Considering a Few Small-Cap Biotech Plays

 | Apr 16, 2012 | 10:30 AM EDT
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Biotech may be the most difficult sector in the market to invest in. The complications of coming up with a new product or compound, getting it through Phase I, II and III trials and all the way to federal approval is a long and arduous process. For every success, there are at least half dozen failures. Hedge funds that employ PHDs in biochemistry still have their share of clunkers. Biotech is built to drive investors crazy. For every dozen investments, expect three to four to fail, two to muddle along and be worth half what you put in two to three years down the road, two to show some minor progress and break even. Two will be substantial successes and become 2-4 baggers and if you are fortunate, one or two will produce a major discovery and/or be bought out that will make them five to 20 baggers or more.

That is why I prefer a shotgun approach to investing in this sector. The best way to invest in biotech is to spread your money around by accumulating small positions in at least a dozen firms. These companies should be focusing on interesting areas, are trading significantly below analysts' price targets, have strong and committed management and either have cash flow or enough cash on hand to get them through critical milestones. Here are a few small-cap biotech plays that meet these criteria and should be considered by aggressive investors.

Vical (VICL) is a company that engages in the research and development of biopharmaceutical products based on its deoxyribonucleic acid (DNA) delivery technologies for the prevention and treatment of serious or life-threatening diseases. Although it has severaI products in different phases, the main hope of the company is a drug called Allovectin which is in Phase III clinical trials. This product targets metastatic melanoma.

 Four reasons VICL has a solid risk/reward profile at $3 a share:

  • Insiders have bought more than $10 million in new shares so far in 2012.
  • Key analysts believe the stock has considerable upside. The median analysts' price target on Vical is $6. Credit Suisse has an Outperform rating and a $7 price target on VICL.
  • Given its small market capitalization (under $250 million after net cash is stripped out) and promising products, it is not hard to see this company being snapped up if mergers-and-acquisition (M&A) activity continues to pick up in this sector.
  • The company has plenty of net cash (more than $45 million or more than 15% of market capitalization) to get it through various trials.

Novavax (NVAX) focuses on developing recombinant vaccines for infectious diseases using its virus-like particle platform (VLP) technology

Four reasons NVAX is a worth a flyer at $1.20 a share:

  • Insiders seem confident as they have bought more than 350,000 net shares in the last eight months.
  • It has a solid balance sheet with $18 million in net cash, which should tide company over until it becomes cash flow positive.
  • It has two full years on a three-year/$97 million government contract. The contract can also be extended for another two years for an additional $82 million. This is key reason why revenues are expected to go up by more than 100% this year and more than 40% in fiscal year 2013.
  • The stock is way below analysts' price targets. The median price target by the four analysts that cover the stock is $4 a share. The low estimate is $3 a share, more than double the current price of the stock.

Geron (GERN) develops therapies for cancer. It has several products in Phase II trials. Classic high risk/high reward biotech play.

Four reasons GERN has potential at just over $1.50 a share:

  • Roughly 60% of the company's market capitalization is in net cash on the balance sheet.
  • Insiders have been net buyers of the stock over the past six months.
  • Three analysts have price targets on the stock. The low target is $3 a share and the high target is roughly quadruple the current price of the stock at $6 a share.
  • Geron just received patent approval for a treatment method for central nervous system-related tumors last week.

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