Commentary: A Biotech Boom with a Difference

By Paul Raeburn

On Dec. 17, biotech stocks got some good news. In the new annual ranking of the Nasdaq 100 index--made up of the 100 largest nonfinancial companies ranked by market capitalization--seven of the 13 companies added were in biotech. The new entrants include such familiar names as ImClone Systems (IMCL ), Cephalon (CEPH ), Sepracor (SEPR ), and Invitrogen (IVGN ); they replace 13 faltering tech, telecom, and Internet outfits, including onetime stars CMGI (CMGI ), 3Com (COMS ), and Palm (PALM ). All told, biotech companies now represent 12.7% of the market capitalization of all the companies in the index, nearly triple the share they held only two years ago. "It is a reflection of the growth sector of the economy," as well as huge investor interest in biotechnology, says John L. Jacobs, president and chief executive of Nasdaq Financial Products Services Inc.

But haven't we seen all of this before? Investors are pouring money into companies that have great stories to tell, but whose earnings are tiny or nonexistent. The result: Along with biotech's sudden rise in the Nasdaq, the Amex biotech index has climbed more than 200% during the past three years. And with Amgen Inc.'s (AMGN ) $16 billion purchase of Immunex Corp. (IMNX ) on Dec. 17, following several other highly publicized biotech deals, the industry seems tempting.

Sounds an awful lot like the Internet bubble all over again. And in one sense, it is: The high market capitalization of many of these stocks suggests that investors are paying a lot in anticipation of future earnings that may never materialize. It costs tens of millions of dollars and can take five to 15 years to get a drug from the test tube to the clinic--and many drugs simply don't make it.

How high are the valuations? By any traditional standards, they appear to be hugely overinflated--if only because the lack of earnings makes applying traditional standards impossible. But even looking at revenues alone, that remains true. One of the stocks added to the Nasdaq 100, ImClone Systems Inc., has a market capitalization about 120 times its revenues. That's about where Amazon (AMZN ) was in early 2000, near the peak of the Internet boom. Pharmaceutical market leader Merck, in comparison, has a market capitalization of less than three times its revenues.

In several ways, however, this boom is different. The industry is more mature than it was a decade ago, when it last rose and fell. New alliances, new products, and new financing should combine to produce lasting growth in this once-turbulent field. There are some 300 biotech products in Phase III testing, the final stage of human experimentation before seeking Food & Drug Administration approval. The FDA issued 32 approvals for biotech drugs in 2000, a 45% increase over 1999. Sales of biotech products rose from $16.1 billion in 1999 to $18.1 billion in 2000, an increase of 12%. And there were 22 profitable biotechs in 1999, up from 17 in 1997. "Everything is going in the right direction," says Arnold L. Oronsky, general partner at InterWest Partners, a venture-capital firm in Menlo Park, Calif.

Furthermore, unlike many Internet companies, the biotech companies are targeting clear and existing markets. Many Internet companies devised products without knowing whether there were markets for them. Others, such as Yahoo!, aimed for ad revenues that proved far smaller than hoped. Biotech companies don't have that problem: A drug for arthritis or cancer, say, has a huge market. If their drugs work, the biotechs will make money.

Excitement in biotech will likely get another boost when the climate for initial public offerings improves. There are 50-100 biotech companies waiting to go public, says Oronsky. That's where casual investors should be especially careful. Some of today's most promising biotechs will undoubtedly fall short of the hype. Unfortunately, that's one way this boom won't differ much from the last.

Raeburn covers science from New York.

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