In current times, biotechnology remains one of the few bright spots in the uncertain economic landscape. IBISWorld estimates that global biotechnology industry revenue will reach $228.6 billion in 2012, having increased at an average rate of 10.4% per annum over the past five years. As the nation's baby boomers continue to age, the demand for pharmaceuticals continues to grow and revenues of the biotechnology industry will increase at a compounded annual rate of 9 percent between 2012 and 2015. This is a marked turnaround from the 9% decline when the economy hit bottom in 2009.
The NASDAQ Biotechnology Index rose 10% in third quarter and is up 40.5% this year whereas S&P500 increase was only 12.1%. Although the $33 billion in biotech investment approached levels not seen since the venture boom 12 years ago in 2000, there is a major difference in the nature of the current investment compared with 12 years ago. Only about half of capital investment went to companies with revenues smaller than $500 million. This portion means only a bit more than $16 billion was venture, or small capital investment. The rest is larger pharmaceutical companies taking advantage of low interest rates to finance acquisitions and stock buybacks. The main reason is big pharmaceuticals are now plunging over the much discussed drug patent cliff. Most of them saw some of their key proprietary drugs become public domain, resulting in significant revenue loss as generic versions entered the market. The resulting scramble to fill in the revenue gap or maintain share price produced new acquisitions, stock buybacks, etc. This according to the latest Ernst & Young Beyond Borders Biotechnology Report 2012, which states that major pharmaceuticals have lost about 30% of their "firepower" in the last 5 years. They just don't have the liquid cash they used to, so they are reducing upfront payment amounts on deals and borrowing to maintain dividend payments, buy back stocks, and finance mergers and acquisitions.
The $16 billion amount of small company investment is pretty consistent with the previous few years. There has been a reduction in venture capital for new enterprises in all industries since 2009. Further, this situation is not expected to change. In fact, it is likely to worsen as capital funds are shrinking due to overall economy of the last few years.
Venture capital is often called risk capital. These investors are paid to take risks with the goal of outsized returns. Value today is a function of that risk and return ratio, and asymmetric views of that ratio create arbitrage opportunities for investors. If an asset was widely perceived to be low risk, it would be easy to raise capital at higher prices, and returns (appreciation) would be smaller. If an asset is high risk, you can buy it cheaply. And if you believe there's a capital efficient path to de-risking it, you will be able to create and capture the value of that risk reduction. This is especially true in biotech investing, where perceptions of risk become the driving factor (especially since profitability of successful drugs is very high). One common misperception of risk is that early stage biotech plays are more risky than later stage clinical deals. Thus, two weeks ago, late stage biotech Alimera Sciences, Inc. (ALIM) blew up after the FDA sent it a Complete Response Letter (CRL) rejecting its Iluvien product for eye diseases. The stock is off 80%.
This risk often pays off spectacularly that is reflected in performance of Biotech index. Thus, Trius Therapeutics (TSRX), a biopharmaceutical company focused on the discovery, development and commercialization of innovative antibiotics for life-threatening infections, ranked number 42 on Deloitte's Technology Fast 500, a ranking of the five hundred fastest growing technology, media, telecommunications, life sciences and clean technology companies in North America. Trius' revenues grew 3,420 percent during the five year period ending 2011. Last year, Trius was ranked number 226 on the Fast 500 list (thus it was on this list two years in a row).
Another example is Sarepta Therapeutics (SRPT) whose stock grew 593% this year. The company's lead drug eteplirsen shows tremendous promise as a groundbreaking treatment for Duchenne muscular dystrophy (DMD), a rare genetic disorder that forces patients into wheelchairs in their teens and can be fatal shortly after. Initial results in April from a Phase II study of eteplirsen in DMD patients were tantalizing, but essentially ignored by Wall Street. Follow-up data from the same study announced in July and presented in October were nothing short of astonishing. Sarepta is hoping to convince the FDA to approve the drug early and DMD advocates are already mobilizing to lobby FDA on the company's behalf.
But what's happening at Northwest Biotherapeutics (NWBO) is truly game changing. It is entering Phase II clinical trials for DCVax-Direct. When DCVax-Direct was administered in pre-clinical animal studies, existing tumors regressed. Importantly, the regressed tumors included not only tumors treated with DCVax-Direct but tumors on the opposite side of the animal's body (which were not injected) as well. Further, when the animals were subsequently injected with cancer cells, the animals didn't re-develop cancer, indicating immune memory. DCVax-Direct takes out a patient's immune cells and reprograms them to attack cancer. It can treat any kind of tumor anywhere in the body.
Northwest Biotheraupetics can repeat performance of Pharmacyclics (PCYC) whose stock doubled in value in 2011, then more than tripled in 2012. As a result a market cap already exceeds $3.7 billion. The object of Wall Street's affection is ibrutinib, a pill designed to block the production of an enzyme responsible for the unchecked or cancerous growth of B-cells. Investors see blockbuster potential in ibrutinib as a treatment for a variety of B-cell related lymphomas and leukemias, and so does Johnson & Johnson (JNJ), which licensed the drug from Pharmacyclics in December 2011. Phase III studies of ibrutinib already started enrolling patients.