Commentary: Biotech: Smart Companies, Dumb Investors

Never quite understanding where they were stepping, President Clinton and British Prime Minister Tony Blair rudely popped the biotech stock bubble last week. On Mar. 14, they jointly declared that rivals in the race to discover new genes should share their results. The sequence of the human genome should be open information available to the public.

Wall Street misinterpreted that pronouncement as an attack on patent rights--and investors well beyond biotech quickly paid the price. Biotech shares tumbled almost 13% in a day, taking the entire Nasdaq index down 200 points with them.

Of course, in the twisty-turny world of biotech, any impugning of patent rights is bound to have market repercussions. So will talk of good or bad results in clinical trials for blockbuster drugs. Or talk of mergers among pharmaceutical and biotech companies. Biotech has been, and always will be, a wild roller-coaster. As Wall Street investors slowly educate themselves about the challenges of building gene-based drugs, get ready for plenty of violent market gyrations.

That's because living systems are unpredictable. We're not dealing here with conventional engineering. Biotech has no equivalent of the computer world's Moore's Law, which tells us that chip power will double every 18 months. Human biology took billions of years to evolve and doesn't take lightly to radical intervention by clumsy humans in white coats.

Unpredictable science makes for irrational behavior in the marketplace. Nobody knows more about genes these days than the folks at Incyte Pharmaceuticals, Human Genome Sciences, and Celera--and all three say they're little threatened by the open dissemination of human genome data. More perverse, investors fled blue chips such as Amgen Inc., which actually has products, profits, and things in the pipeline.

Not to worry. In the short term, these stocks were probably inflated anyway. And the herd is bound to wheel right around, driving stocks back up. At base, genomics--the study of genes and their function--wields the magical power to create drugs from the 3 billion bits of information contained in the human genetic code. Analysts predict that biotech companies will launch as many drugs in the next five years as they have the past 20.

HOT TIPS. That makes for a sexy story. But here's the rub: Many of the companies pursuing these drugs don't have much in the way of a business model. And few biotech investors seem to grasp how long it takes to translate the raw information into a product that generates cash flow: on average, at least five years to develop a compound worth testing in humans. Then comes another 5 to 10 years to show the Food & Drug Administration that the drug is safe and effective. "Time lines are long, and risks are high," says Eric M. Hecht, a biotech analyst at Merrill Lynch & Co. "That's always been the Achilles' heel for biotech."

Hotshot day-traders probably don't want to bother with all that. And they don't have to. If the goal is simply to time the market and make a quick buck, there are signs to watch for:

Hot Tip No. 1: The sharing of gene research won't jeopardize the intellectual-property rights of fledgling biotechs. The fundamentals that drove stock prices up--financing, research pipeline, and viable products--haven't changed in the past week. So stock prices will come back, at least until the next imaginary crisis.

Hot Tip No. 2: Human Genome Sciences has three drugs in clinical trials. If they meet FDA expectations, HGSI will spike skyward and pull other small genomics players along with it. If those new therapeutics fail, the group will tank--duh.

Hot Tip No. 3: The mapping of the whole human genome will be done this summer. Although everyone knows it's coming, the market will probably treat it as a big surprise. Be there, and enjoy the ride!

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