I am currently a research analyst intern at a relatively decent sized hedge fund. One of my responsibilities is being in charge of the biotech stocks in the portfolio as well as researching new opportunities in the biotech sector. Hopefully this helps some people who are in need of some help whether it's pitching a stock for an interview or just for personal investing. There is big money to be made in the biotech sector.
Evaluating biotech companies to invest in cannot be done in the conventional way (i.e using common metrics such as P/E, Revenue,etc.) A biotechl company, especially a small one, has little to no revenue and earnings. Does this make the company crap? No, because all these companies are focused on research and development. Instead, there are three main keys to focus on while looking at a bio-pharmaceutical company.
1) Cash
2) Catalysts
3) Pipeline Potential
The first key point is cash. How much cash does the company have on hand? When was the last time they diluted their shares? How long can they last with the current cash they have on hand? How do they receive cash (i.e. by partnership, outside institutional funding, issuing more shares)?
Cash is the lifeblood of biotech companies. Without cash, they cannot fund their testing and trials which means that the company is doomed for failure.
The next key point is catalysts. What are some predicted events that will shift the stock price in a positive way? Is it the announcement of a trial that will be concluded? Is a new management team being hired? Did the quarterly financial results beat the expected data?
Catalysts are a huge attribute to biotech companies. That is how money is made and lost when investing in biotech.
Ex. A certain company is in the midst of their Phase IV trial. The trial is suppose to conclude at the end of Quarter 2 in 2013. If you expect the results to be favorable, that would be a catalyst for the stock price.
The last major key point is pipeline potential. The pipeline is all the company's drugs that they either have on the market and/or are currently testing. A diversified, well-rounded pipeline is favorable. When one speculative company only has one drug in their pipeline, it is incredibly risky to investors because if that drug is unsuccessful, then the company is at risk of completely failing.
To put this into action, let's do a quick evaluation of Celsion Corporation (CLSN).
First, let's look at their cash situation. At the end of Q3 in 2012, they had a total of $23m in cash & equivalents. In addition to this $23m, Oxford and Horizon has promised to fund $5m to CLSN if their HEAT study trial, which will be completed at the end of January, shows positive results.
Management has directly stated that the current cash is sufficient to last until the end of 2013 and no dilution will be issued until at least after the results of the HEAT study trial is out.
So for CLSN, cash situation looks fine.
Second, let's look at some short-term catalysts. The major one will be the announcement of their HEAT study trial results at the end of January. Many investors are optimistic about the results and investors have often seen biotech share prices increase as much as 200% after a successful announcement of testing.
Last, let's look at their pipeline. ThermoDox is the drug that they are currently performing tests on. However, ThermoDox is believed by Celsion to be able to treat multiple types of diseases. ThermoDox is on the verge of treating liver cancer, and is being tested for the treatment of breast cancer, and colorectal liver mets.
Due to this quick evaluation, one can see how to generally evaluate a biotech company.
Hopefully this has helped. If you have any questions or comments feel free to ask/share.
NPV analysis is really the only way for a biotech.
First, establish the probability of launch (generally by looking at previous launches - e.g. targeted antibodies for cancer with good early Phase 1/2 tolerability/toxicity are generally more likely to be successful compared to a drug targeting multiple organ systems such as in sepsis (noting in decades except a withdrawal by FDA), or complex less well fundamentally understood areas of science like neuroscience) or just use "standard" Phase 1/2/3 probabilities, 20%, 40%, 60%.
Second, look at managements guidance and clinicaltrials for expected launch year and then build a peak sales estimate based on time to peak sales and height of peak sales using things like diffusion models and decision trees. Or just use the standard 5 years after launch argument or compare to similar products - e.g. Novartis' Gilenya/Sanofi's Aubagio when looking at Biogen's BG-12
Third, Assume a sales plateau period consisting of incremental price rises and estimates of NRx versus switches and new competitors entering (Zytiga and Xtandi in a few years)... generally plateau when growth slows to below discount rate - generally 10%-20% for biotech). This lasts until patent expiry (e.g as in FDA Orange book).
Estimate an operating margin for each product - very rarely given but often given COGS for a division/segment (e.g Speciality Pharma or Interventional medicine or Cardiovascular EBIT). Probably best to use post-tax pre-R&D margins. Also look at competitive environment as some drugs (e.g. statins/medical devices) may require large sales forces thus >SG&A.
Patent expiry...ummm, what region is the product going off patent in (US/EU/Japan), is it a biologic/white pill, exclusivity/paediactric extensions, authorised generics (e.g, Shire/Impax in aDHD) or straight pure generics, how is it taken/administered (e.g. Advair/Seretides inhaler), what has happened when previous same class drugs have lost patent protection (e.g. Zocor-Lipitor-Crestor).
Obviously other factors to consider too but that should be a start - let me know if i have missed anything important...