Inside Wall Street: 2010 Could Be Big for Small Biotechs

Biotechnology stocks pulled a huge surprise in 2009: They surged.

Few analysts expected the sector to handily outscore the rest of the market. Equally surprising was the robust performance of the young and small-cap crowd of mostly development-stage companies, which trumped their large-cap brethren. That was a switch from 2008, when the big guys outslugged the tykes, with the likes of Amgen (AMGN) and Genentech (which Roche acquired in 2009)leading the way.The prevailing sentiment among some avid biotech watchers is that 2009's pattern will prevail again this year.

"Generally, the passion for small- and mid-cap biotechs persisted through the second half of 2009," says biotech analyst Mark Monane of investment firm Needham. In contrast, he notes, the five largest biotechs -- Amgen, Biogen Idec (BIIB), Celgene (CELG), Genzyme (GENZ), and Gilead (GILD) underperformed. That group was down an average 6.1% vs. a gain of 15.6% by the Nasdaq Biotech Index.

The American Stock Exchange Biotech Index rocketed 43% in 2009, walloping the Standard & Poor's 500-stock index, which rose 19.7%.

Winners and Losers

Among 2009's top biotech gainers were Vanda Pharmaceuticals (VNDA), which advanced 2,150%; Human Genome Sciences (HGSI), up 1,342%; and Keryx Biopharmaceuticals (KERX), up 1,034%. Vanda is developing clinical-stage products for central nervous system disorders. Genome Sciences has three products in late-stage clinical trials: Benlysta, a treatment for systemic lupus; Zalbin, for hepatitis C, which already completed phase 3 clinical trials; and Raxibacumab, a treatment for anthrax. Keryx posted promising results from its KRX-0401 cancer drug currently in trials for multiple myeloma.

Biotech also had casualties last year. The big ones included Repros Therapeutics (RPRX), which tumbled 92.4%; GTC Biotherapeutics (GTCB), skidding 76.6%; and GTX (GTXI), down 75.1%.

Assuming the U.S, economy continues to improve over 2010, this pattern of small-cap biotechs outpacing the rest may persist, says Monane. However, any economic deterioration will likely send investors back to a defensive position by embracing the cash-flow-positive big biotechs, he warns.

Clinical Trials Are Key

For 2010, some top biotech investors are betting on companies that are in advanced stages of developing drugs against cancer, cardiovascular, infectious, central nervous system and metabolic diseases. "Individual small-cap biotech stock performance in 2010 is likely to be driven by clinical trials and regulatory outcomes," says Monane.

Among those that some veteran biotech watchers believe will pull ahead in 2010:
  • Achilllion Pharmaceuticals (ACHN), which is down to $2.24 a share from its 52-week high of $3.89 on Dec. 16, 2009
  • CytRx (CYTR), trading at $1.17 a share, up from its 52-week low of 25 cents a share on Dec. 27, 2009
  • Clinical Data (CLDA), which has fallen to $16, down from its 52-week high of $21.94 on Oct. 16, 2009
  • Allos Therapeutics (ALTH), down to $7.26 a share from its 52-week high of $9.30 on Feb. 4, 2009
  • Big-cap Alexion Pharmaceuticals (ALXN), now at $45.74 a share, off from its 52-week high of $49.57 on Jan. 4, 2010.

Achillion is attracting fresh Wall Street attention because of its strong hepatitis C programs, potentially a multibillion dollar market. Edward Nash, analyst at Roth Capital Partners, believes the stock, which he rates a buy, is worth $12 a share (it's now trading at $2.24) based on the "robust and impressive" data the company recently reported on its ACH-1625, a treatment for chronic hepatitis C infection. Nash notes that hepatitis C virus is the most common cause of viral hepatitis, an inflammation of the liver. More than 170 million people, he says, are infected with hepatitis C virus worldwide

The true value of ACH-1625 isn't yet being reflected in the stock's current price, says Nash. Achillion is also developing ACH-702, a treatment option for serious and resistant bacterial infections. The company has raised more than $24 million in financing the past year to fund development of the drugs.

"ACH-1625 is a truly differentiated molecule with potential to be one of the best-in-class protease inhibitors," says Jason Kolbert, analyst at National Securities, who rates Achillion a buy.

CytRx, which is focused on human therapeutics, has a partnership with the Massachusetts Medical School that provides it access to RNAi technology, which serves as a platform for drug discovery applications, including for acute leukemia, obesity and diabetes. "CytRX plans to initiate phase 2 oncology clinical trials this year, and coupled with its 36% equity stake in RXI Pharmaceuticals (RXII), it represents an exceptional asset," says Chrystyna Bedrij, analyst at Griffin Securities. She rates the stock, now at $1.17, a buy with a price target of $3. RXI, co-founded by Nobel laureate Craig Mello, is an emerging leader in RNAi therapeutics.

Clinical Data expects to file a new drug application with the Food and Drug Administration in the first quarter for Villazodone, an antidepressant, says Bedrij, who also rates the stock, now at $16 a share, a buy with a 12-month target of $38. The company is also preparing to conduct phase 3 trials for Stedivaze, an anti-stress treatment. "If the drug proves successful, it could double the value of the stock," says Bedrij.

Allos Therapeutics, focused on developing small-molecule therapy to treat cancer, is expected to soon launch Folotyn, a treatment for relapsed/refractory T-cell lymphoma. It's the only FDA-approved drug for the disease and is expected to be in the market early this year. Nedham's Monane estimates the average annual cost for a patient will be $120,000, and he estimates peak sales could reach $350 million to $500 million. Monane figures the stock, now at $6.65 a share, could double in 12 months.

Alexion Pharmaceuticals is riding high with its lead product, Soliris, the only treatment specifically approved for paroxysmal nocturnal hemoglobinuria (PNH), a very rare and life-threatening blood disorder that strikes people of all ages. Sales growth has been strong, notes Monane. Beyond the U.S., the drug was also launched last year in Canada and Britain. The company expects to market Soliris this year in Latin America and the Middle East. Now at $48 a share, the stock should hit $57 in12 months, says Monane.

Biotech stocks always present a lot of risk because developing drugs requires huge financing and takes many years to complete, and the odds of coming up with a great product are steep. But the rewards are phenomenal when a company finally develops a breakthrough drug -- that is, if you're an investor who makes the right bet early on.
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