Buyside, April 2005

Last September, when Merck (MRK) whisked Vioxx off shelves, the once-successful pain remedy became a catalyst for a shareholder stampede from the pharmaceuticals industry. As a result, the pharma components of the S&P 500 ended the year down 9.5 percent while the index as a whole gained 9 percent.

Investors who’d placed faith in the power of medicine are now looking elsewhere. Adam Chazan, life sciences analyst at California boutique Pacific Growth Equities, suggests clients “play a derivative of what’s going on in biotechnology.” He underscores three West Coast developers of clinical diagnostic tools: Cepheid (CPHD), Illumina (ILMN) and Invitrogen (IVGN).

Cepheid, based in Sunnyvale, Calif., makes genetic analysis and testing equipment. “It has a novel, fully integrated molecular testing technology,” Chazan explains, which uses less space and takes less time than competitive systems. “You get results in less than an hour and don’t need a highly trained staff or dedicated room,” he says. Perhaps that’s why Cepheid, which has a market capitalization of approximately $420 million, was chosen by the U.S. Postal Service (USPS) to provide anthrax-screening devices. “Implementation of the USPS contract will continue to drive value,” asserts Chazan.

The company hasn’t released 2004 results as of this writing, but Chazan expects to see reported revenue jump 158.4 percent last year to $47.8 million, climbing to $72 million this year and then $98 million by 2006. According his forecast, top-line growth should help the company cut its losses from 55 cents per share in 2003 to 34 cents last year and then to 13 cents this year. In 2006, the forecast is for a profit of 10 cents a share. Although Pacific Growth Equities doesn’t publish its price targets, Chazan’s January upgrade report anticipates a relatively conservative 44 percent upside opportunity in the stock over the next 12 months. “Realistically,” he says, “we’re not likely to see anything pop this year, but steady appreciation will reward patient investors.”

Illumina has similar long-term growth potential. With a market cap of some $376.2 million, the San Diego-based maker of genetic analysis tools is on the forefront of drug development. Its products are used for genotyping and gene expression assays. “There are already drugs tailored to specific populations,” Chazan clarifies, citing NitroMed’s (NTMD) BiDil, an experimental congestive heart failure treatment that’s shows enhanced effectiveness in African-Americans. “The age of personalized medicine is here, and Illumina enables researchers to detect differences in individual genomes at a low cost.”

Chazan forecasts the company to report $52 million in revenue for 2004, a year-over-year increase of 85.7 percent, while cutting its losses 65.9 percent to 29 cents a share. For 2005, he projects $72 million in revenue and a loss of just 13 cents a share.

Investors who need to concentrate on larger companies with positive earnings might prefer Invitrogen. The Carlsbad, Calif.-based maker of research tool kits for genetic engineering concerns has a heftier market cap of $4 billion and earned $2.24 a share in 2003 on $777.7 million in revenue. Chazan estimates the company made $2.91 per share last year on revenue of $1.02 billion and will report $1.11 billion in revenue and $3.37 in EPS in 2005. “It’s one of the dominant players in life sciences consumables,” he says. “It also sells cell culture media” in which researchers grow cells. “The company occupies a key niche in the biotech/pharma value chain.” Furthermore, at a recent $68, the shares “trade at a discount relative to peers,” Chazan notes.

BIG GROWTH PROSPECTS
If these three stocks require too much patience for capital gains to emerge, investors might consider more rapid growth opportunities. Tarrytown, N.Y.-based Progenics Pharmaceuticals (PGNX-PH,CR), for example, has several products on the cusp of regulatory approval — and these are treatments for conditions with massive market potential such as HIV and cancer. One program, methylnaltrexone, recently demonstrated a “dramatic” effect on post-operative bowel dysfunction, says Sharon Seiler, a biotech analyst at Punk, Ziegel & Co. who expects the stock to climb around 107 percent by the end of the year.

Because it’s delivered intravenously, methylnaltrexone was shown to work more quickly than existing oral treatments. Seiler expects Progenics, which has a market cap of $299 million, to enter the final stage of regulatory approval before the end of this year, and other drugs are moving behind it through the pipeline. “It could have a lot of regulatory catalysts over the next several months,” says Seiler, who expects the company to report revenue of $8.5 million for 2004, up 13.3 percent and growing to $9.6 million this year. Burn rate, however, will likely remain significant, although the losses should narrow to $2.59 per share this year.

Two other opportunities on Seiler’s growth list are Genitope (GTOP-CR) and VaxGen (VXGN-PH,CR). Based in Redwood City, Calif., Genitope is in late testing stages for immune-based cancer therapies like MyVax, a vaccine that targets the individual genetic makeup of B-cell lymphoma. Seiler anticipates MyVax to bring in $280 million in its first year on the market, soaring to $990 million by 2010. If she’s right, the company, which has built a market cap of $385 million on no revenue, could jump another 37 percent by year-end.

A somewhat more mature vaccine maker, Brisbane, Calif.-based VaxGen, has won an $877.5 million contract with the U.S. government to supply anthrax vaccine to the Strategic National Stockpile. However, even though the company did “nothing untoward” according to Seiler, the stock and its $466 million in market cap have been banished to the Pink Sheets. The company will likely operate a loss until 2006, when Seiler anticipates the federal contract to kick in to the tune of 56 cents per share in profit on a respectable $275.7 million in revenue. She sees 57 percent upside in the stock this year.

UNAPPRECIATED PIPELINES
Other experts highlight a variety of different companies, principally for unknown, misunderstood or otherwise unappreciated product pipelines. Jason Kantor, biotech analyst at WR Hambrecht & Co., endorses four names in this space: Cell Therapeutics. (CTIC-CR), Seattle Genetics (SGEN-PH,CR), Genaera Corp. (GENR-CR) and ImClone Systems (IMCL). “They’re all long-term plays,” he says, “but their undervalued drugs make them well positioned for performance in 2005.”
Cell Therapeutics, a Seattle-based oncology firm that makes less toxic and more effective cancer therapies, is likely to report positive trial data for its new Xyotax lung cancer treatment by the second quarter. “That will be a huge home run,” Kantor attests. Even if the program strikes out, the $568.9 million company has several other promising cancer remedies in development and should boost its revenue to $36.6 million this year and $201.6 million in 2006. Even though Kantor doesn’t expect the company to see a profit in that time frame, he still wouldn’t be surprised to see the stock climb 73 percent in the near future.

Elsewhere in the Pacific Northwest, Seattle Genetics develops antibody-based medicines to treat cancer and immune diseases like HIV. Based in Bothell, Wash., the company has a market cap of $237.03 million and reported revenue of $6.34 million in the most recent 12-month period. “Although there isn’t a single drug that’s likely to move the stock, Seattle Genetics has three promising therapies in clinical trials,” explains Kantor, who says shares have 183 percent upside potential at their current $5.65. He expects the company to grow its revenue to $14.5 million for full-year 2005 and $16.7 million in 2006, while operating losses should fall to 75 cents per share.

Moving east, Plymouth Meeting, Penn.-based Genaera, with a market cap of only $180 million, has an experimental treatment for age-related macular degeneration, the leading cause of blindness in adults. The drug, called Squalamine, is intravenously administered, which gives it a definite advantage over rival remedies that have to be injected directly into the eye, and Kantor expects a “strong likelihood of a big partner” to come along as a catalyst to push the stock up to 180 percent higher in the near term. Meanwhile, he says the company has the potential to boost its sales from under $1 million last year to $13 million in 2006, while cutting its losses in half.

Finally, New York City-based ImClone is best known for the scandal surrounding its former head Sam Waksal and one-time stockholder Martha Stewart, but the drug developer nevertheless has a strong balance sheet and, according to Kantor, remains undervalued at $41.40. The company is currently testing Erbitux, its already FDA-approved antibody for certain types of colorectal cancer, on head and neck cancers. While Kantor warns that investors will have to be both risk-tolerant and take a long view, he says the drug has terrific market potential in these added applications.

Big Bets in Biotech:

Big Pharma may be feeling the pang of product withdrawals, but upside beckons in the form of personalized medicine, platform plays and undervalued pipelines.