or acquire." The company is hoping this strategy will help revive its fortunes. The stock declined sharply in late 1993, after FDA issued a directive that ProCyte stop a Phase III study for Iamin gel, a wound-care product for diabetic patients, as FDA wanted time to analyze data on patient deaths and cardiovascular events. Four days later, studies resumed when FDA concluded that the reported adverse events were part of the normal disease progression, and not due to Iamin gel. The stock did rebound, but fell again when late-stage studies showed equivocal results for Iamin when compared with placebo. According to Hedine, "Wall Street saw this as a failure. The Street does not seem to acknowledge the technology of this product, or of others in our pipeline. In a situation like this, the scientists become even more critical, as they continue to investigate what happened. Also, they play a key role in evaluating the science in new partnering opportunities." Cummings of Celtrix comments that some companies may have to scale back promising research when faced with a plummeting stock price due to a clinical disappointment: "Celtrix was able to go through restructuring without cutting programs, but when this happens, you must determine what your company does well." Because of biotech industry volatility, Cummings concedes, "I think there is a real limit to what a company can do. It is important to be very clear with the investment community, and not oversell the technology. But since there are SEC [federal Securities and Exchange Commission] requirements to disclose material events, disappointments will affect stock price, especially for the smaller companies." Whatever the problems and solutions to the crisis in biotech investment, analysts don't expect the situation to turn around quickly. Kenneth B. Lee, Jr., national director of life sciences industry services for Ernst and Young in San Francisco, remarks that currently, investors are reluctant to buy biotech issues. "Nobody wants to buy right now, and everybody who wanted to sell has already gotten out," he says. "People are still concerned about the impact of national health care, and the increasing power that managed-care mergers may have on pharmaceutical prices and formularies." Garnet of A.G. Edwards comments: "What the sector needs is enthusiasm. And for enthusiasm to come back into this market, it needs a few big wins. I don't expect this to happen in 1995 because there aren't enough momentous products with vast market potential finishing Phase III trials this year." ProCyte's Hedine adds: "Wall Street seems to be surprised and disappointed by so many failures, but many of us are surprised by so many successes in such a young industry." Ann Neuer is a freelance science writer based in Cincinnati.

Biotech Investors Hampered By Naivety About The Science

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