West Coast Editor

A dizzying, roller-coaster year for biotechnology sent the industry to record highs, which by the end of 2000 had leveled to what seemed like a clattering halt, with some investors ready to find another ride.

What happened?

“It was a combination of a lot of things,“ said Thomas Dietz, managing director of Pacific Growth Equities in San Francisco. The mapping of the human genome made heads turn toward the biotechnology sector just as high-tech investors – flush from “dot-com“ hauls yet unsure about the durability of that space – began looking “for somewhere to go,“ he said.

“We were over the top in the beginning of 2000, and whole new sets of investors had jumped in,“ as part of an upswing that had begun the year before, Dietz said. “It fed on itself, a lot of paper came out,“ he added, noting that his firm had to advise more than a few companies against trying to board the bandwagon.

The heyday couldn't last, and didn't. Nasdaq's “first big crunch“ came in April, resurged in summer, and fell again in October, Dietz recalled.

In the spring, much was made of the joint statement in the spring by then-president Clinton and British Prime Minister Tony Blair, who said data from the human genome map should be made freely available. Apparently, to many investors, this suggested the pair of politicos opposed patents for inventions, and the biotechnology market's downturn was blamed on the rash statement – which Clinton later hastened to “clarify.“

But the original remarks were, really, just more of the sorts of thing politicians say. As eager as some might have been to specify the industry's patterns and chart its peculiarities, Dietz said, “biotech doesn't trade in isolation,“ and already was in trouble.

Biotech Stocks Couldn't Hang On

Still, as soon as Clinton restated himself, the biotechnology market saw something of a revival, especially in the genomics space, where Celera Genomics, of Rockville, Md., gained 56 percent following the president's second set of remarks.

“In fact, if you look at the overall Nasdaq, and the macroeconomics of it, we hung in a little bit longer [than other sectors],“ Dietz said.

After the market's autumn cooling came a wintry chill. By the first part of 2001, the picture was decidedly more sober, and sobering. Dietz called it the “classic“ aftermath of a post-boom flattening.

“Every time we come out of a downward trend like this, [investors] get more selective,“ he said. “They're paying attention again to fundamentals, business models.“

Peter Drake, managing director and senior biotechnology analyst with Prudential Vector Healthcare in Deerfield, Ill., agreed, but said the sector is too volatile to make long forecasts.

“Just when you think it is the darkest, is usually the time the market, for one reason or another, takes off,“ he said. “And when these stocks move, they move.“

In any case, Drake and Dietz agreed nothing like the roaring year 2000 is likely in 2001, for “a whole lot of reasons,“ Dietz said. Chief among them is that investors are “overweighted“ because of the feasting in 2000.

The calmer atmosphere from last spring's frantic pace will lead, as other slowdowns have, to a deepening wisdom and temperance, he said.

“The volatility in the [biotechnology] market, and the risk profile of these companies, argues that investments should be done in groupings, through mutual funds,“ he said, repeating advice that has been regularly offered in years past. “You've got to own a mix.“

The truism will only become more valid, Dietz said, in 2001 and beyond.

“It's hard to see, when you live it day in and day out, but [biotechnology] was an empty box 15 years ago,“ he said. “We're still in the early days of an earnings-driven sector, but it's going to accelerate.“ As it does, he said, those companies with products will make it, and the others won't.

“The pie is starting to be divided up,“ Dietz said. Investors are distinguishing between service and product lines, and “slowly gravitating toward different valuation factors.“

Sparks Expected In Next Few Years

With about 300 drugs in Phase III or Phase II/III trials, Dietz said, “the next couple of years are going to be tremendous for the amount of data that comes out. Not being 'there' in the next three to five years is going to put early stage companies at a significant disadvantage.“

Consolidation will pick up, he said, as a way of moving toward earnings, but also as a way of survival in a more sophisticated investing arena. This, too, has been predicted every year, and has come to pass.

“Everybody's not going to buy everybody, because there are not a lot of great fits,“ he said. But leaders of the savvy companies know a repeat of 2000 cannot be counted on. Smart squirrels are burying plenty of nuts, and looking for mates with stockpiles that might include FDA-approvable drugs.

Drake allowed as much, too. “This is a market where deals will get done,“ he said, adding that the hardiness of biotechnology firms is not to be underestimated. After all, the sector is no stranger to hard times.

“You can look at that sorting through some really ugly cycles, like 1988 to 1989,“ he said. “1992 to '94 was outrageously painful. But we saw many more [merger and acquisition] deals than we saw people going Chapter 11. What has always impressed and surprised me about this group is that, when access to capital is very tight, and you would think you'd start to see a shakeout, you just don't. They're incredibly resourceful.“

As Tech Goes, So Will Biotech

Drake said the performance of biotechnology shares will likely continue to follow those of high-tech stocks, for better or worse, although the sector may avoid some of the disillusionment with dot-coms.

“[Biotechnology stocks] trade very much like tech stocks, and they're owned by similar buyers of growth stocks,“ he said.

Events on Wall Street in the first quarter of 2000 require perspective to understand, and mutual funds hold a clue, Drake said.

“We track this weekly, and every week, throughout calendar 1999, there was a negative flow of funds from dedicated health care mutual funds,“ he said, yet the stocks thrived.

“In the second half [of the year] particularly, the stocks did very well,“ Drake said. “They did so by rotation out of big pharma and into biotech.“

The switchover had become plain as early as December 1999, “when the stocks really started to explode, led by genomics,“ he said. “We saw record amounts of retail money flow into dedicated health care mutual funds. Twelve billion dollars came into the group during the first eight weeks of calendar 2000. That was throwing fuel on the fire. But, was it sustainable? No.“

Steam ran out. The boom held on for a little over a month, and then seemed to collapse of its own weight, Drake said.

“It turned over for five consecutive weeks,“ he recalled, “and then the group went into a major-league correction. I don't see that repeating itself.“

He said smart investors will figure out first how much cash they have to gamble with, and then take one of two options, if they want to stay in biotechnology. They might either plunk a sizeable sum into a few painstakingly chosen shares and prepare to stay aboard for a while, or shop around for a mutual fund or hedge fund, he said.

“It's really a combination of what one's risk profile is, as well as net worth,“ Drake said. “Buying individual stocks is something one needs to do as part of a broad portfolio approach,“ he added, although – given a willingness to take on risk – an investor would be well served to “find one or two situations, and own those long term.“

Selecting them is the challenge, he acknowledged, but the lesson of late 1999 and 2000 shows how to go about it.

A gauge “that has to be looked at is how are the pharma stocks doing, and what is the flow of money into the dedicated health care funds,“ Drake said. “You want pharma stocks to do well, and then you get the rotation into the biotechs. And the large caps have to do well before the mid-caps and small caps do well.“

Dietz noted their product portfolios and overall strength will determine the stocks most likely to be rotated into. The emphasis on fundamentals, he said, may not kill many companies, but will create more distance between them as time goes on – making the choices steadily clearer for everybody.

“There's going to be a big dichotomy,“ Dietz said, “between the haves and have-nots.“