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November - 1999 - issue > Wall Street View
Internet Boom & Biotech Bloom
Monday, November 1, 1999
Investors today are participating in an investment boom of historic proportions, particularly in the Internet sector. While Internet stocks have experienced some recent weakness as compared to their recent 52-week highs, stocks like Amazon.com and eBay continue to trade at many times their 52-week lows and year-ago prices. Biotech, however, is another sector that once again has its proponents and momentum among investors. For example, biotech leaders like Amgen are trading at or near 52-week highs.

Understanding biotech’s past should be a requirement for today’s Internet investors. At the same time, however, understanding the Internet’s present boom may foreshadow a bright future ahead for biotech. In the 1980s and again in the early 1990s, biotech stocks experienced gains that may be analogous to the Internet sector returns that we have witnessed over the last several years. Consequently, analysts have compared the folly of previous biotech cycles to the present mania for technology investment opportunities. Analysts point out that each previous biotech boom has been followed by a successive bust resulting in significant losses and disillusionment among investors, implying that Internet investors are in for a similar fate.

Biotech 101

Like the Internet today, biotech investment opportunities in the early 1990s captured the imaginations of a broad base of investors. Also like the Internet, biotech was initially largely funded by individual retail investors and was scorned by the majority of institutional investors that regarded the sector and its companies as too speculative and difficult to value. However, as enthusiasm grew, institutional investors also piled in, driving valuations even higher and simultaneously perpetuating and validating the mania.

Since investors rely primarily on their expectations of the future, valuations were driven skyward by hopes of quick progress. Companies went public well before having products or distribution channels or business plans. At the height of the mania, all it took was a few PhDs in biotech, a sexy mission such as finding the cure to cancer or AIDS, and some patent filings or research claims. Venture capitalists were, of course, eager to fund biotech startups, anticipating quick returns when these companies went public, often within 12 to 18 months of inception and often at valuations representing many multiples of the original investment. At some point it became clear to investors that creating a successful drug and bringing it to market was much more difficult than expected. Each time, this realization resulted in a quick deflation of the previous valuations.

There are several lessons from the biotech boom and bust of relevance to today’s Internet investors. First, valuations of companies that are the source of widespread public enthusiasm often already reflect many years of hard work to get to that point, and in the case of many biotech companies in the early 1990s, decades of future growth potential. When this is the case, investors can face an inordinately high risk of massive capital losses. Second, even if the industry is as significant as biotech or the Internet in terms of its potential to change and transform our lives, individual companies within these industries can take much longer to benefit from the potential of those industries, and take more time to turn into real business than many investors initially expect.

A third lesson is to pick companies carefully and hold on to leaders through short-term swings. Today, for example, Amgen, with a $45 billion equity market value, is worth 30 times its value in May 1990, whereas many other smaller companies with great ideas have been forgotten, are still struggling, or have gone bankrupt. Those that choose to invest in these sectors are well advised to stick with the leaders. This is true because when a truly enormous opportunity for change like biotech or the Internet presents itself, most consumers and investors are initially caught unaware. The early companies to go public are often the leaders from in the areas of management, financial backing and quality. However, as the early companies do well and command extraordinary valuations, a number of me-too or second-tier companies will receive funding by virtue of the principle that a rising tide can lift all boats. As the number of opportunities increases rapidly, investors need to be more selective.

Differing Models

There are, of course, a number of differences between biotech and Internet business models. The Internet is accessible and familiar to more investors than biotech. It is a mass-market communications phenomenon and is understood and used by a large and growing percentage of the population. Although in the big picture, biotechnology promises to transform all of the many billions of lives on this planet through better drugs and genetic engineering, its dynamics are less understood and less readily grasped by those selfsame masses. Most importantly, biotech companies face more uncertainty and regulatory risk. While Internet business models face marketing and execution risk, these models are easy to understand and do not have the element of chance faced by the biotech companies, which can spend many years and tens of millions of dollars developing a promising new drug, only to discover that it cannot be brought to market for efficacy or safety reasons. It has been this time requirement, coupled with the fact that approximately 1 in 10,000 drugs makes it to market, that has dashed potential investors’ early hopes about making quick riches in this industry.

A Tantalizing Future

According to Hoovers Online services, biotechnology was a $10.8 billion revenues industry, with 11 percent revenue growth in 1996. The market capitalization of the biotech industry has increased to well over $110 billion in just three years. Despite the differences, the current Internet boom may offer tantalizing hints of the future of biotech. After all, on a fundamental level, the current biotechnology and Internet/communications technological innovations are probably the two most important developments in terms of the profound impact that they will have on our lives over the next two decades. Unlike technology, however, biotech may not yet be in full bloom. The late 1980s and early 1990s brought a resurgence in investor enthusiasm for the industry, due to successful product launches from giants like Amgen, Biogen and Chiron, many hundreds of other biotech companies are still not profitable today, but are working hard on a variety of promising pathways.

Says Dr. Len Schleifer, CEO of Regeneron Pharmaceuticals Inc., “I believe that the promise of providing breakthrough drugs to address unmet medical needs is the major force attracting investors to the biotechnology industry. On the other hand, the inherent high failure rate of drug discovery and development combined with the long, expensive nature of the process makes many investors uncomfortable investing in biotechnology. Nevertheless, the opportunity to earn dramatic financial returns through investing in companies that can improve the lives of millions, makes biotechnology a terrific industry to be part of.”

Is the biotechnology industry today where the computer and hi-tech industry was 20 or 30 years ago? Perhaps the mini-boom that the biotechnology industry is experiencing now will be dwarfed by developments over the next 15 to 20 years. As genetic engineering and DNA technologies improve, R&D efforts will also improve. These gains will be driven in part by bioinformatics, a powerful and developing tool for discovering novel protein therapeutics that combines database mining, molecular modeling and DNA chemistry developments.

Today, it may be difficult to fully appreciate the possibility of a time when technology and Internet are not the only game in town, since high-tech industry activity in the last five years has been blinding. Nevertheless, the current enthusiasm caused by instantaneous financing rounds, instantaneous IPOs, and instantaneous high stock valuations of the dot-com companies is based on nascent ideas and dreams of large potential profits. As the biotech runs of the last two decades have illustrated, such booms can be quickly deflated for an extended period of time. However, the biotech revolution that began in the early eighties continues to quietly but steadily pickup steam.

The views expressed in the article do not necessarily represent the views of Merril Lynch or Regeneron Pharmaceuticals.

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