Bullish Thesis for Biotechnology Remains Intact

At the start of the year I provided a positive outlook for the biotechnology industry in 2009, citing the sector’s defensive characteristics, favorable technical aspects, and improving fundamentals, such as the number of new product approvals, products in clinical trials and the brisk pace of industry consolidation and licensing transactions.

With January officially on the books, it appears an appropriate time to revisit this bullish biotechnology thesis. After all, there’s a saying on Wall Street: As January goes, so goes the rest of the year.

However, while a gain in the S&P 500 during the month of January has led to a positive overall year for stocks 85 percent of the time, the so-called January barometer may be no better than the proverbial toss of a coin when the month’s return is negative. The most recent example being 2003, with a positive return greater than 25 percent for the full year despite a negative 3.5 percent return during January. That may be good news in view of the fact that both the S&P 500 and Dow Jones Industrials lost nearly 9 percent for the month in 2009.

In contrast to one of the worst yearly starts for the broader market, the NASDAQ Biotech Index (NBI) was virtually unchanged during January 2009. In fact, the NBI has been outperforming the S&P 500 since mid-2008. This strong relative performance may signal that defensive industries like biotechnology remain in vogue with investors.

In addition to this defensive attribute, my previous column pointed out that new drug approvals by the FDA during 2008 were the highest in three years. With more money and greater resources, new drug approvals by the FDA could accelerate during 2009. This is important, as there are currently more than 400 biotech drug products and vaccines currently in clinical trials targeting more than 200 diseases according to Ernst & Young and BIO (Biotechnology Industry Organization).

2009 is off to a decent start with the mid-January FDA approval of Savella™, a selective serotonin and norepinephrine dual reuptake inhibitor for the management of fibromyalgia by Forest Laboratories, Inc. (FRX) and Cypress Bioscience, Inc. (CYPB). Additionally, Galderma Laboratories, L.P. received FDA approval for Vectical™, a unique vitamin D3 product for the treatment of mild-to-moderate plaque psoriasis in adults.

From a technical perspective, last month’s column introduced an indicator called the Bullish Percent, based on the percentage of stocks in an industry group or index that are currently trading above their 200-day moving average, and discussed how the indicator had turned positive for the NASDAQ Biotech Index going into the New Year.

But the field of technical analysis encompasses a variety of indicators to gauge the direction of the market and the Bullish Percent is just one arrow in the quiver. Technicians also keep a close eye on the number of stocks making new 52-week highs and lows.

In view of the poor performance logged by the broader indices in January, it’s not surprising that a paucity of stocks made new 52-week highs during this period. Interestingly, of the mere half-dozen NASDAQ stocks reaching new 52-week highs on a daily basis during the month of January, many were biotechnology companies.

For example, companies working in the field of stem cell research, such as Geron Corporation (GERN) and StemCells, Inc. (STEM), frequently appeared on the new 52-week high list during the month. Anadys Pharmaceuticals Inc. (ANDS), Repros Therapeutics Inc. (RPRX), and Maxygen, Inc. (MAXY) also frequently appeared on the new high list throughout January. Myriad Genetics Inc. (MYGN), which commercializes molecular diagnostic tests that can determine if a person is predisposed to certain cancers, exceeded prior 52-week high territory throughout the month of January and continues to do so after reporting strong second-quarter earnings this week.

Another biotechnology company that reached a 52-week high during January is CV Therapeutics, Inc. (CVTX), which received an unsolicited proposal from Astellas Pharma Inc. to acquire the company. Indeed, merger and acquisition activity along with licensing transactions remain brisk and is central to the bullish outlook for biotechnology.

In addition to CVTX, M&A activity since my last column includes (acquirer/target): The Medicines Company (MDCO)/Targanta Therapeutics Corporation (TARG), Pfizer Inc. (PFE)/ Wyeth (WYE), and an option for Cephalon, Inc. (CEPH) to acquire Ception Therapeutics, Inc. Recent major licensing transactions include (licensor/licensee): BioMarin Pharmaceutical Inc. (BMRN)/La Jolla Pharmaceutical Company (LJPC), Myriad Genetics Inc. (MYGN)/Panacos Pharmaceuticals, Inc. (PANC), and Bayer Schering Pharma AG/Micromet, Inc. (MITI).

I also previously noted that upcoming conferences offer an excellent opportunity for biotechnology leaders to generate momentum for the industry in the year ahead. Next week, a total of 150 companies will present at the BIO CEO & Investor Conference held February 9-10, 2009 in New York. Now in its eleventh year, the BIO CEO & Investor Conference is the largest independent investor conference for the life sciences industry focused on publicly-traded biotechnology companies.

To provide a fair balance of information, it is prudent to reiterate that the capital markets remain turbulent and there may be casualties along the way among undercapitalized biotechnology companies. According to industry statistics compiled by BIO in January 2009, 120 companies are trading with less than 6 months of cash on hand and 180 companies have less than 1 year of cash.

However, hope remains that the Net Operating Loss (NOL) refund provision that BIO has been advocating will be included in President Barack Obama’s economic stimulus options to promote innovation and job creation. Unlike bailouts, the NOL refund provision could allow biotechnology and other research-intensive industries to accelerate the utilization of their existing tax assets. As an example, a company with $100 million in accumulated NOL’s could potentially claim a refund of $20 million on their 2008 tax return.

The proposal is modeled after a New Jersey State law that went into effect in 1999 allowing emerging technology and biotechnology companies to sell net operating losses and unused research and development credits to get the cash they need to flourish. Profitable companies paying New Jersey corporate tax buy these credits and use them to reduce their state tax obligation. The main difference is that the government would provide the cash directly if the federal tax law change is approved as proposed under BIO’s NOL refund provision.

Using history as a guide for the potential benefits of the NOL refund provision, Celgene Corporation (CELG) was one of the first companies that benefited from New Jersey’s tax-credit transfer program and has since become the largest biotechnology company in New Jersey and one of the world’s largest as measured by market capitalization.

The bullish thesis for biotechnology in 2009 remains intact, as evidenced by the sector’s defensive characteristics and favorable technical and fundamental attributes. The favorable outlook is further bolstered by the sector’s relative outperformance during January 2009.

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Disclaimer: This article contains the author’s own opinions, and none of the information contained therein constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. To the extent any of the information contained in the article may be deemed to be investment advice, such information is impersonal and not tailored to the investment ne
eds of any specific person.

2009: Positive Perspectives for Biotechnology

After a brief bout of euphoria during the early portion of the decade, the biotechnology industry, as measured by the Amex Biotech Index (BTK), was shunned by investors for the better part of the 1990’s. The BTK, which was established with a benchmark value of 200 on October 18, 1991, declined by 50% to nearly 100 seven years later (around mid-1998) despite improving industry fundamentals, including record levels of late-stage clinical trials, new product approvals, profitable biotechnology companies, and industry merger and acquisition activity. With this in mind, and being somewhat of a contrarian, it was July 1998 that I first started publishing an investment newsletter focusing on biotechnology.

The BTK quickly doubled from its low and reclaimed the 200 level towards the end of 1998. Over a two-year period, the BTK rose from approximately 100 to 800 – from September 1998 to September 2000. In other words, $10,000 invested in the BTK stock index would have turned into $80,000 during this two year period.

But similar to the experience of the 1990’s, exuberance turned to despair in the early portion of the new millennium. Once again, it took the BTK seven years to rise above the high of 800 achieved during the year 2000.

By mid-2008, the BTK nearly reached 900 and was outperforming the broader market. Analogous to 1998-2000, it looked like another multi-year biotechnology bull market was beginning – that is until the equity market meltdown that occurred in the second half of the year.

Indeed, 2008 is a year that many investors would like to forget. The Dow Jones Industrial average recorded its worst annual performance since 1931 and the NASDAQ Composite had its worst year since inception in 1971. On the heels of such a miserable year, it may seem counter intuitive to provide a positive outlook for the biotechnology industry in 2009, but there are both fundamental and technical attributes worth considering.

Defensive Sector

The biotechnology sector is often portrayed as defensive given that disease is relentless in both good economic times and bad. Despite medical advances, there remains a need for quality, innovative products to diagnose and treat a broad variety of diseases such as cancer, central nervous system disorders, cardiovascular diseases, diabetes and infectious diseases. This defensive characteristic appears to have held true in 2008 given the 13% decline in the NASDAQ Biotech Index compared to declines ranging from 30 to 40% for the major market indices, such as the Dow Jones Industrials, S&P 500, and NASDAQ Composite. With all of the uncertainties going into 2009, defensive industries like biotechnology may remain in vogue.

More Resources for FDA

Beyond its defensive attribute, new drug approvals by the FDA during 2008 were the highest in three years. Of course, cynics will rightfully call attention to the quarter-century low number of approvals in 2007, that the FDA failed to decide whether to clear many products within the timetable established by Congress during 2008, and that 2008’s performance still pales in comparison to the high of 37 new approvals in 1999. But viewing this in the context of internal resource constraints that have plagued the agency may provide optimism going into 2009, as legislation passed last year gives the FDA more money and resources in 2009.

The Bullish Percent

From a technical perspective, one market indicator turned bullish for biotechnology industry going into the New Year. This indicator, called the Bullish Percent, is based on the percentage of stocks in the broader NASDAQ Biotech Index that are currently trading above their 200-day moving average. A stock that is trading above its 200-day moving average is viewed bullish by technical analysts, while one trading below its 200-day moving average is viewed bearish. Accordingly, if 34 out of the 136 companies in the NASDAQ Biotech Index were currently trading above their 200-day moving averages – the Bullish Percent for the group would be 25%.

In general, Bullish Percent levels above 70% are considered overbought, whereas levels below 30% are considered oversold. However, just because a stock or sector is oversold doesn’t mean it cannot become even more oversold, so the Bullish Percent technical indicator doesn’t turn bullish until the level falls below 30% and then subsequently reverses up by at least 6%. Conversely, the Bullish Percent indicator turns bearish when it goes above 70% and then reverses down by at least 6%.

After the Bullish Percent hit a low of 5% on December 1, 2008, when a mere 7 companies were trading above their 200-day moving average, the indicator has been steadily rising and exceeded the 11% reversal level (calculated by taking the 5% low plus the requisite 6% reversal) required to turn bullish. In fact, the Bullish Percent reading was 21% as of December 31, 2008. Amgen (AMGN), ArQule (ARQL), Cubist (CBST), Cephalon (CEPH), Micromet (MITI), NPS Pharma (NPSP), Sequenom (SQNM), ViroPharma (VPHM) and Vertex (VRTX) are just a few of the 29 biotechnology companies trading above their 200-day moving average at that time.

Consolidation

Merger and acquisition activity remains brisk and may also generate renewed interest in the biotechnology sector as U.S. pharmaceutical companies stand to lose billions of revenue from 2010-12 due to patent expirations. Pfizer, Wyeth and Merck have recently indicated that they are on the prowl for acquisitions. In addition, the challenging financing climate may force many small biotechnology companies to combine for survival. M&A activity over the past year includes, among others (acquirer/target): Eli Lilly/ImClone, Takeda/Millennium, Roche/Memory, EUSA/Cytogen, Stiefel Laboratories/Barrier Therapeutics, and just this week – Endo Pharma/Indevus. Incidentally, both Endo and Indevus were trading above their 200-day moving averages at the end of 2008.

Investor Visibility

Upcoming conferences offer an excellent opportunity for biotechnology leaders to generate momentum for the industry in the year ahead. More than 300 companies will deliver presentations to thousands of investors next week at J.P. Morgan’s 27th Annual Healthcare Conference held January 12-15, 2009 in San Francisco. This event is the first and perhaps most important biotechnology investor meeting of the year, followed quickly by the BIO CEO & Investor conference held February 9-10, 2009 in New York.

On a more local level, and as the nation’s center of bioscience and pharmaceutical research and development, more than 300 members of New Jersey’s bioscience community will gather for BioNJ’s 16th Annual Meeting held January 22, 2009 at the Hilton East Brunswick, New Jersey. Featured speakers include Barclays Capital Vice Chairman Frederick Frank and Biotechnology Industry Organization (BIO) President & CEO James C. Greenwood, the former U.S. Congressman of Pennsylvania’s 8th District. For more information, visit the BioNJ website: http://www.bionj.org/

Conclusion

To be sure, the capital markets remain turbulent and there may even be casualties along the way among undercapitalized companies, but many of the biotechnology industry’s fundamentals, such as the number of products in clinical trials, new product approvals, profitable biotech companies and industry mergers & acquisitions remain favorable. Combine these positive attributes with yet to be seen benefits from decoding the human genome, an improvement or stabilization in the capital markets, greater resources for the FDA and a novel blending of technology, chemistry and biology and many of the necessary ingredients for The Biotechnology Revolution that I first proposed in December 1999 remain intact.

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Disclaimer: This article contains the author’s own opinions, and none of the information contained therein constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. To the extent any of the information contained in the article may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person.