Why it's worth watching out for the next Viagra

The sick are always with us - and so are the sizeable potential profits from new treatments, says Nick Clayton

Sex and drugs, even without the rock 'n' roll, sound as if they should be a surefire way of making money. An investor's dream is to uncover another Pfizer, which saw its share price double every year in the run-up to its introduction of its male impotence drug Viagra in 1998. Although the value has dipped since it peaked in the heady months following the launch, an investment in the company is still worth five times more than it was a decade ago. That is rather better than many other businesses in the healthcare sector.

Sex and drugs, even without the rock 'n' roll, sound as if they should be a surefire way of making money. An investor's dream is to uncover another Pfizer, which saw its share price double every year in the run-up to its introduction of its male impotence drug Viagra in 1998. Although the value has dipped since it peaked in the heady months following the launch, an investment in the company is still worth five times more than it was a decade ago. That is rather better than many other businesses in the healthcare sector.

The industry has not fared well in recent years, but that does not mean there are no good investment prospects. There are no fewer people getting ill nor drugs being developed. And the fact that share prices are poor for the whole sector could mean the potential returns are higher. It is not, however, a place for the faint-hearted.

Developing a treatment is a long process, with pitfalls along the way. It takes at least a decade from the point at which a drug is discovered to its being launched onto the market. Promising early trials can prove illusory, and other, more effective, forms of treatment may appear. Side effects may become apparent, even after the drug has gone on sale, forcing its withdrawal. And the length of time that a company has to recoup its outlay on research and development has become increasingly uncertain following successful patent challenges by manufacturers of generic products.

The pharmaceutical industry also has a huge image problem, particularly in its biggest market, the United States. Last autumn, the drug company Merck & Co voluntarily withdrew Vioxx, which was used to treat arthritis pain. A whistleblower scientist claimed that studies showed it had been implicated in up to 139,000 people who had suffered heart attacks. It was approved for sale by the US Federal Drug Agency in 1999. This was just the latest in a series of high-profile cases where pharmaceutical companies have been seen to respond slowly to problems with their products.

There are also strong pressures on pricing from governments. In the UK, the National Institute for Clinical Excellence (Nice) makes recommendations on treatments on behalf of the NHS. Globally, pharmaceutical companies have been pressed to reduce the cost of drugs for Third World countries, particularly for HIV/Aids.

Despite this, it was only last year, when it dropped to third place, that the drugs industry ended a two-decade run as the most profitable industry in the US. Both of Britain's drug giants GlaxosmithKline (GSK) and AstraZeneca have their biggest markets in the States. The companies have also started this year with new chairmen, former Vodafone boss Sir Christopher Gent and Louis Schweitzer of Renault respectively.

Of the two, Sir Christopher would appear to have the better prospects over the next couple of years. GSK is due to launch a vaccine called Cervarix, which recent tests show to be 70 per cent effective against the most common form of cervical cancer, the second most common cause of death from the disease in women after breast cancer. Potentially, vaccination could be mandatory across many countries, bringing tens of billions of pounds in income. It would transform GSK.

"Investors should look at how good the drugs are that companies have in their pipelines," explains Joanna Chertkow, senior healthcare analyst at Datamonitor. "The best prospects are either aimed at a big area or a niche market." Cervarix, for instance, could face competition, even if it overcomes all the hurdles necessary for approval, but the market is so vast that it would still be enormously profitable.

AstraZeneca does not have anything with the same potential in its pipeline and what looked to be a big earner, the anti-cholesterol pill Crestor, was described by FDA scientist David Graham as one of five drugs that should be withdrawn. Other trials are continuing, but even if it proves to be safe, that may not be enough to restore public confidence in what looked to be a blockbuster when launched two years ago.

The answer for AstraZeneca may be to look for deals with other companies that have products closer to market. These may come from the smaller biomedical companies that focus on a limited number of products. In recent years, it has often been those specialist businesses that have fared better than the pharmaceutical giants. Without products on the market, price squeezes, market withdrawals and patent losses are not the same threat. The volatility of their share price, usually on Aim in the UK, comes from the performance of their products in clinical trials.

"Biotech is clearly high-risk and no investor should let it take up more than 5-10 per cent of their portfolio," says Samir Devani, European biotech analyst with CODE Securities. "But with high risk comes high reward." Although this type of investment is speculative, that does not make it short-term. "From when a drug is discovered, it takes 10 to 12 years for it to come to market. But the vast majority of drugs don't make it to market," says Mr Devani. And even if they are eventually successful, during the years of development the companies have no income and, therefore, shareholders receive no dividend.

With such a high failure rate, he suggests looking for companies that have "numerous shots at goal". That is not simply a matter of having a portfolio of products, but also having adequate funding to see its products through to market. A partnership deal with one of the major pharmaceutical companies is a good sign because it is unlikely to happen without some degree of due diligence.

As when investing in any company, he says, it is important to look at the quality of the management team and its ability to take the product through to commercial use. Those best equipped, he says, are often people with a background in management from large pharmaceutical companies.

Even after the most careful research into biotech companies, there are no absolutely safe investments. Even the experts get it wrong and that shows in the volatility of the share prices, which reflect the way the market is often caught unawares by bad news. However, with many analysts predicting 2005 is going to be tough for many sectors, particularly retail, healthcare may be worth a look, especially for longer-term investments.

"I don't think 2005 is going to be a particularly good year for the healthcare sector," says Ms Chertkow. "But there are a lot of good drugs in the pipeline. People are always going to be ill and always going to be cured. And there are a lot of new markets, particularly China."

FOUR COMPANIES TO EXPERIMENT WITH

GLAXOSMITHKLINE

After four years, the merger between Glaxo Wellcome and SmithKline Beecham could finally bear fruit in 2005. The company said this week that it would announce mid-stage clinical trial results on 15 drugs over the year. Key results to watch out for are for the dual-acting cancer drug Lapatinib. The company released a vaccine in Mexico for one of the major causes of diarrhoea worldwide and in 2006 will file for the FDA approval of the anti-cervical cancer vaccine Cervarix. Share price: £12.01. Market cap: £70bn.

CAMBRIDGE ANTIBODY TECHNOLOGY (CAT)

A recent victory over royalties on its Humira treatment for rheumatoid arthritis may not have been fully reflected in its share price. An appeal is pending, but seems unlikely to fully reverse the original decision. Share price: 698p. Market cap: £354m.

ANTISOMA

Last summer its anti-ovarian cancer treatment failed to prove effective. But this week's £11.5 million purchase of US company Aptamera could prove astute. The science has already been proved in other areas of medicine, which makes it a timely fit with the three disparate formulations Antisoma currently has in testing. Share price: 19p. Market cap: £48m.

NEUTEC PHARMA

Its share value quintupled over the past two years, largely because of the potential of its MRSA treatment Aurograb. It is seeking regulatory approval this year. Share price: 530p. Market cap: £153m.

ARK THERAPEUTICS

It has already launched Kerraboot, a treatment for lower limb ulcers. Early trial results for its brain cancer treatment, Cerepro, are also promising. Share price: 85p. Market cap: £107m.