The Red-Hot Biotech Sector Has Experts Screaming Bubble

The Red-Hot Biotech Sector Has Experts Screaming Bubble

SAM RO

FEB. 10, 2014, 8:55 PM 1,208 2

There’s just been so much talk about bubbles lately. And Business Insider has been reporting on many of these bubbles. Apparently, there are bubbles in tech stockscraft beersNorwegian housing … PIMCO’s Bill Gross once even said, “All markets are bubbly.

So, why stop there?

The next terrifying chapter in the book of bubbles is on biotech stocks.

These are the companies that spend much of their time in labs working on drugs and other medical products that rarely hit the market.

Biotech Stocks Sure Look Like A Bubble

“The fastest start to a year for US biotech initial public offerings is stoking fears of a bubble amid concerns investors are taking risks on companies at the earliest stage of medical research,” reported the FT’s Arash Massoudi and Andrew Ward. “Another eight biotech companies raised a combined $502m in US listings last week, setting a weekly record for the sector and continuing a boom that has seen the Nasdaq biotech index rise more than two-thirds in the past year.”

With everyone from Nuveen’s Bob Doll to GMO’s Ben Inker forecasting an era of low returns in the stock market, perhaps it’s no surprise that there’s a boom in capital heading to one of the most speculative corners of the world as investors search for returns.

“Shares outstanding in the Biotech ETF, IBB, is near a all-time record,” said Stifel Nicolaus’ Dave Lutz, who first pointed us to the FT article. “The current price/earnings ratio for the Bloomberg biotech index comprising 118 companies stands at 174 times, with a price-to-book ratio of 6.75, compared with 2.59 for the S&P 500.”

174x earnings should completely explode the brain of those complaining that 17x is too high for the S&P 500.

Here’s a one-year chart of the IBB (blue line), which is up 71% in the past year. That completely eclipses the S&P 500 (red line), which is up an extraordinary 18% during the same period.

Here’s The Crazy Stuff You Hear About In Biotechs

January was a big month for Intercept Pharmaceuticals (ICPT), a biotech company developing drugs to treat liver disease. This typical biotech stock rang in 2014 at $67.79 per share.

On January 8, the stock closed at $72.39. And on January 9, it opened at $231.89. That’s a 220% return overnight.

While you were losing money in the S&P 500, Intercept speculators got rich.

Here’s an excerpt from the announcement the morning of January 9 that had everyone perked up:

Intercept Pharmaceuticals, Inc. today announced that the FLINT trial of obeticholic acid (OCA) for the treatment of nonalcoholic steatohepatitis (NASH) has been stopped early for efficacy based on a planned interim analysis showing that the primary endpoint of the trial has been met. FLINT is a multi-center, double-blind, placebo-controlled clinical trial assessing the safety and efficacy of a 25 mg oral dose of OCA administered daily to biopsy-proven adult NASH patients over a 72-week treatment period.

If that doesn’t get your blood pumping, here’s Bank of America Merrill Lynch analyst Rachel McMinn in a note to clients the following day. It has the right amount of English.

We are raising our PO to $872 driven by our revised model which now includes a heavily positive probability adjusted potential for ICPT’s development stage drug OCA (obeticholic acid) for the treatment of nonalcoholic steatohepatitis (NASH). Based on the staggering est prevalence of 6 million US advanced NASH patients (similar exUS), and trajectory for NASH leading to epidemic cirrhosis and liver transplant rates, this market has a potential to be as big or bigger than Hepatitis C. As a base case in our model, we are assigning a $4B peak sales estimate on OCA on what we view as extraordinary study results. While the stock quadrupled yesterday, we see additional significant upside as investors size the market opportunity for NASH…

McMinn addresses three things every biotech investor is looking for.

Progress: The drug in question is not on the market for the treatments identified. But the trials have made enough progress that McMinn now sees a “heavily positive probability” the drug will get the green light by regulators.

Addressable Market: McMinn estimates $4 billion peak sales. That’s obviously a game-changer for a company that had $2.4 million in revenue in 2012. Yes, that’s billion versus million.

Price Target: McMinn raised her price target to $872 from $81. The stock was at $275 when the report was distributed to client.

All biotech companies dream of hitting these milestones. But few do.

However, the prospect of mindblowing returns arguably makes biotechs the sexiest sector in the market.

So, Here’s Why We’re Not In A Biotech Bubble

The reason why valuation multiples are so high is because many of these companies have no earnings (as expected) as they bleed money in R&D trying to discover the cure for cancer or the next Viagra.

As such, these companies are notoriously difficult to value because overnight they can go from losing tens of millions of dollars to earning billions of dollars.

Who’s to say that all of the companies in the biotech sector won’t nail their trials and get on the fast-track to becoming the next Lipitor?

“I don’t think it is a bubble,” said Rich Bernstein in an email to Business Insider. “It’s certainly very speculative, but speculation alone doesn’t make a bubble.”

This is not to say that a turn in the markets could cause the air to come out of the biotech sector. Rather should the sector fall, it would be relatively isolated as these stocks aren’t as widely held as the bulk of the S&P 500.

“Bubbles pervade society,” said Bernstein. “They are bigger than the financial markets.  I don’t think the biotech speculation is that broad, so no bubble in my opinion.”

“Whether it is wise to invest in speculative stocks is a totally different issue.”

Our Verdict

Honestly, who knows? Bubbles have an unfortunate history of becoming obvious only after the fact.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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