Rules of Biotech Investing Change, and So Must Biotech Investors

Investing in the small biotech space is a lot like dating down here in Miami -- volatile, exciting, and every time you think you have everything figured out, the rules of the game change. One of the changes in the biotech space over the last few years has been the struggle of small concerns to penetrate mass markets even with approved and superior drugs. Back in years past, the big unknown in making an investment decision on a small developmental concern with a superior product was whether it could get its primary drug compound over the finish line to approval. If it accomplished that goal the stock was usually successful or the company was bought out for a nice premium by a larger concern with an established sales force. Unfortunately, this has not been the case for several years now. Rather, companies that have garnered their first approvals and become what I dub 'Tier 3' stocks -- those with approved drug(s) but not yet profitable -- routinely are not rewarded by the market and often see their shares sell off substantially after approval. This situation exists in part because the merger-and-acquisition market is not as active as it has been in the past and fewer of these companies are bought soon after approval like they have been historically. Most of the deal volume in recent years has been around oncology, immunotherapy and rare disease names, none of which target mass markets. The transition from development to commercialization always has been a challenging one. However, recently it seems few small firms can master this obstacle, especially when entering a large market. Companies targeting small or niche parts of the markets where most of the potential customers are known and can be served by a small sales force seem to be doing fine. Rare-disease concerns and others with Breakthrough Therapy status are good examples of these types of firms. Unfortunately, companies targeting a large market consistently seem to struggle to establish beachheads or achieve their projected ramp up of sales. This is even true when the new drug is clearly superior to anything on the market. Synergy Pharmaceuticals Inc. is the poster child for this kind of disappointment. Synergy had a drug named Trulance that was clearly superior to anything on the market and should have done $300 million to $500 million in peak U.S. sales in the right hands. Instead, inept management drove the company into a recent bankruptcy. Bausch Health Companies picked up Synergy's assets for slightly less than $200 million and has seen its market value rise by $1 billion primarily due to this smart small acquisition. It appears it is becoming harder and more costly to roll out a new drug and get to break-even cash flow status. Over the last year or so, acquiring new financing via secondary offerings or new debt issues also has gotten more expensive. This is why I have purged a lot of these sorts of names recently from my portfolio. That includes Adamas Pharmaceuticals Inc. on Tuesday after it offered up tepid forward guidance for its recent approved drug Gocovri. Instead, I am sticking primarily with developmental names targeting niche markets and small concerns that have drugs on the market than are already profitable; these include Exelixis Inc. and Eagle Pharmaceuticals Inc. . Unfortunately, life never stays constant for long. When the rules of the game change, modifications need to be made whether you like it or not.

Rules of Biotech Investing Change, and So Must Biotech Investors

One big change over the last few years has been the struggle of small concerns to penetrate mass markets even with approved and superior drugs.

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