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Thanks to new drugs, acquisitions and other factors, biotech and health-care firms alike are forging beneficial growth and development strategies – which is good news for investors.

Jason Kantor, Ph.D.RBC Capital Markets [email protected]

An increase in M&A among earlier-stage public [biotechnology] companies is likely and would enhance investor confidence in small-cap stocks. Large-cap companies with good earnings have performed well and will likely continue to do so.

We continue to favor large-cap biotech companies particularly industry leaders with multiple years of visible growth … In the small-cap space, individual stock performance has become substantially de-linked from company fundamentals. We favor companies with near-term clinical catalysts and reduced near-term financing needs, such as Alexza and Allos. Investors with longer-term horizons can find deep value in many of the small-cap companies that despite solid clinical progress are trading at very low enterprise values.

We believe the best valuation metrics for biotech companies are price/earnings and price/earnings to growth. Currently, the top-tier biotech companies … trade at a mean of 23.6 times 2008 consensus EPS estimates and at a PEG of 1.1 times. These metrics are significantly below their historical averages.

In comparison to the large pharmaceutical companies, biotech has historically traded at a higher P/E multiple (consistent with higher growth rates), but the premium over pharma is at a multi-year low.

The biotech sector is now trading at a significant PEG discount to both pharma and its long-term historic average, indicating to us significant room for upside in the group through multiple expansions. The biotech sector is trading below its eighth-year historical PEG of approximately 1.64 times earnings. Even excluding the “bubble years,” the historic PEG is substantially higher than current levels (1.47 times for 2002-2008).

We believe that we are in a period of rapidly improving fundamentals in biotech (more products, more profitable companies, more retained product rights, etc.,) so we believe that the depressed valuations make the sector very attractive for investors willing to ride out the current cycle.

We believe that the growth prospects for biotech remain strong, and innovation and investment in the first half of the decade are now generating new products and better understanding of disease processes.

Outperform: Affymax (AFFY), Alexza (ALXA), Allos Therapeutics (ALTH), Avigen (AVGN), Curis (CRIS), Cubist (CBST), Epix Pharmacueticals (EPIX), Genentech (DNA), Gilead Sciences (GILD), ImmunoGen (IMGN), Medivation (MDVN), Micromet (MITI), Progeneics (PGNX), Regeneron (REGN), Seattle Genetics (SGEN), Synta (SNTA), TorreyPines (TPTX), Xenoport (XNPT), and Xoma (XOMA).


Douglas Maurer, CFAValue Line 212-907-1500

U.S. drug stocks are considered a “safe haven” because their sales are less correlated with the economic environment than most sectors.

Some top firms are establishing positions to oversee their overall strategy, including new business opportunities and cost-cutting initiatives. As new drugs become harder to come by and generics encroach, the strategy person is charged with setting priorities and allocating resources more efficiently. Firms are diversifying their product lines to include consumer health care items like vitamin supplements that tend to have steady, though lower, profit margins than drug sales.

The drug industry contains a varied selection of investment opportunities … U.S. drug stocks have outperformed the S&P by an average of 7 percent in the past four recessions.


Charles C. Duncan, PhDJMP [email protected]

We reiterate our Market Outperform rating and $12 price target on Allos Therapeutics. On May 15, Allos surprisingly held a call to discuss interim results from its pivotal Phase II PROPEL study with pralatrexate (PDX) in patients with relapsed/refractory peripheral T-cell lymphoma (PTCL). The data look promising and suggest to us that timelines could accelerate. Patient enrollment was completed in April; we expect top-line data by year-end ’08 and, if positive, for Allos to file a new drug application in first-half of 2009. Allos also has six other ongoing trials looking at PDX in other cancers (hematological and solid tumors). Our $12 price target is based on 8 times 2010 product sales, discounted at 30 percent.

We look forward to updates from the previous investigator-lead trial in PTCL, as well as information on the broader PDX clinical program (interim CTCL or NHL data) at an upcoming European hematology meeting. Additionally, in second-half ’08, we anticipate the company will bolster its balance sheet either through an equity raise (we have modeled an approximate 7-million share raise in 4Q08), or out-licensing ex-US rights to PDX, or by being acquired.


Damien Conover, CFAMorningstar, Inc. 312-696-6052 [email protected]

Earlier in the summer, Sanofi-Aventis announced a $2.6 billion acquisition bid for generic Czech firm Zentiva. The bid represents a 15 percent premium to Zentiva’s closing price before a previous bid by financial firm PPF Group. Since PPF lacks the operational synergies expected in a Sanofi acquisition, we don’t anticipate a bidding war between the firms. While the premium appears a little low, we believe Sanofi’s current 25 percent ownership in Zentiva will probably provide a nudge to close the deal.

We like the deal, as the acquisition provides Sanofi with additional access to the fast-growing Eastern European market. Further, with the U.S. patent expiration approaching on cardiovascular drug Plavix in 2011, the increased exposure to generic pharmaceuticals should help blunt that loss.

Sanofi-Aventis’ wide lineup of branded drugs and a robust pipeline create strong cash flows and a wide economic moat. Growth of existing products and new product launches should offset patent losses on allergy drug Allegra and cancer treatment Eloxatin. Further, Sanofi dodged a bullet in mid-2007 by holding on to patent exclusivity of blockbuster Plavix, removing a major risk hanging over the company.


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