Editor

Second-quarter earnings disappointments, recent clinical trial failures and investors' apparent refusal to credit any of the good news have pushed biotechnology valuations down to levels not seen since the mid-1990s.

Good news or bad? That depends like everything else on how you look at it. The Chinese word for "crisis" (as readers of self-help books may groan upon seeing again) is composed of two characters, one meaning "danger" and one meaning "opportunity." But not everyone is oriented to see the situation that way, particularly not some CEOs.

For investors, though, it may be time to make calculated moves. Analyst Eric Ende, with Merrill Lynch, finds valuations "back in line for stock pickers."

Ende told BioWorld Financial Watch it's "a difficult argument to make that we're undervalued. We're back in line with what I would describe as historical norms." Elise Wang, with Salomon Smith Barney, echoes Ende, declaring the hour is nigh for "bottom fishing."

Analyst Michael King noted in a mid-May research report he wrote when with Robertson Stephens that the market has been relatively indifferent since December 2000 to what ordinarily would register as positive developments (in other words, product approvals), and counted the same number of negative events as approvals during the period that is, 11. King has since moved to Banc of America Securities LLC.

"While regulatory risks have clearly risen in the past two years due to the FDA's increasing conservatism (especially as concerns non-life-threatening conditions)," King wrote, many of the snags "can be characterized as product setbacks, as opposed to product failures. Thus, it would seem to us that the value-driving events are delayed, not vaporized."

Still, using the American Stock Exchange's Biotechnology Index (BTK) as a measure, things were hardly looking sanguine in mid-May. "The net result is a mean level of valuation in the BTK in terms of market capitalization vs. cash not seen since 1994 and market capitalization to revenue not seen since 1998," King wrote.

In King's view, investors "correctly, but perhaps too severely, punished biotechnology stocks for their perceived transgressions," and a few near-term tidbits of happy news "could be the spark tossed onto some very dry tinder."

Ende sees a flame worth fanning as well. Sell-offs last year and the first part of this year have corrected the genomics-boom hysteria (and then some), pushing valuations back into a more sensible zone. Long-term fundamentals are strong, he said, and top-line growth during the next few years should reach about 21 percent, and earnings-per-share growth about 25 percent. Just ahead, though, no quick rally is due, he said.

At the same time, Ende said, it's worth keeping in mind that last week, "at [about] 380 on the BTK, we're exactly at the group median of the price earnings-to-growth and price-to-earnings ratios" as established by measuring from Jan. 4, 1991, to the present.

The worst of the sell-off may be over, but "the psychology of [the biotechnology] group has been damaged in three areas," Ende told BioWorld Financial Watch. Trouble with the FDA has made investors skeptical about regulatory hurdles. Less than stellar clinical data have focused investors on development risks. And earnings numbers have made investors think even more.

"We'd like to see some drugs approved, and some new exciting data with new classes of drugs, so we could get some idea that all this innovation promised from biotech is real," Ende said. "I'd like to see these companies start hitting or beating their numbers."

It might be a year to 18 months before the good news flows again, he added. What to look for in the meantime? Firms that can intelligently promise sustainable growth of at least 20 percent, "with the potential for upside surprise," Ende said. Specifically, he recommends Gilead Sciences Inc., IDEC Pharmaceuticals Corp., Amgen Inc., MedImmune Inc. and somewhat more tentatively NPS Pharmaceuticals Inc.

Last month, NPS disclosed it had run into manufacturing problems with Preos (formerly ALX1-11), a recombinant human parathyroid hormone, being studied in 2,600 patients enrolled in a Phase III trial, and Ende downgraded the stock from "strong buy" to "buy."

Wrote Ende: "We remain convinced that Preos is a promising drug for severe osteoporosis, but the timing of the product's launch has become increasingly uncertain."

He said "if [NPS] can't fix these problems, then they have some real issues. We're kind of in a holding pattern. I've spoken to them a couple of times in the past week," he added, but remained cautious.

For Gilead, sales of the antiretroviral drug Viread (tenofovir disoproxil fumarate) are likely to keep surpassing expectations, and adefovir for hepatitis B a nucleotide analogue, the Asian and Latin American rights to which GlaxoSmithKline plc in April agreed to pay more than $40 million is expected to launch later this year. Ende put Viread sales at $186 million for 2002 and $350 million for 2003, pushing Gilead into its first full year of profitability in 2002, with a long-term growth rate of more than 35 percent.

Overall, Ende predicts the number of profitable biotechnology firms will jump from 32 last year to 45 by the finish of this year, even though earnings reports from some were disappointing not only in the second quarter of 2002 but in the first quarter as well and, for that matter, in the final quarter of 2001.

IDEC is likely to see sales of its lead product Rituxan (rituximab) for non-Hodgkin's lymphoma slow from 84 percent last year to 29 percent this year, but Zevalin (ibritumomab tiuxetan), approved in February for the same late-stage disease, will keep the ball rolling despite a temporary lack of Medicare reimbursement, Ende said.

Drugs for rheumatoid arthritis, asthma and psoriasis are behind those compounds in the pipeline, he added.

Amgen's earnings-per-share growth rate will be revved by Aranesp (darbepoetin alpha, the second generation of red blood cell booster Epogen), Neulasta (pegfilgrastim, the second generation of white blood cell stimulator Neupogen) and Enbrel (etanercept, the rheumatoid arthritis drug to be gained in Amgen's merger with Immunex Corp.), Ende said.

Aranesp, likely to hit $2 billion in sales, might not be taking off as fast as some had hoped and supply concerns remain about Enbrel, he said, but Phase II/III data for Enbrel in psoriasis are expected by the end of the year, and the FDA is likely to approve Immunex/Amgen's Rhode Island manufacturing plant in early 2003. Anyway, those factors are pretty much factored into the stock price already, Ende said.

MedImmune has Synagis (palivizumab) for respiratory syncytial virus in high-risk infants, with sales for the 2001-02 season expected to total about $710 million, but the firm needs FluMist, the FDA-stalled nasal flu vaccine acquired in the company's merger with Aviron Inc., disclosed in December, Ende said.

He forecast MedImmune would still trade at $30 per share if FluMist doesn't make the 2002-03 flu season which is about where the stock was priced last week.

Although not talking about Aviron or MedImmune specifically, Ende said the FDA, which lately has held up a number of drug candidates, is taking more blame than it deserves for the hard times.

The agency "has issues" he allowed. "It's understaffed, it has no commissioner. But in all reality, I think they're doing their job. The FDA's job is to protect the public, and some of the data packages these companies are submitting are just insufficient. They're taking shortcuts."

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