Finding Opportunity In Small Biotech Companies

| About: Vertex Pharmaceuticals (VRTX)

By Kelly Brown

Investing in biotech is a little like playing roulette - one could hit at any time. While large biotech companies, like the $54 billion Amgen (NASDAQ:AMGN) or the $40 billion Gilead Sciences (NASDAQ:GILD), have more to spend on research and development than their smaller counterparts and more resources at their disposals in general, sometimes the underdog comes out on top anyway - and the payout can be extraordinary.

Vertex Pharmaceuticals (NASDAQ:VRTX) fits this bill nicely. With a market cap of just $7.91 billion, the company is markedly smaller than many of its competitors, but it could be one of the best biotech buying options available right now. The company offers a reasonable investment that produces solid, reliable earnings. Year to date, Vertex is up 13.53%. It features two products that are in high use. The first, Kalydco, is a prescription drug used to treat cystic fibrosis in rare cases of the disease when the patient suffers from a mutation in their CF gene. This niche market is small, but Kalydco is the only drug available for this market. The other drug Vertex makes is Incevik. This is a prescription medication used in conjunction with ribavirin and peginterferon alfa to treat hepatitis C in adults. But, the real potential with Vertex is its pipeline.

Vertex has one drug in phase 2 trials and two drugs in phase one trials for treating hepatitis C, one drug in phase 2 trials for treating immune-mediated inflammatory disease, two drugs in phase 2 trials for treating cystic fibrosis, one drug in phase 2 trials for treating epilepsy, and one drug in phase 1 trials for treating influenza. Vertex is also dedicated to more than a dozen preclinical programs focused on tuberculosis, cancer, Huntington 's disease, multiple sclerosis, and pandemic influenza, to name a few.

Vertex recently traded at $37.53 a share. Last year, the company reported an EPS of 14 cents after sustaining some heavy losses but analysts are bullish about the company going forward. Consensus estimates put the company's earnings at $3.00 a share this year and $3.21 next year, making Vertex's forward price-to-earnings ratio somewhere around 11.69. Vertex does not pay a dividend.

It seems several hedge fund managers are bullish about the company, at least in the short term. David E. Shaw's D E Shaw increased its stake in Vertex by 106%, to 6.87 million shares worth $228.17 million, during the fourth quarter 2011. In addition, Vinik Asset Management, Healthcor Management and Diamondback Capital each initiated new positions in the company that quarter. Bain Capital's Brookside Capital reduced its position but, as of the end of December 2011, the fund still had nearly 3% of its portfolio invested in Vertex.

In addition to Vertex, investors could consider the $17.21 billion market cap Valeant Pharmaceuticals (NYSE:VRX). The company focuses on both prescriptions and over the counter treatments in the fast-growing cosmeceuticals industry, as well as neurological treatments. It recently announced that it was buying gastric, analgesic and anti-inflammatory drug assets from Mexico-based Atlantis Pharma for $71 million. Valeant is currently trading at $56 a share. Last year, it earned $2.93 a share. Analysts are expecting that figure to reach $4.16 a share this year, rising to $4.66 next year. At this rate, the company is priced at roughly 12 times its future earnings.

Questcor Pharamceuticals (QCOR) is another great option. The biopharmaceutical company focused on studying difficult-to-treat medical conditions, specifically those related to nephrology and neurology. Like Vertex, Questcor produces just two drugs - flagship multiple sclerosis drug Acthar and insomnia treatment Doral. It has surpassed analyst estimates for five straight quarters. Questcor recently traded at $42 a share. Last year, the company earned $1.27 a share, beating analyst estimates of $1.21. Consensus estimate put Questcor's earning at $2.40 a share this year, rising to $3.28 a share next year, putting its forward price-to-earnings ratio at 12.80.

I like Vertex best of this group. The company is positioned much better than Questcor or Valeant, in spite of being much smaller. Plus, it is priced lower relative to its future earnings and is poised to heavily trump last year's earnings, making it perfect for a shorter-term play. I recommend buying in soon before the rest of the market catches on and Vertex's price jumps.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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