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Dudley Did-Wrong? Federal Reserve chief blamed in last week's big biotech sell-off

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By Randy Osborne
Staff Writer

Last Thursday’s midday sell-off in the sector raised some eyebrows, but market watchers say the sudden moves were no cause for alarm, with ISI Group analyst Mark Schoenebaum pinning the seismic rumble on remarks made during a luncheon by Federal Reserve Bank president William Dudley.

“That’s the most plausible explanation I have,” Schoenebaum said. The subject line of an email to investors Friday asked, “Is the NY Fed shorting biotech?” followed by a smiley emoticon.

The New York finance honcho “thought a couple of asset classes were overvalued, and in his list of overvalued asset classes, interestingly, he included biotechnology,” Schoenebaum said in a video circulated to ISI Group clients. News of the comments quickly circulated, and the Nasdaq Biotech Index began its plunge in the early afternoon.

“I obviously haven’t had a chance to talk with [Dudley],” Schoenebaum joked, and therefore could not guess why the banker made his comments. “On the one hand, we sort of say, ‘Haha, what does the fed president know about the biotech universe?’” he said. On the other hand, blurts by highly placed and mildly informed outsiders can have an impact.

“Stuff like this is potentially a little bit threatening,” Schoenebaum said, recalling the pronouncements by then President Bill Clinton and British Prime Minister Tony Blair in the spring of 2000 that genetic information should not be patented or copyrighted.

Still, Schoenebaum found scant reason to expect worse developments. “We all know that these stocks, most of the bigger biotech stocks at least, trade 10 to 20 percent, in some cases 25 percent, over base-case discounted cash flow analyses [which] are only as good as the assumptions you put in,” he said.

His approach is to include zero percent (or negative) terminal growth rates, modest value for phase I and phase II assets, and “limited” value even for phase III assets – a “fairly conservative way of looking at the world,” but “we used to pick stocks according to this framework,” he said.

“Actually, it worked generally pretty well,” he said. “You couldn’t really time when stocks were going to ‘break out,’ but it was a good way of identifying cheap stocks. Now, none of the big biotechs trade at or below this kind of analysis. Amgen is the closest, but many of the other stocks trade significantly above it.”

Schoenebaum said that “if things get really bad” and the market corrections keep on, “sell-offs among these stocks [could range] somewhere between 10 and 25 percent. I doubt very much [this will happen].”

Regarding Thursday’s action, other factors may have been at work. Foster City, Calif.-based Gilead Sciences Inc., one of the harder hit stocks, along with Celgene Corp., of Summit, N.J., disclosed that the company had recalled some lots of the HIV drug Atripla (efavirenz / emtricitabine / tenofovir disoproxil fumarate). “I spoke to Gilead and do not believe this news was material,” Schoenebaum said. Although he listed other potential reasons for the slide, there was “no fundamental or macro news that I believe was responsible for the move,” he wrote in an alert to investors.

Wells Fargo analyst Brian Abrahams did not address the single-day sell-off specifically, but in a research report Monday speculated that the market correction in biotech stocks may have leveled out, and seemed to echo Schoenebaum.

“An analysis of [price-earnings to growth] ratios, despite its intrinsic limitations, does suggest that multiples have recently retreated back down to those of the broader market when accounting for growth,” Abrahams wrote, adding that the settling provides “some comfort that additional downside risk from here may be limited.”

In Abrahams’ view, the higher valuations of larger-cap firms “can be justified on a [discounted cash flow] basis and [we] continue to see opportunities in certain mid-caps which we believe became or remain overly discounted.” He cites Celgene among them, along with Vertex Pharmaceuticals Inc., of Cambridge, Mass., “especially with shares down from recent highs” and with the phase III TRAFFIC and TRANSPORT studies fully enrolled (as of last October) testing lumacaftor (VX-809) in combination with ivacaftor in cystic fibrosis with two copies of the F508del mutation.

Abrahams also likes Intermune Inc., “given recent significant de-risking from positive ASCEND results.” Late last month, Intermune reported positive phase III data with Esbriet (pirfenidone) for idiopathic pulmonary fibrosis, and could file for a new drug application in the third quarter of this year. (See BioWorld Today, Feb. 26, 2014.)

The recently public Five Prime Therapeutics Inc., of South San Francisco, also gained favor from Abrahams for its “differentiated biologic discovery engine and promise in areas including immuno-oncology.” Five Prime priced an upsized, $64.5 million initial public offering last September. A recent pullback in the pricing of Sunnyvale, Calif.-based Pharmacyclics Inc. “provides an opportunity to enter at an improved valuation,” in Abrahams’ opinion, given the approval late last year of Imbruvica (ibrutinib), the oral Bruton’s tyrosine kinase (BTK) inhibitor developed with Johnson & Johnson unit Janssen Biotech Inc., as a single agent to treat patients with mantle cell lymphoma. (See BioWorld Today, Sept. 19, 2013, and Nov. 14, 2013.)

As for ISI’s Schoenebaum, Gilead and Cambridge, Mass.-based Biogen Idec Inc. remain his “top biotech ideas.” Amgen Inc., of Thousand Oaks, Calif., “is cheap, but less ‘exciting,’” he wrote in an email to investors.