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Can Genentech Keep Its Glow?

By Sarah Lacy In biotechnology, one bad piece of news can erase years of promise in the minds of investors -- just ask Biogen Idec (BIIB) and Elan (ELN). Their multiple sclerosis drug, Tysabri, was one of the most anticipated offerings of the year before it was withdrawn from the market on Feb. 28, due to unexpected side effects in two patients. One of the patients died. The day after Feb. 28, Biogen's and Elan's stocks sold off 43% and 70%, respectively.

Yet when things go right, a company's stock can be in for an exhilarating ride. Latest case in point: Genentech (DNA), which has seen its shares rocket on promising news this month for its wonder drug, Avastin, currently used to treat colorectal cancer.

HISTORY'S WARNING. On Mar. 14, Genentech announced preliminary results of a Phase III clinical trial that tested Avastin with chemotherapy in non-small cell lung cancer. Survival was longer than with chemo alone, Genentech said. Then on Mar. 21, Novartis AG (NVS) and Schering AG (SHR) announced that potential competitor PTK787 had failed to reach a key goal in its Phase III trials.

Genentech's share prices have risen more than 30% since the news hit, closing at $58.75 on Mar. 25. The question for investors: How much further can this already rich stock climb, given that better Avastin test results are expected in the coming months? The outlook is promising, but if the history of biotech stocks is any guide, investors will still want to proceed with caution.

Genentech's fundamentals are rock-solid: The world's second-largest biotech, it is anticipated to grow by between 20% and 25% a year for the next five years. It's also widely regarded as having the best drug pipeline in the business, with Avastin the most exciting offering.

NO PARTNERS, NO SHARING. To date, Avastin has been the most successful launch of any oncology drug, raking in $554 million its first year on the market. By blocking receptors on the tumor cell so it can't get the blood supply it needs to grow, essentially starving the cancer, the anti-cancer drug works in a totally different way from earlier drugs.

What's next? Genentech will release final data from the lung cancer trials in May, and early data from breast cancer trials is expected as soon as later this year. If results are good, Avastin would be well on its way to being one of the only oncology drugs to treat all categories of large tumors.

Even if it only treats colorectal and lung cancer, the drug is set to bring in several billions of dollars in revenue a year, the biggest-ever hit for the $4.6 billion outfit. And, unlike many blockbuster-drug launches today, Genentech developed and commercialized the drug by itself, so it won't have to share the profits. It's enough to make analysts remember why they fell in love with Avastin in the first place.

BIG MEDICINE CHEST. Meantime, Genentech isn't too worried about the possibility of facing what happened with Tysabri, says Howard Liang, vice-president and biotech analyst at AG Edwards. Avastin, and other cancer drugs, only have to prove longer survival. These drugs are not cures. Moreover, since patients are already seriously or even terminally ill, potentially fatal side effects like those seen in Tysabri aren't grounds for market withdrawal.

Nor is this South San Francisco-based company a one-hit wonder. Its current stable of drugs continues to show steady growth. This year, it will announce Phase III data of its already successful cancer drug, Rituxan, to treat rheumatoid arthritis. New drug Lucentis will have Phase III results for patients with macular degeneration, a disease causing vision loss. Plus, Genentech's new cancer drug, Tarceva, could increase revenues from $13 million in 2004 to $250 million in 2005, according to analysts.

Still, pessimists caution there's too much riding on just one drug, and that much of that hope is already priced into the stock. Since May, 2003, when the first positive data showing Avastin extended patients' lives by five months came out, Genentech's market cap has increased by $42 billion. But the Avastin ride hasn't been without bumps. Last fall, the stock slumped after adoption of Avastin began to slow, as patients and doctors expressed concerns about its high price, and me-too drugs began to appear.

FLICKERS OF DOUBT. ImClone System's Erbitux (IMCL) was already on the market, although not approved for Avastin's target audience of first-time diagnosed cancer patients. Lurking in clinical trials was Novartis and Schering's PTK787 -- a competitor that leapt from Phase I to Phase III clinical trials, giving few hints of how well it was performing in patients.

On Jan. 10, Genentech missed earnings by a penny -- its first slip in eight quarters. Analysts figured it was the outfit's way of removing some of the hype from Avastin's projected growth. Fourth-quarter Avastin revenues came in at $200 million, some $20 million less than the Street estimated, causing many to wonder if the drug could break $1 billion on the strength of its use in colorectal cancer treatment alone.

Trading at 56 times earnings, Genentech's stock suddenly looked expensive, groused analysts. Many said that Avastin needed to show positive results with lung cancer patients, and that results from competitor drug PTK787 had better be bad. If not, Genentech's shares were in for a correction. Investors listened, and the stock crept down to $44.08 on Mar. 11, edging toward November's 52-week low of $41.

TOO LATE? Since then, Avastin news has been nothing but positive, and Genentech's stock has responded accordingly, veering upward. Some analysts now worry that investors who thought they might have a chance to buy a ballyhooed large-cap biotech on the cheap have missed their shot.

True, it's still trading at a valuation many analysts consider rich. But others, such as Banc of America Securities' Michael King, see no letup in the biotech giant's growth, which he expects to run as high as 28% annually over the next five years. "There's no other company in the space that has the same kind of growth potential as Genentech," he says. "My mantra is: This is the best management with the best products and best pipeline. Why wouldn't I want to own that?"

The biggest shorter-term gains on this stock may already have passed, but for long-term investors, the future is looking bright. Lacy is a reporter for BusinessWeek Online in the Silicon Valley bureau

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