International Biotechnology Trust (IBT) 31 Aug 2002 Page 5
This has severely impacted the performance of IBT. An example of this is Essential
Therapeutics, which is trading at a dollar a share, down from just under four dollars at the start
of the period under review. This is despite a planned restructuring to focus on clinical
development rather than earlier stage research, and an acquisition that brought in an interesting
compound that is already in the clinic.
Positive news has tended to be overlooked by investors and there has been a spate of bad
news from the sector, which has depressed sentiment. This included the ImClone scandal and
concerns over Elan's accounting practices. In addition there have been a number of late stage
product failures including Cubist's injectable antibiotic for pneumonia and Emisphere's oral
heparin formulation. These failures have reminded investors of the risks of drug development
although, given that there are more late-stage drugs in the pipeline than ever before, more late-
stage failures should be expected.
The FDA appears to be taking a more cautious approach to the approval of drugs following a
series of product withdrawals. The perceived increase in regulatory risk has increased the
discount rate that investors use to value biotech stocks, however, history has shown that many
of the drug candidates initially held up by the FDA, are ultimately approved. Recent drug
approvals have largely been ignored by investors, for example Gilead's HIV drug Viread, IDEC's
Zevalin for Non-Hodgkins Lymphoma and portfolio company, Atrix Labs' two formulations of
Eligard for the treatment of advanced prostate cancer.
However, more recently newsflow from the sector has begun to improve with good earnings
numbers from the larger biotech companies and two well-subscribed follow-ons for Telik and
Trimeris. In addition Biogen's Amevive for psoriasis and AstraZeneca's oral cancer drug Iressa
both received positive reviews from FDA advisory panels. Most importantly for sentiment, a new
Commissioner for the FDA was nominated in September. The Agency has been without a Head
since President Bush came to office and this new leadership may help reduce some of the
delays in decision-making. In addition the third Prescription Drug User Fee Act was passed in
June, which should improve funding for the agency and increase the number of reviewers and
external advisers.
Fundamentals
The correction in the biotech market overshadows strong fundamentals for the sector; an
increasing supply of new potential drugs driven by scientific innovation, high barriers to entry for
competition and the demand dynamics of an ageing population coupled with increased drug
usage. Biotechnology drugs generally treat serious, life-threatening, and unmet medical needs,
so revenues and earnings are generally insensitive to changes in the macroeconomic
environment. The industry comprises an unprecedented and growing number of profitable
companies, a plethora of products on the market and more than 350 products in late-stage
clinical trials (Phase II or beyond) and while many of these products will not succeed, many of
them will.
Pharmaceutical companies are relying more and more on biotech companies to supply them
with in-licensing opportunities in order to meet double-digit earnings growth expectations. Their
own pipelines are generally lacklustre and they face looming key patent expiries and declining
R&D productivity. There is typically strong competition to in-license late stage products and the
balance of power in negotiating these deals has swung firmly in favour of biotech companies.
An example of a significant late stage transaction is GlaxoSmithKline's $270m licensing of
portfolio company Adolor's Phase III compound Alvimopan. Given the nature of this competition,
pharma companies may start in-licensing some of the more plentiful earlier stage compounds,
which should translate into richer incentives for biotech to partner out these programs. This
could allow biotech companies to bolster their increasingly precious cash piles and to reduce
