A Biotech Bloom in July

by: Option Dragon

The best performing sector in the past month has been biotech. With investors flocking to safety due to recent financial turmoil and the sharp correction in energy, funds and investors have been warming up to biotech.

The biotech sector is not without its large risks though and investing here requires more homework and experience than most sectors. The biotech landscape is full of landmines especially with unproven companies with their yet to be proven drugs. The recent backlash the FDA has received due to major flaws in its Vioxx approval and other well publicized failed post approval drugs has made future FDA committees and agency approvals much more stringent in safety profiling and thorough in analysis of drug data.

This has in some ways created a higher hurdle for non-approved and novel drugs and their respective companies to get regulatory approval as well as making trials more expensive in order to meet all of the FDA’s protocols and in meeting data primary and secondary endpoints and goals. This in turn is helping established, already approved biotech drugs and companies grow market share easier and increase revenue streams over a longer period of time with less threat from competition. These U.S. biotech drugs are now expanding into ever more populous nations.

As our global economies grow more prosperous, modernized health care becomes more universal and these old/new biotech drugs find resurging growth on top of increasing disease indications such as in cancer. For example, Onyx Pharmaceuticals’ (NASDAQ:ONXX) cancer drug Nexavar is expecting approval in China and Taiwan in the next 6 months for hepatocellular carcinoma (NYSE:HCC) or liver cancer. The patient population in China for HCC liver cancer is enormous, China accounts for 45% of the world’s cases!

China’s pollution problem will only saddenly increase the amount of cancer patients within their incredibly large population base that triples the size of the U.S. Hopefully China will reverse this course but it is a sobering trend.

Imclone’s (OTC:IMCL) cancer drug Erbitux received approval in Japan on July 16th for use in advanced colorectal cancer. With this approval, Eribtux is the first ever EGFR-targeted monoclonal antibody to be submitted for and receive marketing authorization in Japan. Most of these blockbuster drugs have received European approval as well and that has boosted revenue growth in the past couple years.

For the next half of the year, there are numerous catalysts which could be big for the sector. On the whole, the amount of big named drug catalysts could further boost and sustain gains already achieved by the sector possibly through the fall. The new story which is emerging could be about how much revenue growth there is globally once these drugs penetrate higher population areas and modernized, emerging nations (i.e. China approval for ONXX’s Nexavar for HCC). Strength in this sector could help strengthen the market, as a new band of sector leaders emerge.

Posted below are the stocks in focus on the IBD biotech list. I also have weekly chart snapshots and components on four biotech indexes to follow (IBB, BHH, BTK, XBI). I have also posted my own Optiondragon Biotech Watchlist as well as upcoming biotech catalysts you need to keep an eye on for the rest of the year.
I have been trading in the biotech space for several years and am very excited about the future ahead. We missed out on the recent DNA move (we decided not to roll our July calls into Aug. oooops!) but took advantage of the ACOR jump with an overweight call strangle into its data release. We look forward to the upcoming catalysts and trading opportunities ahead.

IBD Biotech Watchlist:


iShares Nasdaq Biotechnology (NASDAQ:IBB)

An excellent way to play biotech is by investing in an ETF. One must pay particular attention to an ETF’s holdings which could cause skews in performance based on its components. This is an excellent ETF with a good choice of components although DNA and OSIP are most notably absent as well as AZN, ONXX and IMCL. Not having Genentech (DNA) during its recent big pop as one of its components hurt this ETF’s performance recently, while the others did. I still do like nearly all the biotech choices in this group with CELG being my favorite but feel it could be more encompassing with the names I mentioned.

One good idea could be to own two biotech indexes or one ETF index and a couple other select names to further diversify your portfolio within the sector. You also want to pay closer attention to the largest weightings in each ETF and do even more analysis on those components. Technically, the biotech indexes show strength although in some cases they are short term overbought so waiting for a pullback in the selected ETF’s or buying individual favorite names on the dips and trading them could be a good strategy going forward.

Weekly chart:


This ETF was the biggest outperformer amongst its peers due to a high percentage holding of DNA at 38%. This too would be better situated in the cancer growth market with an addition of the above mentioned. 60% of its holdings is between Gilead Scences (NASDAQ:GILD) and DNA. One should consider adding additional diversification in this space if one chooses to add this to your portfolio.
Weekly Chart:


This is a great index as well to follow and is the most diversified of the three within the biotech space. This index is now approaching all time highs at 864.82.

S&P Biotech Fund (NYSEARCA:XBI)
This ETF is also one of my favorites due to its even allocation amongst its components as well as its component makeup. ONXX, UTHR, SVNT, VRTX, ALXN all are great companies with bright outlooks. XBI does have a relatively high turnover rate of 74%, this in my opinion is a good thing because the biotech space has many crosscurrents within the space due to catalysts and competitive forces. Staying nimble is important.


The Optiondragon Biotech Watchlist:

These are the main focus names on my biotech watchlist going forward: DNA, OSIP, ONXX, CELG, GILD, IMCL, VRTX, CMED, AUXL, ACOR, SVNT, SQNM, MDVN, GTXI, MYGN, ALXN, UTHR.

Some have catalysts going forward and I will be constantly analyzing the price action going into their respective catalysts, mostly strangling the chosen catalyst plays. Some have excellent momentum and technical strength and make good trade candidates.

For disclosure I do own an ALXN overweight call strangle going into earnings and I will be owning and trading the majority of these names on my list. I will be analyzing each name as we go along during the rest of the year. Things are definitely heating up in this space.

Upcoming Biotech Catalysts:

AMGN: NEW NEWS- Denosumab data trial results for osteoporosis came out this weekend and was positive and should boost AMGN shares higher Monday.

ONXX: China approval and Taiwan approval of Nexavar for HCC (liver cancer) in the second half of 2008.

OSIP: Tarceva drug expansion but the stock could be affected by upcoming trial results of AZN’s lung cancer drug Zactima which is due out in the next couple months. OSIP charts show that investors aren’t too worried about the competitive threat.

DNA: Roche buyout offer could be raised. The longer the eal negotiations go on and a deal is done at this price range or higher, the respective indexes and the biotech sector could stay aloft for sometime. Here is some updated information and analyst comments on this big deal:

- DNA: Believe Roche is unlikely to significantly raise offer@JEFF
Jefferies believes that while Roche’s bid could be increased to fully value DNA’s pipeline, Roche may be unwilling to allow any premium to drift significantly higher than the current offer. The firm raised DNA’s target price to $95 from $78 but keeps a Hold rating.

- Roche delicately attempts squeeze-out for remaining Genentech shares-WSJ
Roche Holding ((OTCQX:RHHBY), the majority shareholder of Genentech (DNA), is attempting to buy out the minority holders but it has to tip toe around any appearance of getting a sweetheart deal or that its insider position gives it an advantage over others, according to the Wall Street Journal. As a result Genentech’s three independent directors will direct negotiations. If that doesn’t work two investment banks would be asked to value its shares and decide the price Roche would have to pay for the remaining shares.

- DNA: Expect deal to go through at premium to $89/share@RBCM
RBC believes an acquisition price in the $95-$100/share range is reasonable and maintains an Outperform rating on DNA shares.

- DNA downgraded to Neutral from Buy@PIPR
Piper downgraded shares as their analysis suggests Roche will modestly increase their acquisition bid. Piper raised their target to $96 from $94.

- DNA target raised to $97 from $85@DBAB
Deutsche Bank believes the company’s negotiating leverage with Roche has increased substantially following last night’s press release. Shares remain Buy rated. The press release was based on reports of DNA management’s more aggressive stance regarding the acquisition price.
He said in a research note that the price is seven times estimated 2009 revenue for Genentech — a 10 percent discount to large biotech merger deals over the past seven years since Roche will likely not need to pay a change of control premium.
“We believe investors can now feel confident that Genentech has sufficient leverage to negotiate a higher price for any potential Roche transaction,” Schoenebaum said, adding that risk has also increased that the asking price could exceed Roche’s threshold.

- ”It seems clear from Genentech’s response that they are at least positioning themselves in potential opposition to this deal,” said RBC Capital Markets analyst Jason Kantor.
He said Genentech’s stance increases the risk that the deal will fall through or be delayed, but also likely ups the potential purchase price. Kantor raised his price target on Genentech’s stock to $100 from $95.

- ”The committee is not obligated to agree to any process or transaction price, and we expect a negotiation with Roche’s management,” Oppenheimer analyst Bret Holley said in a research note. “We believe $102 to $110 a share is a more acceptable price range, and we see a high probability that Roche will bid higher,” he said. Holley raised his Genentech share price target to $105 from $88. (I’m sure the falling dollar doesn’t hurt the chance of a bid increase….)

Potential FDA drug approvals for the second half of 2008:

click to enlarge

Phase III Clinical Trials for the Second Half of 2008