Biotechs Are Crashing: Here's This Week's Action Plan

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If you hold any biotech stocks in your portfolio, then it's time for a gut check.

Share prices in this high-risk/high-reward group posted their biggest one-week loss in recent memory, leading investors to figure out if it's time to get out now... or to commit more funds.

How bad was the carnage? The SPDR S&P Biotech ETF (NYSE: XBI ) slid nearly 10% on the week, and for many individual stocks, the erosion was far more severe.

#-ad_banner-#Cancer-focused biotech Exelixis saw its shares plunge on poor clinical testing data, but all of these other stocks fell out for seemingly no explicable reason. Actually, there was a negative catalyst impacting this whole group: Congress recently questioned a move by Gilead Sciences (Nasdaq: GILD ) to price a new hepatitis C drug at more than $1,000 per pill. Many investors quickly concluded that new drugs in development from other biotech firms may not fetch the high reimbursement rates that analysts had been suggesting.

To be sure, few drugs in development will be priced quite that boldly. (Indeed, Gilead subsequently relented and suggested that many insurers will get 20% to 30% discounts from that list price.) Yet the issue reminds investors that biotech stocks face not only face approval risk for any new drugs, but will no longer be able to command any price they want while shielded from generic competition. The FDA used to approve new drugs that were merely "good enough." Now, the FDA wants to see that they are clearly better than rival drugs already on the market, or are priced at lower rates than existing drugs.

The biotech sector's woes may also be attributable to a sudden decision by many investors to lock in profits after a remarkable multi-year surge. Indeed, the SPDR S&P Biotech exchange-traded fund ( ETF ) showed all the signs of a bubble. The fact that this ETF is still 100% higher that it was at the start of 2012 is hardly good news for bottom-fishing value investors. Still, the fact that this sudden sell-off has been indiscriminate means that investors can start to look for oversold opportunities.

One of those opportunities can be found in the post-IPO arena. Newly public companies often lack a stable shareholder base, and have found few buyers in recent sessions. Here's a look the biotech firms that came public in the first quarter of 2014 and have already fallen more than 25% from their trading peaks.

The rapid pullback in these stocks doesn't make them bargains per se. But it does make them worth a fresh deep look now that they can be bought for so much less.

And since these firms are newly public, they are all several years away -- if ever -- from having a key drug come to market. That's why it pays to focus on companies that have raised enough money to sustain them for at least a few years, as the capital markets for biotech secondary offerings may be fast-closing. Most of these firms will be providing a quarterly update in the next four to six weeks, and the conference calls will be a good chance to hear directly from management about the various drug development strategies in place.

What Analysts Are Saying
Wall Street analysts, many of whom have biotechnology backgrounds, are also a good source of ideas. I am fan of investment firm Leerink Sawn, as they focus exclusively on health care and have deep domain expertise. Leerink's Michael Schmidt recommends shares of recent IPO Dicerna Pharma (Nasdaq: DRNA ) , which opened for trading in late February near the $45 mark and is already below $30. Schmidt believes that Dicerna has developed a solid platform of RNA drugs, and sees shares more than doubling to $60, noting that the company has enough cash on hand to last through 2016.

I also track the research work of Cantor Fitzgerald's Irina Rivkind, who has developed a solid track record as a stock picker over the past few years. Rivkind currently sees more than 100% upside for Synergy Pharma (Nasdaq: SGYP ) , which had soared past the $6.50 mark in early March, only to be pushed below $5 again in the recent biotech rout.

Biotech investors should also take a fresh look at Threshold Pharmaceuticals (Nasdaq: THLD ) , which has more than $80 million in cash on hand, a key drug that has shown solid clinical progress by starving tumors of oxygen, and a key partnership with Germany's Merck.

Lastly, investors may want to revisit the opportunity presented by Intercept Pharmaceuticals (Nasdaq: ICPT ) , which I profiled at the start of 2014 . Shares of Intercept surged from $300 in late January to more than $450 by mid-March -- but are back down near $300. Some analysts still see this stock nearly tripling from current levels.

Risks to Consider: Investors should assume the worst in terms of balance sheet replenishment. As we saw in 2008 and 2009, when the capital-raising environment is unreceptive to biotech firms, their cash balances can become perilously low.

Action to Take --> One of the reasons that biotech had been surging in recent years is the rapid clinical progress being made in many areas such as cancer and hepatitis. Indeed, there now dozens of drugs in Phase II and III trials that have shown impressive efficacy and safety profiles. How all of these drugs will be paid for in the tight health care spending environment is another question. Still, many drugs face potential blockbuster opportunities, and the sector pullback has given investors a fresh chance to capitalize on that opportunity.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: ETF

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