Investors are starting to warm to biotech stocks again, with indices that track the sector posting double digit gains this year.
But capital has not been very discriminating, and billions of dollars have been flowing into companies whose primary business seems to be selling their own shares, one influential and “contrary-minded” journal of the financial markets notes.
The latest issue of Grant’s Interest Rate Observer says the biotech sector has largely avoided attention for riding the stimulus wave unleashed by the U.S. Federal Reserve.
Publisher Jim Grant’s disdain for the Fed’s “grievous distortions of asset values” is well documented. He now argues that the rising share prices of many biotech firms are a product of this broad phenomenon.
The S&P Biotechnology Select Industry Index is up 18 per cent since January and the Nasdaq Biotechnology Index (NBI) has jumped 28 per cent, with both building on impressive gains from 2012.
Two recent articles offer some explanation for investors’ return to the sector after a lengthy dry spell. Barron’s Kopin Tan writes that the market is willing to pay for R&D again, citing research that there exist “fewer than 20 companies globally with market caps of more than $30-billion (U.S.) that do any health-care research.”
And my colleague Scott Barlow says massive gross margins among some biotech players are another feature attracting investors.
However, Grant’s says biotech stocks are benefiting from central bank stimulus – similar to most other equities and bonds – and as such many are ripe for short sellers.
The NBI benchmark has a smaller average market capitalization than the S&P index, and many of the 118 companies NBI tracks have yet to get drugs to market. The biotech rally has added $115.7-billion of valuation to these companies, two-thirds of which had no income last year and 28 per cent of which posted annual revenue of less than $25-million.
In the lengthy and expensive U.S. regulatory approval process, just 16 per cent of drugs make it through to market. In the meantime, many biotech firms are keeping the lights on by issuing shares and steadily diluting the holdings of existing shareholders, Grant’s says.
Among the companies the newsletter spotlights: Shares of Sangamo Biosciences have returned 258 per cent since the start of 2012, yet the company lost $22.3-million last year on revenue of $21.7-million derived from research grants and partnership agreements. Sangamo hasn’t brought a single drug to market in its 18-year existence, and not a single insider has bought a share since 2010, Grant’s notes.
“A would-be investor in a biotech company, short of arming himself or herself with a degree in medicine, could do worse than to watch what the insiders do, instead of what they say,” the newsletter advises.
Shares of Isis Pharmaceuticals, meanwhile, have returned 210 per cent since the beginning of last year. The company has 28 drugs in the pipeline but has reported a pretax loss in every year since its IPO in 1991. Last year, Isis lost $65-million on revenue of $102-million. No insider has bought a share of the company since 2006, and the chief executive officer unloaded 30,000 shares last week at a price of $22.16, Grant’s writes.