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How Biotech Stocks Behave

Example: the Swiss public biotech scene

Typically, many biotech companies end up as failures. This is even true for com-panies that have reached the public market. A company can usually float with a phase 2 project, but even then many obstacles await the companies on their path to the releasing drug reve-nues. The Swiss public biotech scene went through particularly hard times. Two years ago Swiss biotechs seemed unable to fail, no company suffered a major loss. But then bad news followed each other, either failures in phase 2 or phase 3 trials, or FDA disapproval. Today, even the European star company Actelion trades 40% below its all-time high because of, amongst other reasons, a disappointing phase 3 trial.

Table 1: Swiss biotech performance (only companies with more than 2 years track record included)

Company

All-time high

May-10

Performance

Actelion

74

43

-42%

Addex

75

12

-84%

Arpida[1]

45

1

-98%

Basilea

283

73

-74%

Bioxell[2]

64

7

-89%

Cosmo

33

20

-39%

Cytos

179

12

-93%

Newron

80

19

-76%

Santhera

135

26

-81%

Looking at this poor track record (of course, compared to the all-time high it always looks bad, and the crisis also helped worsening the situation, but only Actelion and Cosmo are still more or less on track) many might ask whether it is actually worthwhile investing in biotech; is it possible to make money with biotech?

What valuation tells us

Any valuation model using success rates takes care of these negative events, and on average you should be able to make money as long as first, the value is positive when you invest, and second, your assumptions are not completely off. But that’s the theory, what does the reality look like?

First, in reality Actelion is a company worth CHF 5.5 Bn and should definitely be counted as a success. Actelion probably already compensates for the other companies when invested early enough. Second, we have to define success and failure more clearly. Naturally, one or two companies out of ten become a success if invested from the start (let’s say IPO to be generous) to the end (either with products on the market or failed). But we don’t need to hold the shares to the end. In reality many more events happen that can be called success or failure. Table 2 shows that based on biotech success rates[3] we get out of 100 phase 1 projects 167 positive events and 87 negative events, although only 13 projects actually get approved. If we look only at phase 2 projects or later then we get a ratio of 82:72 positive and negative events, almost 50:50.

When then looking at the value development of a normal drug development project as indicated by rNPV we get the value jumps as in figure 1.

Table 2: Success and Failure Events for 100 Phase 1 Projects.

 

Success Rates

100 projects

 

 

Success

Failure

Phase 1

85%

85

15

Phase 2

58%

49

35

Phase 3

40%

20

30

Review

65%

13

7

Overall

13%

167

87

Overall (≥P2)

13%

82

72

 

Figure 1: Value development of a one-compound company (calculated with ri:val).

Of course, in case of negative trial results the company value falls to the value of the remaining assets of the company, or in the case of a one-compound company pretty much to zero.

The real picture

We have collected all clinical news of public companies from a group of biotech newsletters and looked at their impact on the share price of the corresponding companies. The following list gives an impression of the reactions of the share prices to the news flow. The list is, however, far from being complete.

Table 3: Share price reactions to trial results.

Company

Date

Phase

Result

Reaction

Neuropharm

Feb09

P3

failure

-90%

Synta

May09

P3

failure

-27%

Poniard

Nov09

P3

failure

-78%

Spherix

Nov09

P3

success

+77%

Addex

Dec09

P3

failure

-65%

Achillion

Dec09

P1

success

+48%

Ark

Dec09

Approval

failure

-50%

Medivation

Mar10

P3

failure

-68%

Antisoma

Mar10

P3

failure

-72%

Arqule

Mar10

P2

success

+63%

Ardea

Apr10

P2b

success

+23%

Omeros

Apr10

P2

success

+28%

Intermune

Apr10

P2

success

+65%

Dynavax

Apr10

P2

success

+35%

Vertex

Apr10

P2

success

--

Cadence

Apr10

Filing

success

+10%

Gilead

Apr10

P2

failure

-9%

BioCryst

Apr10

P2

success

+15%

Dendreon

Apr10

Approval

success

+15%

Raptor

May10

P2

success

+29%

Pozen

May10

Approval

success

+21%

Pharmasset

May10

P2b

success

--

InterMune

May10

Approval

failure

-81%

Newron

May10

P2

failure

-55%

The vast majority of share price reactions obey the model, i.e. a failure leads to a drop and a success to a steep increase of the share price. The amount of the value change depends, of course, on the rest of the company. The loss of a phase 2 project affected Gilead just with a 9% value drop, while a negative FDA decision took 81% of InterMune‘s value.

Other events

There are also other events that can have a significant impact on the value. Table 4 lists a few examples:

Table 4: Share price reactions to trial results.

Company

Date

Event

Reaction

Ligand

Apr 07

Dividend Payment

-24%

Javelin

Apr 10

Merger announcement

+63%

CSL

Apr 10

Collateral effects

-4%

Array

Apr 10

Deal with Novartis

+33%

Transgene

Mar 10

Deal with Novartis

-19%

Glenmark

May 10

Deal with Sanofi Aventis

+3%

Also this list confirms that the value follows the lines that are proposed in the valuation framework. It is, however, a little more complex. A dividend payment results automatically in a 1:1 value reduction, there is no secret about that. A merger announcement is already more interesting. As soon as the merger price is communicated, the stock surges to that price (with a slight reduction for the time value until the transaction). This could be observed in several occasions like in the cases of Serono and Merck or Genentech and Roche. The CSL example shows, that even once a treatment is on the market, it is not free of uncertainty. The reported collateral effects of Fluvax have led to an adjustment of the sales estimates and consequently to a value reduction. Finally, the announcement of a partnership can also increase the value. First, such a partnership confirms the potential of a drug, or in the case of Transgene it disappoints the shareholders and leads to an adjustment of the valuation assumptions. Second, a license deal leads to a changed risk-profile of the company, as usually no significant expenses are linked to that project anymore and the cash position improves. This should typically lead to a lower cost of capital. This effect is quite opaque and cannot be separated from an adjustment of the assumptions; but we recognise it in several stock charts.

Conclusion

We can observe an excellent correlation between share price reactions and valuation. Of course, all the above-mentioned share price reactions were observed and explained after the event. But it should give us confidence that we can also predict what is going to happen to the share price in various R&D and corporate scenarios.

[1] Arpida has been taken over by Evolva after FDA disapproval.

[2] Bioxell has been taken over by Cosmo after phase 2b failure.

[3] From the report „Biotech Success Rates – Going the Wrong Way“ by Avance.

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