10.5 m capital raising, page-10

nice reading regarding biotechs Even though MBP is not mentioned here there are some very relevant points... especially when they mention..
"Generally, the most value uplift one would normally get would be on completion of phase 2 trials,".. here is article..


Investing in biotechs . . . it's a science
Author: Chris Wright
Date: 25/11/2006
Words: 2994
Publication: The Financial Review
Section: Smart Money
Page: 40

A successful biotechnology stock can increase wealth many times over, but investing involves patience and risk, writes Chris Wright.
Biotechnology. It's such a fantastic word. It has that mix of science fiction and medical promise that makes it a perfect buzzword: exciting yet little understood. Just right for an investment fad.

Because the sad truth, for all the zest encapsulated in the idea of biotechnology, is that most investors in recent years have found it a lame duck. The Bioshares 20 Index, run by stock-report publisher Bioshares, is down 3.2 per cent since June 30, 2005, and lost 16.7 per cent in the June quarter this year alone.

But it might not stay that way, and that's what keeps investors interested, knowing the successful biotech stock could increase their wealth many times over.

The definition of a biotech company itself is problematic but in most cases in Australia, the term is seen as synonymous with life sciences. It embraces therapeutics, which use biological compounds to treat conditions, and medical devices.

Most of Australia's success stories so far have been within the area of medical devices, in which the company tries to develop an item that will assist with a condition. Cochlear (ear implants) and ResMed (respiratory medical devices) are rare examples of companies that made the leap from being clever to strong.

According to EG Capital BioEquities Fund director Brad Ross-Sampson, these two companies and CSL (which makes plasma products and vaccines) account for 70 per cent of the $24 billion market capitalisation of biotechs in Australia, and about 120 companies make up the remaining 30 per cent.

When things go right, they go very right. "When these companies get taken over or get good critical trial results, the stock doesn't go up 10 or 20 per cent but 10 or 20 times," says Harry Karelis, managing director of Titan BioVentures Management, a private-equity group.

As Peter Hall, the founder of fund manager Hunter Hall, which has holdings in four biotech companies, puts it: "You are looking for the opportunity to turn $1 into $5 or $10."

Hall looked for one such opportunity in biotech company Sirtex, which makes micro-spheres filled with radiation as a method of cancer treatment, and holds 23 per cent of the stock. Earlier this year, Hall says, its share price was $1.20, giving it a market capitalisation of about $56 million after allowing for cash in the bank. Its treatments sell for $US14,000 ($18,200) per dose; its gross margin is about 80 per cent.

"The incidence of liver cancer is in the hundreds of thousands," Hall says. "If they get a tiny little share of that US market, maybe 10 per cent of secondary liver cancer treatment, they would make about $110 million. That's a stock where it could go up by a factor of 10 or 20."

Underpinning interest in biotechs is an undeniable demographic truth.

"All around the world, everyone's getting older," says Karelis. "Most people are prepared to spend quite a bit of money to prolong their life or improve their lifestyle, whether it's viagra or something to keep the heart pumping longer, and from a demographic point of view, that's a sector that's not going to go away."

Deutsche Bank private wealth-management director Thomas Murphy adds: "The ageing population story is a compelling one. But interestingly, most investors associate it with Western Europe. It's today's story there but it's the 2020 story in China, and a big one."

Clearly the market's there. So why the poor performance?

It is common for biotechnology specialists to blame Australia's mining boom for the lack of recent interest in the sector. "One typically runs at the expense of the other," says Ross-Sampson. "They are both similar types of investment thesis: high risk, high return. You've seen significant outperformance in mining and energy and it's pretty hard to argue against investing in BHP at 20 per cent returns per annum versus taking risk with an earlier-stage life science company."

There have also been a few bits of bad news in the biotech sector recently. In December 2004, Metabolic Pharmaceuticals announced the results of key clinical trials for a new drug designed to combat obesity, only to find that the market didn't consider its results conclusive; its share price dropped to less than a quarter of its previous level.

Chemeq, another biotech, whose stock has traded as high as $6, now trades at about 20? a share after board reshuffles, lack of revenue and a fight with the Australian Securities and Investments Commission.

Others have had delays with rollouts. Even global heavyweights like Merck have had problems, sending shock waves through the sector worldwide. The sector is highly vulnerable to bad news.

But there are reasons to be optimistic. Australian companies are beginning to be acquired by overseas parties, mirroring a trend already well in evidence in Europe. A bid from Danish group Novozymes for Adelaide developer Gropep in August was one example.

"In the pharmaceutical sector, a lot of products are coming off-patent and being replaced by generic drugs, so they are looking for proprietary products to replace their pipeline and are buying biotechs at significant premiums," says Karelis.

Graeme Wald, senior analyst at Wilson HTM, counsels caution about investing on this theme.

"More mature companies say: we've got a product we're going to develop to market, and if someone wants to come and buy us then fine, but we're running as a stand-alone company. I do not advocate investing in the hope that a company will come and buy you out," he says.

Others believe there are cyclical reasons to look at the sector.

"The cycle goes up every five or so years, and history says it should turn around now," says Karelis.

What should investors look for when considering a biotech? Scientific nous is only part of the challenge. There must be management who can sell the products.

"These are often early-stage companies where the CEOs and scientists don't have the commercial skills to execute," says Ross-Sampson. "You've got limited shots at goal and you have to get it right first time, so you're relying on a board with the right international pharma experience, or diagnostic experience, or connections with the US market."

David Blake, who runs the Bioshares stock analysis report, says: "Ask the question, is there anyone associated with the firm who's done this before? Somebody who's got experience in understanding markets or consumers, the nitty gritty of therapeutic product and clinical trial management - who knows how to raise money?

"Biotech is not a charity, it's not about doing early-stage research, it's a business: to make something that somebody else will use to make a product that will be sold to people. I don't really have time for accountants and lawyers on biotech boards unless they have been inside companies and been in the business."

Another vital area to look at is the strength of the intellectual property, but this is very difficult for the retail investor to get a handle on, and in any case it can still be rocked unexpectedly.

There's no clearer example of this than Sirtex, which looked something of a golden child of Australian biotechnology until it was sued by the University of Western Australia, which claims to have been involved in the development of the technology.

It is perhaps easier for the small investor to think: is there a clear need for this product or technology? "There's no point developing a product where 10 US players are doing the same thing," says Ross-Sampson.

Blake adds: "People often think the science is the complicated part. In fact, it's managing the commercial side of the drug development or clinical development where a lot of companies fall over."

Hall says that, as an investor, "that's the risk: can they commercialise it or not".

It's also important to understand the path to market. But it's also about distribution, where in some cases a company will appoint a licensing partner to do late-stage clinical trials, or an international distributor for a medical device. In some cases they want to do it alone, in which case, what's their sales force and their track record?

Other things to look for include deals with big-name companies such as Johnson & Johnson, Pfizer or Merck, and also what shareholders are on the register and if they include any smart value-style fund managers.

One thing you generally can't do is look at earnings, as you would for most other stocks.

"It's not about earnings, it's about creating an asset that you sell or license on to another party, who takes it to the next stage of development or marketing," says Blake. "The object of the business model is to take it as far as you can possibly go, then sell it out to another party."

Hall puts it another way. "It's really valuing an option, rather than something that's got value in itself. It's what its earnings could be," he says. "What you're looking for in broad terms is a situation where the earnings three to five years out might be equal to the current valuation of the whole company."

Some are more conservative: Murphy tells his clients to invest only in companies with revenue streams, "because the most dangerous thing you can do is have a company that is involved in R&D and development but doesn't have a revenue stream from alternative sources".

"Pure R&D companies, in my view, don't belong in the listed arena. It's like exploration in the commodity world. They may run short of cash at a time when the economic cycle does not facilitate raising capital in the listed arena," he says.

Some are more conservative still, finding the lack of recurring earnings and dividends intolerable. Perpetual Investments' Industrial Share Fund, which manages $10 billion, won't invest in biotechs.

A company that comes up frequently in discussions with professional investors is Pharmaxis. It has two major products under development, one to diagnose airway inflammation (useful for asthma), and the other to help remove fluid from lungs as a treatment for cystic fibrosis and bronchiectasis. The asthma product has passed phase three trials in Australia and Europe and has regulatory approval in Australia and Sweden, opening the door to the EU; the cystic fibrosis product has passed phase two trials and is well advanced. So investors like Pharmaxis because it's not reliant on just one product, is progressing through the trial process, and there's a clear need for its products. The stock has almost doubled since July.

Other stocks that have caught the eye include, for Ross-Sampson, Progen Industries, which develops cancer therapeutics. Karelis highlights two in his own portfolio, Phylogica and Starpharma, as well as two he doesn't hold, Sirtex and Pharmaxis. Hunter Hall, apart from Sirtex, holds Biocompatibles International, a Norwegian company called Photocure and a burns treatment group called Clinical Cell Culture.

There's money to be made in biotechs, but it takes patience and risk. Karelis concludes: "It's cyclical and bloody difficult to analyse, but the cycle is probably right to put some money into the sector. You've got to be choosy where you put it. Do your homework and don't put all your eggs in one basket."

And Blake suggests: "If you want to get into biotech, give yourself 12 months to learn. After a few losses, you might be able to get some wins, to understand your timing and your exit better. People do make these leaps, and think: I know about biotech, I've found out about three companies, I'm an expert."


GETTING TO MARKET

It's a long, long road from a big idea to a product on the shelves. "It can take 10, 12 years," says Dr Graeme Wald, senior analyst at Wilson HTM. It goes like this.

Preclinical development This involves finding a compound of potential interest, doing the work on initial structures of the molecules and testing on animals.

Phase 1 This is where you test for safety. This is mostly done on healthy volunteers.

Phase 2 It is then tested on patients who would require the drug, firstly testing for safety and then for efficacy. What are its side-effects, its toxicology?

Phase 3 A multi-centre, randomised, large-scale trial.

If all three phases have been successful, the product moves to the next stage.

Regulatory approval This is handled by different regulators, with different approaches in the US and Europe, the two key markets. Twelve to 18 months is typical for this stage. For medical devices, the pathway is different, the manufacturer doesn't have to prove as many things, and the journey to market is usually much shorter. Understanding where a company is at with its product or products is vital in an investment decision. You can find this out from annual reports, or from company announcements released to the Australian Stock Exchange.

"Generally, the most value uplift one would normally get would be on completion of phase 2 trials," says Wald.

"That's when you've taken out most of the technical risk: the first time you know it works in the target population. If you really want to be a successful investor you've got to have a good idea as to the potential risks of the product not working in humans, or an idea of its potential side effects." Wald calls this "the inflexion point for risk/reward".

A company's valuation changes as it passes the stages. "As they overcome each of their technical and regulatory hurdles, so the value of their intellectual property should increase," he says.

He uses a risk-adjusted probability-based discounted cash flow, which is beyond most of us, but it is useful to know this other rule of thumb: The probability of a drug going from pre-clinical to market is about 1 per cent.

Once it gets past phase one trials, that probability rises to 10 per cent; after phase two, 50 per cent; after phase three, 90 per cent. There are exceptions, though: every single HIV drug that has ever completed phase two trials has reached the market.

As a rule of thumb, things take longer than you want. "In practice it takes a lot longer than expected to get commercialisation to happen," Peter Hall says. Some things get knocked back at the regulatory stage not because they are not effective but because there's a long pipeline.

The data produced in these trials is vital to getting distributors or other groups interested. "In biotech maybe cash is queen, but data is king," says David Blake.