Building a Biotech Basket

 | Jun 11, 2014 | 5:00 PM EDT
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Tuesday, I wrote about value investor Seth Klarman's multi-year foray into the land of biotech stocks and why such a highly regarded value investor would venture into stocks that are widely considered speculative. Most biotechs generate no profits, employ a lot of leverage or issue equity to fund drugs that often never realize any commercial value. But for those biotechs that do succeed, the payoff is many fold. Look at Klarman's recent experience with Idenix Pharmaceuticals (IDIX). Shortly after Klarman's Baupost Group took a 30% stake in the company, Merck (MRK) made an offer to buy it at a 230% premium.

Over the past several years, Klarman has taken many small stakes in various biotechs. Why not copy the master and create your own basket of biotechs? Instead of betting a lot on one, bet a little on several. A single winner will more than make up for a few duds. And if you select carefully, odds are even better that the basket will produce more than one winner and very few losers.

Let's start with the obvious picks, the ones that Klarman still owns today that have not spiked up on a buyout or other milestones. Keryx Biopharmaceuticals (KERX) is a new position initiated by Baupost during the most-recent quarter. Shares trade for about $14, up from a 52-week low of $6, valuing the company at $1.3 billion. Keryx focuses on drugs that treat renal disease.

AVEO Pharmaceuticals (AVEO) is micro-cap biotech focusing on cancer drugs. The company has a market cap of $65 million and Baupost has an approximately 8% stake. AVEO currently has two compounds in Phase 1 and Phase 2 studies.

Kindred Biosciences (KIN) is a name I have written about several times and probably the most intriguing idea. It focuses on drugs for pets -- namely cats and dogs. Shares have been quite volatile. When I first mentioned the company, shares were trading in the mid-teens and went as high as $23 before coming back to $15. Currently, shares trade around $19, valuing the company at approximately $370 million.

Our little biotech basket will consist of these three names for now. While there are dozens of biotech companies, I want to limit the basket to names that have been either screened by other investors or have candidates that are in latter stages of the trial cycle. Those that make the cut will be added, and I hope to have five to seven names in the basket. Each month I will track the performance of this basket and see how it stands up against other biotech exchange-traded funds.

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