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Why you shouldn't bank on quick gains from biotechs

Nicki Bourlioufas  |  25 Sep 2017Text size  Decrease  Increase  |  
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While some biotechnology companies will be successful and make big profits, many others will fail. Investors hoping for a quick gain should be wary and be prepared to wait for success.

 

It can take years for a biotechnology company to make any money. A company's viability and profitability will depend on several factors, including the success of drug trials, the number of products a company has, and whether approvals from government bodies are achieved.

Any sign that a medicine doesn't work or that a company can't get a patent to protect its drug can cause a sharp drop in a company's fortunes, says Chris Kallos, healthcare equities analyst at Morningstar.

"Investors are investing in an opportunity and hope the company's shares may rally if the drug is successful. But in the early phases, businesses may be generating little revenue," says Kallos.

"But if the market for the drug is very significant, then the commercial opportunity can be significant, subject to the success of drug trials and FDA approval."

In a typical biotech scenario, the company develops an idea for a product, raises capital to fund its development and then commences clinical trials--a multi-year process and a highly risky one given that the outcome is far from certain.

In addition, the ASX-listed biotech market is quite small, which adds to volatility for investors.

Kallos cites the example of Acrux (ASX: ACR), an Australian drug delivery specialist focused on developing transdermal pharmaceutical products. The company's lead product, Axiron, was marketed in many countries, including the US, by former licensee partner Eli Lilly for low testosterone levels.

Its proprietary technology, the topical formulation that carries drugs into a patient's body, was FDA approved. But subsequent restrictions imposed on the way the drug could be prescribed, a failed patent infringement case, and the loss of a licensing agreement with Eli Lilly have shattered the company's share price.

"In recent weeks, Eli Lilly terminated at a licensing agreement with the company, given competition from generic products. That was the final straw for Acrux," Kallos says.

"This highlights that even when a company has a licensing deal in place, FDA action such as tighter prescribing conditions can affect the value of the company. It also highlights that a patent infringement case might fail, which has opened up the company to competition from generic products."

For Acrux, Kallos believes the risks now "are skewed to the downside". He has lowered his fair value estimate for no-moat Acrux to 13 cents per share from 40 cents. Acrux shares are currently trading around 15 cents.

Another example of the high level of risk and disappointment is Sirtex (ASX: SRX). While its shares have traded as high as $40, they are now around $14.40. Sirtex has been struck down several times after disappointing trials of its liver cancer drug, which the company had hoped could be used for early stage cancer treatment rather that late stage cancer treatment or "salvage" therapy.

The start of the fall was in March 2015 when Sirtex announced that trials of its SIRFLOX liver cancer treatment, SIR-Spheres, had failed to show a statistically significant increase in survival in patients with liver cancer. This news wiped $1 billion off Sirtex's market value as the stock fell from around $40 to just $15.

In August, Sirtex's shares plunged again after it ended a difficult year with a $26.3 million loss. A $90.5 million asset write-down and restructuring costs led to the loss.

So, the highs can be very high, but the lows can be even more dramatic.

"Our scenario analysis shows that the intrinsic value for Sirtex shares lies between $24 and $9 per share, leading to our very high uncertainty rating," says Kallos.

"Our bull case generates a fair value estimate of $24 per share, and assumes that sufficiently supportive findings will be rendered from the Soramic trial to justify using SIR-Spheres in earlier treatment settings for advanced liver cancer.

"However, our bear case assumes that all current clinical trials fail to render data supportive of a move beyond salvage therapy."

According to Kallos, factors to look for before investing in a biotech include whether a company has a potentially big market for its drug or therapy, approval status, management with experience in the pharmaceutical or biotechnology fields, and product and advancement in the development of the drug.

Another way to spread risk is by investing in a managed fund with exposure to the biotechnology sector, "because picking winners in this space is very difficult," says Kallos.

As an example, Colonial First State's Global Health & Biotechnology Fund [6638] seeks long-term capital growth by predominantly investing in companies globally whose primary business is in the fields of pharmaceuticals, biotechnology, and healthcare services and products.

Over the three years to 30 June 2017, the fund has returned around 20 per cent, compared to the benchmark's 14.6 per cent. Top holdings include multinationals Eli Lilly & Co, Abbott Laboratories, Allergan, and Bristol-Myers Squibb Co.

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Nicki Bourlioufas is a Morningstar contributor and owns shares in Sirtex. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

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