How to spot a healthy biotech investment

How to spot a healthy biotech investment

PUBLISHED: 7 HOURS 10 MINUTES AGO | UPDATE: 4 HOURS 42 MINUTES AGO

MICHAEL BAILEY, The Australian Financial Review

The equity analysts call them “pre-cash flow” companies. All investors really have to go on are the promises. Such companies provide a rare opportunity for ordinary investors to get in on the ground floor of potentially huge, global businesses. There are two main types of pre-cash flow companies in Australia. One type – junior resources explorers – is on the nose as commodity prices wane. As a result, there’s more interest in the other type: biotechnology companies, or “biopharma” as the sector is sometimes known. The success stories out of this sector are well known, but be warned. For every “ten bagger” like a Mesoblast or Sirtex, there are dozens of others that have wiped out their investors or perhaps struggled to break even. More dauntingly, success relies heavily on approval from the only regulator that big pharmaceutical companies care about – the US Food & Drug Administration (FDA).The pathway to commercialisation for the drugs and medical devices offered by Australian biotechs involves three phases of clinical tests which routinely take years, and woe betide the owner of a drug which the FDA knocks back. In January, ASX-listed Pharmaxis got an FDA thumbs-down for its cystic fibrosis drug, Bronchitol, and its shares fell 45 per cent in a day.

Considering the huge rewards on offer, it makes sense that buying biotech companies requires more homework than investing in a blue chip, where analyst coverage is plentiful and there’s a track record on which to base decisions.

‘YOU DON’T NEED A DEEP UNDERSTANDING OF THE SCIENCE’

“But you don’t need a deep understanding of the science,” says Tim Morris, a partner at advisory wiseowl.com, which specialises in research on pre-cashflow companies. Morris has a science degree from the University of NSW but he insists the five principles his firm uses to pick biotechs are common sense. The first three principles on Wiseowl.com’s five-point checklist are:

1. Management – “We look for people on the executive or board with a history of generating shareholder value growth, because the people running the research and development at these companies tend to be good at spending money and not so great at making it,” Morris says.

2. Financial position – “We like companies with a good capital base,” Morris says. “They’ve raised capital in recent months and won’t be going back to the market any time soon.”

3. Catalysts – “We look for a factor that will make the share price go up in the next 12 months,” Morris says. “Some R&D programs can run 10 years in total, so we like to pick points in that development curve where we think the best risk-adjusted return profile is. The price jump you get around a successful phase completion often is not sustained, so we try to jump in 12 months before. I look for risk-mitigating factors, like the size of the potential market for the drug or device being tested, and whether there are any competing products already filling a need in the area.”