Biotech summer rally sparked by deals
Life Science stocks kept pace with market sectors that offer comparable risk and performance: Small cap growth, science and technology and midcap growth.
The bellwether, broadly diversified ETF IBB was up 16% moving from 70 to 81 in the three month period.
About 50% of the IBB holdings are large cap companies such as Amgen, Celgene, Genzyme, Gilead and Teva. The IBB was flat for the year as of July 1 so all the gains were in Q3. The Fidelity Select Biotech Fund (FBIOX) was up 9.4% YTD and underperformed due to overweighting in specific large caps CEPH,GENZ,GILD with underweighting in tools and diagnostics.
The key drivers to biotech performance have not changed over the past few years but M&A activity has come to the forefront as several acquisitions have sparked the sector:
Abbott bought Solvay for $6.6B
Bristol Myers bought Medarex for $2.37B
JNJ bought Cougar for $1B, 18% of Crucell for $441M and 18% of Elan for $885M
Sanofi bought Merial for $4B
The vaccine area was almost abandoned by large pharmaceutical companies in the eighties but now accounts for many of the deals. New immunotherapy technologies and a greater market need for disease prevention against new infectious agents such as swine flu has brought vaccines to the forefront.
Building a long-term product pipeline for large cap pharma has always been an arduous development process of 7-10 years with costs in the range of $1B per drug and a high risk of failure.
The acquisition route has become more attractive because of good technology value and shortage of capital for smaller biotech companies in the current post-meltdown market environment. Over the past few weeks several analysts have rushed to put out their biotech acquisition lists spurring rallies across the screen. Another factor mentioned is that biotech products may be less affected by healthcare reform than more mature drugs.
The Rayno Life Science portfolio as published in GEN in January 2009, without rebalancing, was up 13% YTD and higher for Q3.
With higher weighting of selected stocks as recommended in Raygent blogs the portfolio would be up 15% or more.
The big winners in the portfolio with Sep 30 prices and in order of stock appreciation YTD:
Targacept TRGT up 700% at 21.3
Abaxis ABAX up 65% at 26.75
Inverness IMA up 58% at 38.75
Illumina ILMN up 55% at 42.50
United Therapeutics UTHR up 45.5% at 49
Among the losers in the portfolio were Array, Celera, Cephalon, Cubist, Gilead, and Viropharma.
(CBST,GILD and VPHM are now recovering.)
The results from life science stock performance YTD illustrate the following principles of portfolio management:
1.) It is important to overweight large caps to protect losses due to events and volatility.
2.) Tools and Diagnostics companies provide good returns and excellent diversification with minimal clinical trial risk .
3.) Stock picking can be difficult with the smaller caps due to clinical trial risk so a larger pool of stocks is necessary.
If the small cap growth market holds up and we continue to get good news on clinical trials, the M&A backdrop should support higher biotechnology valuations.