Biotech Values

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WSJ Biotech...civic08801

Scott Patterson: Big Pharma is lugging around a lot of baggage these days, from drying pipelines to stiff competition from generic drug makers. But investors still drawn to the sector may want to explore a corner of the universe usually reserved for the extreme athletes of Wall Street: small-cap biotech.

Savvy investors who bought shares of a small biotechs that ended in the deal-making crosshairs of bigger rivals have seen robust payouts. Wednesday, Alnylam Pharmaceuticals surged 44% after Novartis agreed to snap up a 20% stake to get access to Alnylam's pipeline of genetic-therapy drugs. In June, Pfizer agreed to purchase Vicuron Pharmaceuticals for $1.9 billion; Vicuron soared 79% the day the deal was announced. In May, Genzyme agreed to buy Bone Care International for $719 million (Bone Care climbed 35%) and GlaxoSmithKline bought Corixa for about $300 million (Corixa jumped 37%).

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Some on Wall Street expect even more deal-making as big drug makers like Pfizer and Merck, facing an onslaught of patent expirations, billions of extra dollars at their disposal. The American Jobs Creation Act of 2004, which allows U.S. companies to bring home profits held overseas at a skimpy tax rate of 5.25%, well below the standard rate of 35%, expires at the end of 2005. The nine largest pharmaceutical companies so far have repatriated more than $100 billion -- more than any other industry -- according to David Miller, president of Biotech Stock Research. "People don't understand how much money is going to be flowing into a very small group of thinly traded companies," he says.

Small biotechs aren't for jumpy investors who need to pop sleeping pills at night -- shares can collapse on the slightest hiccup in a new drug's arduous road to pharmacy counters. On Aug. 30, shares of Vasogen plunged 44% after it halted a Phase III clinical trial for its artery-disease treatment Celacade.

Another catalyst for biotechs could come from an unlikely source: short sellers, who borrow stock in companies and sell it, hoping to buy it back later when the share price is lower and pocket the difference. Nearly 30% of the public float of Amylin Pharmaceuticals, for example, has been sold short, and many of its peers are in similar positions. Acquisitions generally elevate shares of the target, and that would force short sellers to become buyers to cover their bets -- a short-squeeze rally. Mr. Miller thinks most of Wall Street hasn't caught on to the wave of cash rumbling toward small-cap biotech. "You're having what's going to be a perfect storm and I don't think the market sees it," he says.

Howard Liang, a health-care analyst at A.G. Edwards & Sons, cautions that the window could prove exceedingly short. Small-cap biotech stocks tend to get beat up during economic downturns as investors frown upon risk. "It's a very risky field," he says. "When the sector turns, investors will get hurt. It doesn't matter what the fundamentals are."