By Alex Seagle
The Contrary Investor
The Baby Boomer Generation is generally thought to include those born after World War II from 1946-1964 inclusive. While there is some debate about the exact years, statisticians generally accept the definition as being valid. Others have attempted to define the generation along experiential lines, breaking the years into broad common ground. For instance, those born in 1964 probably share very little experience with those born in 1946.
Birth rates soared in the post war years as the US experienced a period of rapid economic growth. 1955 marked the top of the birth rate bubble known as the Baby Boom. There are approximately 76 million Baby Boomers and they represent the single largest demographic group in existence today. They are also the most affluent group in American history with some $2 trillion in annual consumption, and Boomers are on the cusp of old age. What do they need to stave off mortality? Prescription drugs, naturally. "Do I believe that drug sales will rise in the next 20 years?" asks John McCamant, the editor of the Medical Technology Stock Letter. "I can't look at one baby boomer and not see that happen."
That's only one of several reasons that optimism abounds among biotech investors, even though many of their stocks have been hit hard for years. Scientists keep fueling hopes of new ways to fight cancer, arthritis, heart disease, even the common cold. Almost every headline from the expanding fields of genomics and proteomics - the study of human genes and proteins - suggests that biotech's Holy Grail, the personalized cure, will soon be within grasp. Big pharmaceutical firms keep pumping money into their farm teams, the more than 400 public biotech companies, in hopes of getting new drugs into the pipeline. Venture capitalists, having abandoned so many infotech ideas, have also kept faith; they pumped $2.25 billion into biotech startups in 2004, an amount topped only in 2000.
And yet some of the canniest observers of the industry are posing an ugly question: Haven't we seen this before? Didn't Internet investors also continue to believe long after the game was over? "Compared to a lot of sectors." Says Jonathan Aschoff, an analyst with Friedman Billings Ramsey Group, "biotech valuations are still high." And while the Nasdaq biotech index fell by about a third in 2004, it's up roughly 80 percent for the past four years. If the skeptics are right, there's plenty of helium still to rush from this balloon.
What's scarier is that the bearish case doesn't rest only, or even mainly, on valuation. It includes a fundamental truth about biotech: The scientists don't know as much as investors think they know. And even when the science is solid, the commercial applications won't come as fast as investors seem to hope.
After the human genome was decoded, mainstream media stories trumpeted how the new ability to identify health problems and treat them at their genetic roots would change everything. Immediately, companies sprang up around technology buzzwords such as genomics, bioinformatics and proteomics as entrepreneurs rushed to get into the game, creating an irrational exuberance not unlike the one that arose around the Internet just a few years earlier.
So a shakeout seems imminent. The investment bubble didn't just burst, but instead moved like a virus first through the Internet sector, then on to telecom, and now to biotech. How can investors deal with the bubble's destructive infection of the biotech industry, and avoid companies that are likely to become terminal?
First, stick to proven profitable business models. The Internet bubble was largely due to a plethora of "concept" companies without a proven way to make money. The good news for biotech is that bringing a drug to market that treats a disease is one of the most high-margin business models known. Investors can start by concentrating on companies that make specific drugs to treat specific diseases. Too many new biotech companies, inspired by the sequencing of the human genome, were funded on the hopes of broad technologies that are only indirectly related to drug development.
Second, be patient and realistic. The biotech companies most likely to make advances still have to go through the cycle of drug development, testing and FDA approval, a prolonged and expensive process. It now takes more than $200 million to bring a drug to market, and it is easy to forget that 80 percent of biotech drugs that make it to human testing will fail. Just as the New Economy of the Internet was a myth, there is no New Economy of Biotech, as no innovations to date have significantly decreased the failure rate or cost of drug development.
Finally, if there's a mantra for investors to avoid biotech bubble-itis, it is that boring is beautiful. During the delirium of Internet bubble-itis, investors were seduced by glitzy "disruptive" companies like Webvan, eToys and Pets.com, all of which peaked early and were some of the first to flame out. Because biotech is such a high-risk endeavor, some of the best returns may come from companies making important innovations in drug therapy that are based on well-characterized biologic mechanisms, unrelated to genomics, nanotechnologies, or other buzzwords to come.
Much has been made of the Internet investment bubble - how spectacular its boom and bust was, and how it possibly could have been prevented with a little more investor foresight. Almost as much has been made of the idea that the biotech sector will be the one to pull high-tech economy out of its doldrums. Financial markets have yet to recover from the severe case of acute bubble-itis that infected most Internet and telecommunications stocks. Is the excitement about biotech valid, or is the recent decline in biotech valuations simply a symptom of bubble-itis spreading to this sector?
The biotech industry holds enormous promise for medical advancements and financial success. But investors would do well to remember the lessons of the Internet and telecom bubbles as they choose where to spend their money. Focus on prevention of bubble-itis, as there is no immunity and no known cure.
Editor's Note: Alex Seagle is associate editor of The Contrary Investor, 1 year, 12 issues, $125 a publication of Fraser Management Associates, 309 South Willard St., Burlington, VT 05401, an employee-owned, fee based investment advisor. www.fraser.com.
