A guide to investing in biotech
Extracts from Bioshares and other contributed articles from the Bioshares team
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Four Events that can Trigger a Biotech Stock Re-rating
First published in Bioshares 34, August 8 2003
Investing in biotech stocks poses some interesting challenges. Valuation of a company is very difficult. Some assets are easy to value for example, cash, investments in other companies, property and equipment. Intellectual capital, which includes patents issued as well as pending, trade secrets and ‘know how’, freedom-to-operate and strategic position are much more difficult to value.

Investing in any asset is a risk evaluation exercise and biotech is no different. An alternative means to gauge investments is to place them at them on a scale of 0 to 100, where 100 equals maximum risk and zero equals ‘risk-free’, and begin to evaluate and value the company or asset by subtracting risk. In financial markets most investments are compared to government securities, ie 10 Year Treasury Bonds, from where the term risk free rate is derived.

For example, if a company sells products and generates cash flow and has done repeatedly for many years, and has grown sales and profits, then subtract 60 points. If the same company is granted a monopoly for its products in a major market, subtract another 10 points.

Much of the analysis of biotech stocks is risk subtraction, so what follows is a short guide to some events that subtract risk from biotech events. When they occur, an effective market should move to re-rate these stocks (ie the price of the stock should increase). Of course, that has not and will not always happen, because companies can be subject to a number of potential up and down re-rating events at the same time. And as recent events have shown, if there is weak or no demand for equities or a sub-set of stocks then no amount of good news will shift stock prices upwards.

Patent Issued in the US
Patents are a fundamental component of a biotech company’s asset. When granted they allow a company 20 years to exploit its invention (i.e. a drug) free of direct ‘exact copy’ competition. The largest and most lucrative pharmaceutical and healthcare market in the world is in the US and to not aim to secure rights for a product in that market would be financially very limiting.

Issued patents do not prove or indicate the commercial or technical prospects of a new biotech product. However, they are critical to the partnering prospects of small biotechs. In many cases, the prospective partners will simply not look at a company unless and until a company has achieved patent security in the US.

Filing an IND
An IND is an Investigational New Drug application set before the US FDA. An IND is similar to the Clinical Trials Exemption (CTX) and Clinical Trials Notification (CTN) schemes in Australia. An IND allows a compound to be tested in human trials in the US. Generally before the US FDA will approve a drug, it requires that some of the studies be conducted in the US (e.g. a Phase III study), although this is not mandatory.

An IND is significant because companies are required to meet with the FDA in a formal capacity and present their plans to the authority. The FDA is a rigorous organisation and companies must work to a high level to satisfy the FDA’s requirements. An IND meeting can influence a company’s plans and directions and impact on their chances of regulatory success.

Only a handful of Australian companies have been granted IND status, the latest of which was Starpharma for its microbicide, Vivagel. (see Bioshares 12 for an excellent summary by Judy Bingham of the IND process)

Confirming a Lead Molecule
The confirmation of a lead molecule is a significant event that concludes the drug discovery process and marks the cross-over into human clinical trials. The lead molecule is the one the company is declaring as the one most likely of many thousands to succeed in one or more chosen disease indications. It follows years of disease study, studies in bio-assays, medicinal chemistry work and pre-clinical studies in at least two animal models.

Complete Phase I Trial
A Phase I trial is designed to evaluate the safety of a potential therapeutic product, in healthy volunteers (Phase Ia) and in patients (Phase Ib). Measures of the Maximum Tolerated Dose (MTD) and a Dose Limiting Toxicity (DLT) are sought as are other indications of toxicity.

Phase I trials are usually conducted relatively quickly and in small numbers and their successful completion paves the way for the much more important Phase II trials, which begins the evaluation of efficacy. Some preliminary indication of efficacy can also be established in Phase Ib trials.

Summary
How can investors use the above information? Here is an example. Company A has two granted US patents, an IND accepted by the FDA, has completed three Phase I trials and has $10 million in cash. Company B has $15 million in cash and has just identified a lead molecule. Both companies have equally good boards and management. Both are targeting the same disease. Both are capitalised at $40 million. On the basis of the characteristics mentioned above, company A has subtracted more risk and therefore can be considered a preferred investment if the target markets are similar in size.

 
 
 
 
A Strategic Milestone in Drug Development: IND approval
First published in Bioshares 12, January 2002
By Judy Bingham – Kendle Pty Ltd
 
Submission and approval of an IND represents achievement of a strategic milestone in the drug development pathway, but one that should not be entertained lightly.

What’s an IND?
An IND (Investigational New Drug) is an application to the US Food and Drug Administration (FDA) seeking approval to commence clinical trials in the US.

The IND must contain information in three broad areas:
· Manufacturing – information on the composition, manufacture, stability and controls for manufacturing the drug substance and drug product. This information is assessed to ensure that the company can adequately produce and supply consistent batches of the drug.
· Animal pharmacology and toxicology – preclinical data to enable FDA evaluators to assess if the product is reasonably safe to administer to humans without undue risk. Also included is any previous experience with the drug in humans, eg trials conducted outside the US.
· Clinical protocols and Investigator information – detailed protocols for proposed clinical trials to enable evaluators to assess whether the initial trials will expose subjects to unnecessary risks. The suitability of proposed investigators and ethical issues are also assessed.

Review of an IND by the FDA, generally takes thirty days, although it may take longer if additional data or clarification of issues is requested by the Agency.

What’s a PreIND meeting?
Prior to filing an IND, a formal PreIND meeting is mandatory. The meeting provides an opportunity for the company to present their development plan for the drug to Agency staff and seek advice on questions such as:
· Is the preclinical program adequate?
· Is the CMC (Chemistry, Manufacturing & Controls) on the right track?
· Is the proposed track to an NDA (New Drug Application) marketing submission valid?

The quality of the background briefing document, identification of specific questions and seeking the agency’s support for the development plan are pivotal to a successful outcome of the preIND meeting.

Why file an IND?
Clinical trials cannot commence in the US until an IND is approved. Each country has specific regulatory requirements that must be met before trials can commence in that country. In Australia, clinical trials may be conducted under the CTX (Clinical Trials Exemption) or CTN (Clinical Trials Notification) Scheme. There is no requirement to file an US IND to conduct trials in Australia.

How is an IND filed and maintained?
The Guidelines for filing an IND are freely available on the USFDA Website. Companies must have a legal presence or sponsor to represent them in the US and liaise with the FDA on their behalf. For non-resident companies this role can be fulfilled by a consultant or legal representative. Companies should not underestimate the quality and depth of data required and the imperative for strategic planning to ensure the data is appropriately presented and be optimally prepared to respond to issues that may be raised either at the PreIND meeting or during the evaluation process.

In addition, maintenance of an IND requires regular Annual Reports, Safety Reports and updates whenever significant new information becomes available. Ongoing interaction with the Agency provides both valuable feedback to the company, but may also place significant demands on a company with limited resources.

When should an IND be filed?
Australian companies developing products for global markets are sometimes of the view that in order to register their product in the US, all clinical trials must be conducted in the US under an IND. The US will accept ‘foreign’ data and in reality, the single most important criteria are that clinical studies are conducted to ICH GCP, the international standards for Good Clinical Practice, and that any FDA specific Guidelines are met. Commonly, the FDA will require that at least one pivotal (Phase III) study be conducted in the US, although this is not an absolute requirement.

Companies should thus consider the merits of conducting early phase studies in Australia where trials can be conducted to ICH GCP standards in a timely and cost effective manner. Regulatory planning can also ensure that specific FDA requirements are met. Timing of a preIND meeting and filing of an IND for later phase studies can then be strategically planned whilst the initial studies are ongoing, with potentially substantial savings in development timelines and costs without loss in opportunity for subsequent US involvement.

 
 
 
 
The Perfect Biotech CEO
First published in Bioshares 9, April 2002
 
There are many facets to biotech investing. A novice investor soon learns about the importance of patents. They might soon learn that cancer is not one disease but several hundred. They will learn that the letters ‘FDA’ stand for the US Food and Drug Administration, an omnipotent regulator that one does not try to force the hand of. (Is erbitux Latin for ‘submit proper data’?). Another early lesson will be that drug and therapeutic product development takes time and is prone to optimistic milestone forecasting. Take any estimate offered by a biotech company about anticipated milestones, add six months, and you might end up being much more closer to the actual date than you realise.

A key educational achievement is to discover why there are many investments opportunities in biotech. In biotech investment markets there are relatively more information disparities coupled to relatively fewer ‘super-attuned’ investment opinion leaders who work to set prices of securities. The situation could roughly be likened to a unique code of football, played over a boundary-less kilometres wide field, in which some rules seem to change frequently, with no restrictions on the number of players, or balls, in contrast to any of the standard forms of site-limited football. Some biotech investment winners will discern the new rules, know when and where the new players will come from and the balls they will play with.

The biotech investor who has grappled with some of these salutary points will have also quickly realised the importance of the CEO to the prospects of the biotech company they have invested in. The position of Chief Executive Officer is important in every company. In a biotech company there are some major differences, and it is worth discussing some of the attributes of a good biotech CEO. A caveat – there is no perfect biotech CEO. Even moderately good biotech CEOs are very hard to find, not just here in Australia, but in every country with an active listed biotech sector.

A sign of a good biotech CEO is that if they haven’t already started the process, then they are probably not far off commencing the search for their replacement. They may be grooming an internal candidate, or building links through and with other companies. Recognition of dispensability and the limitations of tenure is a sign of professional maturity and good leadership. Succession planning matters in a biotech because it is a lengthy, complicated business that perpetually unveils new opportunities. Unfortunately succession planning is not generally a matter for the public record. However, when attending company presentations, note if sections have been delegated to younger members of the management team.

What is the main task for a biotech CEO? Given that biotechs are high-powered vacuum cleaners specially designed suck up cash, there is a very strong argument that a biotech CEO’s primary role is to raise cash, manage at a general level the optimal disbursement of that cash and ultimately get the best returns for shareholders.

Is it important that they have a PhD? It is very helpful that biotech CEOs have scientific, medical or technology education. Commercial experience is also very desirable. What is more important is a demonstrated capacity to learn and assimilate new ideas. They also need to practise the art of delegation. What is essential, even obligatory, is that they possess and exercise communication skills at the highest levels. A biotech CEO needs to persuade staff that they are engaged in a worthwhile commercial endeavour. They need to convince existing and prospective shareholders to supply funds, not once but many times over the commercialisation life of a technology. They need to be able to explain what their company does, why it exists, why it is different. They need to know the difference between hype and justifiable excitement. And to a great degree they will recognise their role is educative, knowing how to continually grow shareholders’ appreciation of the scientific aspects of their business or drug or device or diagnostic, despite some investors protests to ‘not bother them with that technical stuff’. A good biotech CEO will speak intelligently on behalf of the entire biotech sector.

There is a knowledge aspect to the attributes of good biotech CEOs. Its helps if they have a context for their company in the Australian biotech sector, both from an investment point of view and from a technology development point of view. They should know what most other companies in the sector do. The differences between most biotechs are simply not obvious to many people and need to be explained. Good biotech CEOs will identify and easily discuss their competitors. They will be aware of key current events in the international biotech scene.

Should the CEO be one of the company founders or inventors of the technology underpinning the company. Answer – only when the company founder or inventor also has requisite communication skills or learns them quickly. More likely, however, a smart inventor hires a CEO, and gets the best person for the job.

If you are travelling overseas and see an Aussie biotech CEO in airport lounge, be very happy. If they are on the road, at a conference in Boston, or cutting a deal in Cambridge (UK), that’s good news. Hopefully, when they trip over as they rush to greet you, the business cards of the Licensing Vice-Presidents of the major North American pharmaceutical firms will fall from a coat pocket. Another excellent sign!

 
 
 
 
The Clinical Drug Development Process
By George Mihaly and Judy Bingham – Kendle Pty Ltd
 
Introduction
Clinical development and the conduct of human trials are a pivotal phase in drug development. This article outlines some of the key issues to be addressed in a clinical development program to ensure that global regulatory requirements can be met and presents the benefits that can be achieved by working with a Contract Research Organisation.

A Clinical Development Program (CDP) should be designed once a compound is near to completion of initial preclinical studies and the results warrant consideration of full development of the product. A CDP should be designed early in order to create a profile of the product in terms of the intended formulation as well as its expected therapeutic role (ie a “target data sheet”). This will also provide direction for the program of clinical studies that are needed to achieve it.

A CDP describes the target population, formulation requirements, treatment schedule, desired indications, and expected levels of efficacy and safety. In addition, external factors such as requirements of the regulatory authorities will dictate what data must be generated on a new product. Increasingly, the policies of governments throughout the world support the principles of “evidence based medicine”. The implications of these policies is that new medicines must also be shown to represent value for money.

A comprehensive CDP is designed to collect all the necessary data required for a registration package. Throughout the whole development process, progress and results against the CPD must be constantly reviewed and assessed. This should be in the context of critical decisions about taking the next step and possibly making essential modifications of the plan in order to achieve the target data sheet. If unexpected results are observed in a study, this may require further investigation, either in the laboratory or in additional clinical trials.

Regulatory aspects
The pharmaceutical market is global and medicines must be marketable throughout the world. The design and conduct of clinical trials must therefore be undertaken in the context of an understanding of global regulatory requirements, taking into account country specific requirements, medical practice in the countries where the trial is to be conducted and common global standards. The success of an individual clinical trial and a CDP is therefore established as delivery of the end product, the granting of marketing approval in each of the target markets.

The International Conference on Harmonisation (ICH) has made a major contribution towards harmonisation of pharmaceutical standards in the three major regions of the world, the USA, Europe and Japan. Many other countries including Australia, although not a member of ICH, have adopted the ICH Guidelines. In addition to the ICH Guidelines, many countries have their own national laws. These may relate to the conduct of clinical trials and to specific regulatory requirements. For example, metabolism studies in populations where there are known ethnic differences in drug metabolising enzymes.

Clinical trials in Australia
The environment for the conduct of clinical trials in Australia changed significantly following the 1991 Baume Report, which concluded that “Clinical trials are a vital element of the overall drug evaluation process and…. provide significant access to new treatments in Australia.” The Baume Report resulted in the introduction of an optional deregulated scheme for the conduct of trials, the Clinical Trials Notification Scheme (CTN) whereby clinical trials which are approved by an Institutional Ethics Committee are notified to the regulatory agency, the Therapeutic Goods Administration (TGA). The TGA does not evaluate the available data on the drug or the clinical trial protocol. Under the CTN Scheme, the number of trials in Australia has increased from less than 100 in 1990 to over 1500 in 2000.1 Although the majority of these studies are Phase III and IV, a significant number are early phase I or II studies.

The option to conduct a trial under the alternative route, the Clinical Trial Exemption Scheme is encouraged by the TGA for early phase studies where the data has not been previously evaluated by another regulatory agency. This option takes longer and is more expensive than the CTN, however the benefits of TGA interaction and advice may be considerable in contributing to the CDP.

Australia has adopted the ICH Guidelines for Good Clinical Practice (CGP) and the conduct of all trials in Australia should meet these standards. Australia also has some specific requirements for regulatory submissions that must be taken into account when designing clinical trials. For example, the TGA is now requesting specific Australian data on local antibiotic sensitivity and resistance patterns to be included in submissions with five yearly updates. However there is no specific regulatory requirement to conduct trials in Australia prior to registration.

Australia has an excellent international reputation for the conduct of clinical trials, with recognised world class medical expertise, experienced investigators, ethnic diversity and minimal bureaucracy. In addition, a recent survey of the cost of research in over 30 countries, demonstrated that conducting trials in Australia is cost effective compared with Europe and the USA.2

Clinical trials in Europe
As in Australia, Europe has adopted the ICH Guidelines for Good Clinical Practice. In addition to GCP, a series of rules and guidelines have been developed. Many of these apply to all clinical studies, whilst others relate to specific disease areas.

Clinical studies must be designed taking into account these rules and guidelines, as well as any specific country and local Ethics Committee requirements. The present situation in Europe is complex and procedures for Ethics Committees vary significantly.

A new European Clinical Trials Directive is currently being adopted and when fully implemented by 2003 will encourage a harmonised approach to the conduct of clinical trials in Europe.3 The principle purpose of the Directive is to ensure that the ICH Guidelines are implemented into European law. This should result in better acceptability of EU clinical data by the Food & Drug Administration (FDA) in the USA.

Clinical Trials in the USA
In the USA, the clinical development of a new drug is governed by FDA regulations. An Investigational New Drug (IND) application is required by the FDA prior to administration of a new drug to humans. Once approved, the IND must be maintained and regularly updated as new information on the drug becomes available. Regular interaction with the agency is encouraged and is required at defined times throughout the clinical development program of new drug.

The ICH GCP Guidelines are based on the FDA Regulations, and following these will satisfy FDA requirements.4 The FDA usually requires two pivotal (phase III), placebo controlled studies, at least one of which is conducted in the USA. The FDA will accept foreign data for inclusion in a regulatory submission, provided the studies have been conducted according to GCP standards.

Placebo controlled studies
In some other countries, including Japan, it is considered unethical to conduct placebo controlled studies. The ICH has issued a draft guidance on the Choice of Controls in Clinical Trials.5 If adopted by ICH countries including the USA, the implications for Phase III clinical trial design may be significant. For example, the USA may agree to remove the emphasis and requirement for placebo comparisons.

Contract Research Organisations
Competitive pressures and the imperative to increase revenues are increasingly forcing companies to implement strategies to reduce clinical development times.

One of the key factors identified by Getz and Bruin as contributing to reduced development times was identified as collaborative effectiveness, including the effective use of Contract Research Organisations (CROs).6 Recent studies have highlighted that drug development times for clinical trials can be shortened by approximately 33% through the effective use of a CRO.7

For large pharmaceutical companies with significant internal expertise, working with a CRO can provide additional resources to undertake specific activities as needed.

Smaller organisations may consider working with a CRO that can provide specific expertise not available in-house, for example in a particular therapeutic area or in a specialised technical/scientific area. Organisations should identify what a CRO can do as well as or better than the biotech or pharmaceutical company.

The benefits of outsourcing can potentially be increased significantly if an ongoing relationship is developed with the CRO, providing the CRO with an opportunity to contribute to the overall development program as key expert members of the project team. The sponsor/CRO relationship is crucial to the successful fulfillment of a clinical trial or indeed a clinical development program

Choice of CRO should be based on key factors such as scientific, therapeutic, technical and geographical capability to undertake the work. In addition, factors such as the size of the CRO and previous relationships, reputation and costs should be considered.

Pressures on the pharmaceutical industry will continue to transform the extent and ways in which companies work with external providers in the R&D process. A successful development team will most probably include a group of specialist companies, individuals and institutes to ensure a company’s objectives are achieved in a cost effective and timely program.

References
1. Alder S. International harmonisation in early drug development. Presentation at ARCS/SHPA seminar, Melbourne 5 October 2000.
2. Ernst & Young, the Hays Group and the Strategic Industry Research Foundation. Benchmarking Study of R&D Costs in Selected Segments of Australian Biotechnology: Report January 2001.
3. Nickols PC. Some thoughts on the possible impact of the proposed European Clinical Trials Directive. Good Clinical Practice Journal 2000; 7(7): 22-27.
4. Neher G. FDA GCP- a practical approach. Good Clinical Practice Journal 2000; 6: no 3, 30-4.
5. Anon. Regulatory update: ICH E10 “Choice of Control Group in Clinical trials” released for consultation. Good Clinical Practice Journal 2000; 6 (3): 43-49.
6. Getz KA, de Bruin A. Breaking the development speed barrier: assessing the practices of the fastest drug development companies. Drug Information Journal 2000; 34: 725-36.
7. Barnett International Benchmarking Group. Benchmarks for outsourced clinical trials: CRO versus sponsor clinical cycle times. In: Parexel’s Pharmaceutical R&D Statistical Sourcebook 1999.

 
 
 
 
Biotech IPO Checklist for Investors
First published in Bioshares 6, July 2001
 
Last year there were a record 26 new listings and re-listings into the Australian healthcare and biotech sector. This year to date there have been five new listings, which is a very positive sign of the sector given current market conditions, and seven companies have re-focused from mining interests (or other) to biotechnology. With the continual flood of new investment options within the sector that generally comprises of intellectual property based on complicated science, no current earnings, no products on the market in the immediate future and long term projections of sales in the regularly mentioned ‘billion dollar markets’, investors can benefit from atraightforward, although by no means conclusive, checklist for new biotech investments.

1. Is the new biotech company backing into an existing, listed corporate shell? Check escrow stock!
It is expensive to list a company on the ASX. A cheaper and faster alternative for some cash-strapped biotech groups is to merge the company with an existing listed company that is looking to change direction. There have been a myriad of mining companies that in the last 12 months sold off (or are in the process of selling off) existing assets and have invested in biotech research projects. The companies can either invest with existing funds or issue a prospectus and raise public funds. The most recent company to use this approach was Medical Monitors, which was previously Defiance Mining and re-listed in July. An important point to check is whether all of the previously held stock is held in escrow for 12 or 24 months. This means previous shareholders can not sell their stock for the specified period. If the pre-existing stock is not held in escrow, there may be a sell down after re-listing forcing the share price down. This may well have been the case for Analytica. Analytica re-listed in October last year at 50 cents. Analytica was previously the public listed company Wallace International Ltd which was de-listed in 1989. Following listing as Analytica and raising $6 million in public funds, 78% of the pre-existing shares were not escrowed. The stock has since fallen to 10 cents and has stopped trading due to funding problems.

2. Is there a venture capital group on the share registry?
Venture capital (VC) funds invest in early stage companies providing a source of funds to emerging companies and often provide corporate and strategic management input. VC groups are experienced investors that have generally done their homework before investing. VC’s will also often sell down their stock upon listing or at the end of the escrow period, re-investing the funds back into earlier stage companies or make a dividend distribution to shareholders. If a company is listing and VCs are on the share registry, this is a strong, positive endorsement of the company. Recent biotech listings that had VC groups on board included Sirtex Medical and Compumedics. These companies increased in 2000 by 200% and 100% following listing last year.

3. How secure are the patents and is there sufficient life in existing patents?
The assets of most biotech groups consists of intellectual property that includes patents. One of the leading biotech groups on the ASX is Peptech which has a valuable patent relating to TNF-binding compounds. This is clearly the company’s main asset. Peptech has settled with two pharmaceutical groups that have agreed to pay Peptech royalties from sales until 2013. Many biotech companies list with patents that have not been granted and are pending, or licenses from other groups to existing patents. There is no guarantee patents will be granted. Licensing rights to patents is fine, if only a small royalty is being paid to the patent holder, and investors should consider the IP position of biotech companies before investing.

The life of the patents is crucial. Epitan listed this year at 20 cents to develop a systemic tanning product that will also prevent people from skin cancers. A major concern with this company is that its main patents run out in 2006 and 2008 and their lead product may not even be on the market by this time. Epitan is now trading at less that 10 cents.

4. Look for highly experienced and successful Board members
Examine the Board of Directors and look for experienced board members that can bring relevant insight and input into the listing biotech company. Two recent examples of successful listings had leaders of the some of the most impressive medical device companies on their Boards. The Sirtex Medical Board included Chris Roberts from ResMed and Q-Vis included Catherine Livingstone, former CEO of one of the most successful groups in the sector, Cochlear.

5. More advanced biotech companies fare better on listing
Companies with drugs in clinical trials, products close to market or a commercial history have historically fared better on listing. Early stage biotechs with only compounds in pre-clinical development have generally failed to attract strong interest, with Peplin Biotech being the exception. Even new companies such as Cellestis have performed very well because their diagnostic product may only be one year away from market. Companies such as Vita Life Sciences, Pan Pharmaceuticals and GroPep all performed well because they have products on the market and successful corporate histories.

6. Look for exciting research projects with massive markets
New listings need to inspire and excite investors. Interest in a stock can be generated if there is a high unmet need for the company’s drug candidates or if the enabling technology is leading edge and first in its class such as Optiscan’s miniature microscope. Prana Biotechnology, which is developing a treatment for Alzheimer’s has more than doubled in share price since listing last year. Its lead compound is now in Phase II trials.

7. Competitors
Look for companies that disclose extensive information about their competitors. In particular, look for information presented about product markets and competing technologies. Companies that produce ‘simplified’ offer documents should be treated with caution.

Although biotech companies and their technologies can be difficult to apprecaite, difficult and time consuming to obtain information about, and may be speculative investments, following this investment checklist may help investors pick more biotech winners than investment lemons.

 
 
 
 
Focus on Small to Medium Cap Stocks
First published in Bioshares 5, April 2001
 
Ambitious retail investors should possibly concentrate on investing in small-to-medium cap stocks, that is, anything capitalised at less than $500 million – leave the larger cap stocks to the local and international fund managers. If 75% of funds can’t outperform the market index, what makes you think you can!

Funds are managed by professional investment advisors and analysts with better information channels than most retail investors. These people are paid six-figure salaries and spend all of their time analysing the top end of the share market. They are not necessarily smarter than the retail investor. The point is these people have the time, the resources and the investment muscle (or influence) to outperform the ‘mum and dad’ retail investor, who allocates a few hours a week reading the available press, which is often second-hand information, and advice from stock brokers that is definitely second-hand information about the large cap stocks.

The professional investors generally will not invest in the smaller and mid-sized companies for three reasons. Firstly they do not have the time to research all the companies. If they were to invest in a small company, capitalised at say a $50 million, they would only invest a small amount, say $1–$2 million, and they may have $1 billion to invest. That means research needs to be conducted on 500–1000 companies.

Also, these funds can not invest large amounts as the liquidity simply is not there. To move the money in and out of these companies would influence the share price drastically. Lastly, many of these funds have mandates to invest in only the largest 150 to 200 companies.

There are now a number of investment magazines in Australia, including Bioshares of course, that cover the small and medium sized stocks. These include Ian Huntley’s newsletters, the Rene Rivkin Report, and a number of others. Most analysts with these publishers visit the companies they are researching, interview the CEOs and provide varying degrees of quality of analysis and opinion. If retail investors do not have the time to go and meet the companies directly and do not have the investment expertise to assess these companies, serious investors should capitalise on these investment resources. Most publishers will in fact provide sample copies so you can get an idea of the type of publication and the detail included.

Investing against professional investors in large cap stocks doesn’t leave you with much of a competitive edge, generally. As Dr Mark Mobius, the managing director of the Templeton Emerging Markets Fund says in The Super Analysts (see book review below), investors need to know what their advantage is.

 
 
 
 
Book Review - The Super Analysts
First publishedin Bioshares 5, April 2001
 
Reading financial investment books is often not easy and can seem more of a chore than recreational reading – a chore but a very satisfying task once complete. The information can be invaluable. The Super Analysts, by Andrew Leeming, seeks to present the views and investment perspectives of some of the world’s best and most experienced analysts and fund mangers with a conversational easy to digest approach. And it succeeds. It’s a book not just for the professional investor and Bioshares recommend it highly for anyone that takes investing seriously.

If you read only one interview from this book, make it David Fisher’s. Fisher is the chairman of the Capital Group International Inc, the institutional arm of The Capital Group Companies Inc, which has over US$500 billion under management. Fisher confirms that investing in the stock market is not easy. “What is implied by your question is that 77% of the market can’t outperform the market, and by definition they can’t.” Fisher makes the point that “you should use the quarterly numbers to the extent that, when they drive stock prices down, they are opportunities, not risks”. He also says that “things I worry about are assuming that you know a lot more than the market does, and not asking yourself the question, ‘Could the market be right?’”

Below are some other snippets from the interviews worth considering.

Stuart Baker from Australia’s Macquarie Bank believes that certainty costs money. “You have to bet, and buy in the face of uncertainty.” He also says that “you’re only going to make money if you bring yourself to the level that allows you to see what drives the market.”

Dr Mark Mobius from the Templeton Emerging Markets Fund says that “one of biggest mistakes that people make in the investment business is changing their minds too often.” And very importantly he says that investors need to find out what their competitive advantage is.

Lise Buyer from Credit Suisse First Boston in California explains that investors need to be aware of subtle tones made in broker reports. “At any time, I will likely have a couple of companies that I work with where I’m less than enthusiastic about the stocks, but there’s pressure from the investment banking side to be friendly. So, it comes down to the subtlety in the tone of the writing and the hope that investors will be able to read the differences in the research notes. That can be quite a challenge, because you need friends on both sides.”

Tim Jensen from the Oaktree Capital LLC believes that “the wonderful opportunities are when the perception of a company changes. That’s a wonderful chance for outperformance”. And he says that investors should be adaptive when something new comes along. (Think biotech!)

Pierre Prentice from Jardine Fleming Capital Partners in Australia reinforces the mantra that “the mindset has to be one of getting rich slowly.” Prentice supports the argument of investing in smaller cap stocks. “Generally speaking, the smaller the stock, the less researched it is, the less information that is available, and the less perfect the market is. So, opportunities appear that you can take advantage of.” And he confirms the buy and hold strategy. “Yes. You can make a lot of money by doing nothing. Just being with the right stocks longer-term can be very profitable, whereas with broking, you’ve got to do something every day to justify your existence. That leads to output of dubious value at the margin.”

Murdoch Murchison from the Templeton Funds Group points out that “we have a very disciplined framework, which means that we rarely follow the crowd” and believes that “you’re not going to gain exposure to the value-creating companies by investing in the titans or the dinosaurs of today.” An argument for investing in biotechs although not expressly mentioned.

Murchison also subscribes to the buy and hold theory of Jensen, Prentice and Mobius. “I think one of the toughest challenges is resisting the temptation to tinker with your portfolio. All you end up doing is incurring more transaction costs and enriching brokers.”

And what is a good hit rate? “Sir John Templeton always says that if you get two out of every three decisions right, then you’ll have a superior investment record” according to Murchison.

Michael Mauboussin from Credit Suisse First Boston in New York agrees with Jensen and Murchison. “Some of the great investment ideas are when you buy something when you’re going against the tide of what everybody else believes. In fact, most of the great investors seem to have that philosophy.”

Mauboussin talks about an investment approach for Internet companies, one which could also be extended to biotechs. “And so his (Michael Moore’s) approach, which makes a lot of sense, is to buy a portfolio of businesses in given Internet space. Then, when one of them starts to emerge as the leader, you pare back on the ones that seem to be the losers and put the money back into the ones that look like the winners.”

And once again the buy and hold concept is also expressed by Mauboussin: “Successful investors aren’t making a lot of decisions, but they’re looking at a lot of situations. They are busy in the sense that they are always reading, thinking, and looking at the world, but they’re not acting every five minutes.”

Finally Alistair Veitch from BlackRock International Ltd in Scotland says that “the real measure of success or performance will be down to the issue of how you weighted your portfolio.”

 
 
 
Watch the Biorhythms
First published in Shares magazine, September 2000
By Mark Pachacz
Investing in biotechnology stocks can be very profitable. Quantum leaps made recently in cell therapy, and the mapping of the human genome which will lead into functional genomics and proteomics, make it an exciting field to follow. The potential outcomes are enormous although understanding the technology can be a daunting task to investors. Biotechnology in the past has been through boom-bust cycles where late entry investors often get their fingers burnt on companies they know very little about. So why does this happen and what are the golden secrets to biotech investing? Well let’s consider some of the traits of the sector and some of some rules-of-thumb you should know.

Why have biotechs historically experienced boom-bust cycles?
Historically biotechs have been through four year boom-bust cycles. The advent of a new technology or biomedical breakthroughs captures the imagination of investors across the board. All of a sudden biotechnology becomes flavor of the month and prices begin to soar. With apparently unlimited potential in an area where most institutional investors struggle to understand the concepts, the roller coaster ride begins. Simply put, prices overshoot because too much money starts chasing too few stocks. Unlike the recent Internet craze where investors were offered alternative investment opportunities via a smorgasbord of Internet start-ups, this just isn’t possible in biotechnology. Biotech companies are generally founded on decades of experience and this expertise can’t be created over night.

The resurgence in the sector just three months after the slump is a positive sign that biotechs may be here for good. But the supply problem coupled with a lack of technological understanding is unlikely to see this volatility phenomenon change in the medium term. So how should you modify your investment approach with biotechs? There is certainly an argument for taking some profits when your biotech investment does hit pay dirt, and changes to Capital Gains Tax legislation makes this now a more favorable option.

Understand the regulatory approval process
Understanding the technology is difficult. Understanding the significance of the company claims and how those claims stack up on the world biotech arena can be an enormous challenge. But knowing how the drug development process operates and how it creates key milestones can give investors tremendous insight into the external validation markers they should be looking for.

The drug approval process follows a formal and structured regime (see table below). Drugs being developed proceed in quantum leaps. These advances are generally made public through company announcements allowing investors to monitor the progress of their investments. The development process as a general rule-of-thumb takes about 10 years, although this is being reduced with more efficiently conducted trials assisted by the major advances in biotechnology in recent times. Pre-clinical trials can take around four years, where a compound is first isolated and tested on animals to give an indication of possible efficacy in humans. Compounds then proceed through a three stage approval process, beginning in Phase I trials on humans predominantly to gauge the compound’s safety profile. In Phase II and Phase III the compound is tested in people, starting in smaller scale trials leading to larger trials on up to 3000 people. The final step is regulatory approval of the drug in the specific country. This is conducted by the FDA in the US, the TGA in Australia and in Europe approval by one of the member countries’ regulatory bodies. Approval by one country in Europe generally leads to acceptance of the drug throughout the whole of Europe.

Time your investments in biotechs
As the compound does progress through the process, value should be added to that company. It may take 10 years for a drug to be developed, but investors do not need to wait for final regulatory approval before there is an opportunity to take some well earned profits. So when is this likely to be for investors? History has shown that the release of positive Phase II results often has the greatest impact on a company’s value. It is not uncommon for a company’s share price to double or even triple in the period following the release of positive Phase II results. With 50% of drugs historically failing in Phase III trials an argument for taking some profits is well supported.

Another golden rule includes taking profits before the FDA rules on a drug approval application. By this stage all of the good news has generally been factored into the share price. Historically share prices have not jumped of news of a FDA approval. Conversely, share prices can fall between 30% - 70% on a rejection by the FDA. Local company Biota is a good example. The stock fell from $9 to $3 upon news of the initial FDA decision not to approve Relenza. Prices tend to increase in the six months after approval so there is clearly an argument for buying after approval and not immediately before.

Have an edge – do your homework
To some, investments in biotechs are an adjunct to their short-term gambling needs. A rumor from a friend of a friend can spread quickly and all of a sudden you own part of a company that you know absolutely know nothing about. We’ve all been there. That’s fine when times are good and the stock is soaring. But what happens when your favorite stock begins to retrace ground and even moves into negative territory with startling speed? That’s when you get that horrible feeling in the bottom of your stomach. What should you do now? You were so far in front! Well this is when you make your money.

If a stock falls by 50% you need to have done your homework to know why you’re holding the stock. This can be the buying opportunity of a lifetime and you’re thinking about selling? Two examples of this are AMRAD and Bresagen. The stocks fell to 50 cents and 80 cents respectively during the recent biotech slump in the June quarter, 2000. Savvy investors that bought in at the bottom are now sitting on 100% gains two months later.

Create a biotech portfolio
Biotechnology stocks are often viewed as speculative and high risk. This is fair comment to some degree, but there are ways to reduce the risk whilst maintaining an exposure to high growth opportunities. In Australia, biotech drug discovery companies increased on average 62% in 1999 and in the US, the NASDAQ biotech index increased 100% over the same period, while the All Ordinaries Index in Australia increased by 13%.

In the Australian healthcare and biotech sector you can choose from pharmaceutical stocks with have biotech exposure such as CSL or Fauldings, hi-tech engineering and manufacturing companies such as Cochlear and Resmed, biotechs with a portfolio of drug compounds and investments such as AMRAD, Novogen and Circadian, tax-free pooled development funds such as Medica, Starpharma and the soon to list Biotech Capital, or more focused biotechs such as Metabolic Pharmaceuticals and Biota.

Risk can be reduced by investing in companies that are returning a profit and have a proven track record, companies with a range of drug compounds, companies with a platform technology, or by investing in a portfolio of companies. Biotechs offer an attractive opportunity because a diversified equity portfolio can be created almost exclusively from this sector, and returns of over 1000% are possible as investors in Optiscan Imaging found out last year. All stocks can only fall 100% but investing in stocks than could increase 10 fold means large returns are possible.

 
The Drug Development Approval Process*
Phase Description
Average Period
Estimated probability of compound reaching market at beginning of phase
Pre-clinical Screen compounds, choose a lead compound, test drug in animal models for efficacy, side effects and drug metabolism.
4 years
5 % - 10%
CTX/CTN (Australia) IND (US) Submit Clinical Trial Notification or Investigational New Drug application prior to initiating clinical trials
-
-
Phase I To test the compound in healthy volunteers to establish possible side effects and safe dosage levels
1 year
20%
Phase II To determine preliminary efficacy and to confirm safety, tolerance and drug disposition from Phase 1 trial.
2 years
30%
Phase III To determine long term safety, efficacy and cost effectiveness of a new drug in large numbers of patients.
3 years
80%
Registration Assessment by regulatory approval body
1 year
90%
Phase IV Monitor drug once regulatory approval has been received for safety and efficacy
-
100%
*Source: Adapted from: DiMasi, J Clin Phrmacol Ther 2001;69:297-307