More Biotech Bets for the Fearless

Five for the Money's latest look at one of the riskiest sectors of the market identifies a handful of promising drug development companies

Maybe the only thing more nerve-racking than being a biotech investor is actually running one of the risk-laden outfits. Those who brave the category, especially the smaller companies, need to brace themselves for spikes—and precipitous drops—in their share prices based on clinical data results.

The dramatic divergences were illustrated by the trading action in two stocks in recent days. On Mar. 26, investors saw shares in Alexza Pharmaceuticals (ALXA) soar more than 50% after the company released data on successful mid-stage trials for its migraine and schizophrenia drug candidates. The stock fell more than 11% over the next two days.

On the other hand, Atherogenics (AGIX) plummeted 13.6% to close at $2.80 on Mar. 28 after poor late-stage data for a cardiac drug. That's down from more than $38 in November, 2004.

Rife with Risk

So it goes in biotech; the typical trajectory for privately funded concerns is to go public or get acquired to fund the drug development process. For these companies, quarterly earnings reports—basically a tally of their latest losses—are incidental compared with clinical data. As drugs advance through the development pipeline, clinical trials test for safety and then efficacy. Later they evaluate how an experimental drug compares to approved treatments. The entire process can consume more than a decade and cost $1 billion.

Outfits in the sector are testing products that are years away from hitting the shelves. Plenty will never make it. But hope springs eternal for biotech investors. Back in December, 2005, we assembled a list of promising, but risky, biotechs (see, 12/13/05, "Biotech Bets for the Fearless"). For those at home keeping score, four have done a very volatile version of treading water and one, Gilead Sciences (GILD), has performed very well. But it already had a major product on the market.

This week, Five for the Money has gathered another batch of small drug-development outfits with promising products. Each has some attractive characteristics, but these are some of the riskiest stocks on the market.

1. Alnylam Pharmaceuticals (ALNY)

In October, pharma giant Merck (MRK) agreed to buy Sirna for $1.1 billion, a staggering sum for a company very early in the drug development process (see, 10/31/06, "Merck's Big Play in RNA"). The reason? Sirna is one of only a few companies developing drugs based on RNA interference, a technology for which scientists won the Nobel Prize, that involves blocking gene expression.

Alnylam is another. The company has only initiated an early-stage safety trial for its lead product candidate, a treatment for respiratory syncytial virus, but RNAi could be the bigger asset. Douglas Chow, an analyst with investment bank Caris, says, "I would compare it to the early stages of monoclonal antibodies technology in the early 1980s before people could figure out how to use monoclonal antibodies." He refers to another development, for which researchers also won a Nobel, that has provided the base of many approved treatments for cancers and other diseases, among them Genentech's (DNA) Avastin cancer therapy.

2. Affymax (AFFY)

During the past few months, investors have seen more than a few biotech companies stumble during their public offerings. Not Affymax (see, 12/15/06, "Affymax IPO Gets Investors' Blood Racing").

The company priced above its range in December and has a market valuation of almost $500 million. So why does this loss-making company appeal so much to a few investors? Among other factors, the company received funding from big-name venture capitalists like MPM Capital and Bear Stearns Health Innoventures.

Another is potential sales. The company's hopes rest on Hematide, an erythropoiesis stimulating agent designed to treat anemia in patients with chronic kidney disease and for cancer patients undergoing chemotherapy. Anemia-fighting drugs are blockbuster sellers—generally defined as more than $1 billion-plus in annual sales—for Johnson & Johnson (JNJ) and Amgen (AMGN). And Affymax believes Hematide could be longer acting and cause fewer side effects than the existing products. The drug is in several mid-stage trials.

3. Jazz Pharmaceuticals (Filed for IPO)

Oftentimes investors find initial public offerings in biotech come along too early in a company's development before it has much encouraging data on its prospective compounds. Jazz Pharmaceuticals, which filed to go public earlier in March, could wait a little longer because it focuses more on acquiring and licensing drugs than on developing them from preclinical stages. The offering's underwriters include Morgan Stanley (MS) and Lehman Brothers (LEH). Jazz already markets a drug for the sleep disorder cataplexy, and excessive daytime sleepiness in patients with narcolepsy.

By modifying known therapeutics and the methods by which they are delivered, the company also believes it can mitigate the risk of drug development. In January, the company licensed the U.S. marketing rights to Luvox CR, an extended-release version of the antidepressant, which Jazz hopes will win approval to treat obsessive-compulsive disorder and social anxiety disorder. If it succeeds, product rollout could come as early as next year.

4. Altus Pharmaceuticals (ALTU)

Altus' plan is to commercialize drugs that it modifies using its protein crystallization technology. It is pushing two leading product candidates. One is an oral treatment for nutrient malabsorption caused by an exocrine pancreatic insufficiency. The second is an injected treatment for growth-hormone deficiency that it is developing with Genentech.

Cowen (COWN) has an outperform rating on the stock. The firm likes Altus' business model of modifying drugs to treat rare diseases. (Cowen makes a market for and has a banking relationship with Altus.)

But research outfit Morningstar (MORN) is less enthusiastic. It rates the stock one star out of five. A recent report on the company says it believes both of Altus' lead candidates have promise if, of course, they win approval. It adds that the company "does not appear to provide a viable commercial alternative if either of the leading candidates fails."

5. Trubion Pharmaceuticals (TRBN)

Seattle-based Trubion develops drugs designed to bind to targets on cell surfaces. The lead product candidate, now in mid-stage trials, aims to treat rheumatoid arthritis, a market with blockbuster potential. The company believes it may also have use in treating lupus, though it has not yet begun clinical trials aimed at the disease.

Trubion carries all the usual biotech risks, but investors have warmed to the company anyway. The stock is up more than 50% since its October IPO. More than promising pills or potions, those who play biotech stocks may consider ever-optimistic investors as the sector's greatest asset.