Portfolio Building Blocks: Biotech

by: Carol Flake Chapman

Now that President Obama has signed the new health care reform legislation passed by the U.S. Congress, it’s time to think about which companies and which stocks stand to benefit as an estimated 32 million Americans formerly not covered by health insurance will now be receiving medical benefits.

Many observers have pointed out that the U.S. drug industry emerged as a big winner, fending off price curbs and other restrictions in the new health care law. But one sector in particular won some striking gains: biotech. The window of “data exclusivity” for branded biologics will not be reduced from 12 years to five years, as some legislators had wanted. So costly proprietary brand-name biotech drugs will enjoy extended protection against cheaper generic, or “biosimilar,” drugs. For biotech companies, the difference between five years and 12 years of exclusivity could amount to billions of dollars.

The new legislation acknowledges the fundamental differences between biologics and traditional pharmaceuticals. While traditional pharmaceuticals are produced by machines and are relatively simple for generic drug makers to copy, biologics are grown from living cells and are so complex in their molecular structure that current science generally does not allow for an exact copy to be made.

Trying to pick the next biotech blockbuster is a bit too much like gambling for many investors. So one way to invest in biotech without taking excessive risks on any one company is to purchase shares in one of the four ETFs (exchange-traded funds) focused on biotech companies.

By far the best performing of these ETFs over the past year is the First Trust NYSE/Arca Biotech ETF (NYSEARCA:FBT). The NYSE Arca Biotechnology Index is an equal dollar weighted index designed to measure the performance of a cross section of companies in the biotechnology industry that are involved in the use of biological processes to develop products or provide services. Such processes include recombinant DNA technology, molecular biology, genetic engineering, monoclonal antibody-based technology, lipid/liposome technology, and genomics. The ETF includes such star performers as Human Genome Science (NASDAQ: HGSI), OSI Pharmaceuticals (OSIP), and InterMune (NASDAQ:ITMN).

Another choice is the iShares Nasdaq Biotech Index (NYSE: IBB). This one holds over 100 companies of all sizes and hit a new 52-week high on the day healthcare reform was passed.

Thinking a little further afield, another possible choice is a company that delivers products and services to biotech companies. Life Technologies Corporation (NASDAQ:LIFE), formerly Invitrogen Corporation, is a biotechnology tools company. The Company delivers a range of products and services, including systems, instruments, reagents, software, and custom services. Its range of products includes technologies for capillary electrophoresis based sequencing, sequencing, patient care report, sample preparation, cell culture, ribonucleic acid (RNA) interference analysis, functional genomics research, proteomics and cell biology applications, as well as clinical diagnostic applications, forensics, animal, food, pharmaceutical and water testing analysis.

Still another health sector that will benefit from the legislation is the diagnostics industry, which will undoubtedly increase its income from the diagnostic procedures that so many more Americans will now be able to afford.

The two giants in this field are Quest Diagnostics (NYSE:DGX) and Laboratory Corp. of America (NYSE:LH), which offer services ranging from routine bloodwork to molecular genetics and cancer detection. Combined, they generate over US$12 billion in revenue. In fact, molecular diagnostics is expected grow 19% per year to become a US$7 billion a year industry by 2011. Oncology and genetic testing is expected to fuel the growth.

There are some interesting smaller companies in this sector as well, including Genoptix (GXDX), with a projected earnings growth of 25% a year over the next three to five years. Genoptix is a specialized laboratory service provider focused on delivering personalized and diagnostic services to community-based hematologists and oncologists. Its Compass service includes the determination by its pathologists of the appropriate diagnostic tests to be conducted and the performance of these tests. The company's Chart services combine assessments and analyses of disease progression after intervening clinical action, providing physicians with diagnostic tools to track both a patient's disease and response to treatment over time.

Disclosure: Long LIFE