Shares: Market value of miracles - Biotechnology firms promise breakthroughs but the bandwagon has yet to roll

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The Independent Online
A FEATURE of the new issue boom of the past 18 months is that the UK stock market now has a significant biotechnology sector.

The shares have been neglected by investors, probably reflecting the continuing bear market for such pharmaceutical giants as Glaxo and Wellcome. But this reflects pricing pressures on existing drugs. That is not a problem for companies looking to develop new ones.

Biotech and fledgling pharmaceutical companies are hard to value because, like oil exploration companies, they typically have great hopes but little in the way of immediate revenue and profits. Non-experts find it hard to evaluate the potential of drugs under development - particularly when every company seems to be working on cures for cancer, arthritis, heart failure and Aids.

As a result, shares in the sector are typically trading at close to their issue prices, or lower in some cases. Analysts believe they are cheap. Ian Smith, at Lehman Brothers, values companies on the basis of assessing the drugs they have in the pipeline and discounting back from potential revenue.

As an example of his findings, he reckons that shares in British Biotechnology Group, which has a number of promising drugs at various stages of clinical evaluation, including one particularly exciting prospect, has a value of 820p rather than its current 458p.

There is also an argument that biotech shares are much less risky than people believe. New drugs are first developed in the laboratory. Promising compounds undergo pre-clinical testing to see if they have significant therapeutic benefits. Those that do then go into exhaustive human clinical trials, First-phase clinical trials are typically with a small group of healthy volunteers to test for safety. This is followed by second-phase trials on patients to test effectiveness. If results are encouraging, the drug goes into full-scale third-phase trials against placebos. If those are successful, a production application licence follows, with a view to development.

This may sound like a marathon race that few complete. Not so. Peter Fellner, chairman and chief executive of Celltech, the UK's longest-established biotechnology company, says 40 per cent of drugs in Phase 2 clinical trials make it to commercial production.

It usually takes from 10 to 15 years from initial discovery to commercial exploitation, so Britain's biotechnology industry, which began about 13 years ago, is only now starting to take promising compounds into second-phase trials. In effect, investors are showing little enthusiasm just as the companies are reaching the interesting stage in their development. A spectacular success by any of them would have a dramatic impact on the sector.

A front-runner to come up with an important drug is British Biotechnology. It was floated in June 1992, and the shares peaked at 525p but were trading as low as 350p in January, when the company was capitalised at less than pounds 130m.

By comparison, Glaxo has an established portfolio of drugs and is valued at nearly pounds 18bn, with perhaps half that valuation based on Xantac, its ulcer therapy.

British Biotechnology shares have shot back up because of an anti-cancer compound with the generic name batimastat, which provided unexpectedly strong evidence of its effectiveness in early clinical trials. The company is now hoping to complete Phase 2 trials and begin the vital third phase this year, with a view to product applications by 1996.

The excitement is that the drug, a traditional chemical drug rather than a true biotechnology product, is a novel way of treating cancer that does not rely on toxicity, as does chemotherapy. Batimastat works by containing the spread - and possibly the growth - of solid tumours. The hope is that the group has a potential blockbuster on its hands which could revolutionise cancer treatment.

Typically, each company has a front-running compound on which most hopes rest, and a number of others at less advanced stages. The doyen of the industry is Celltech, which floated at 250p in December but has seen its shares flop to 219p. This looks harsh.

The company already generates significant amounts of cash through payments on drug development from larger partners and has a profitable business making human antibodies, which quadrupled operating profits to pounds 2m last year.

Celltech's main prospect is a joint venture with Bayer. The latter has a drug in Phase 3 trials for treating shock, based on mouse antibodies.

If successful, Celltech has rights in certain European countries and - more important - has its own version, based on human antibodies, about to enter Phase 2 trials. Celltech's version is also being tested for effectiveness against rheumatoid arthritis and inflammatory bowel syndrome.

Last of the three UK-quoted true biotech companies is Cantab Pharmaceuticals at 464p. It has a joint venture with the US giant Baxter to develop a compound, called LM-CD45, to reduce the threat of rejection of human transplant organs.

In return for world marketing rights, Baxter, the world leader in peritoneal kidney dialysis, is funding the entire development cost.

My guess is that at this stage British Biotechnology must be the hottest prospect. Aggressive investors should look out for the warrants issued as part of its fund-raising, which start trading separately on 10 May. More cautious investors could consider buying a mini-portfolio of all three shares.

(Photograph omitted)