Thursday, January 5, 2012

A Case for a Small-cap Biotech Basket

Small biotech stocks are fun for many reasons. The companies often have noble causes. They aim to treat wretched diseases. And their shares sell for small prices. Sure, many run on borrowed money and spend years deep in red ink. But they give us the potential of a five-bagger, 10-bagger, or even better.
In the small-cap biotech world, profits are ephemeral, but dreams loom large. That’s why I’ve always thought it was good to own one, if for no other reason than to keep things interesting.
But maybe owning one isn’t the way to go. Maybe owning a few is far better. Call this a case for a small-cap biotech basket.
I recommend this not because it’s something I’ve done. I do so because it’s something I wish I’d done, but didn’t.

To a 3-bagger ... and back
I’ve owned one small, speculative biotech since I started investing in 2008:  Cytori Therapeutics (NASDAQ: CYTX).
Cytori is one of a handful of stem-cell therapy companies that sell for a low per-share price and have a chance to break out, and break out big. That looked like it might happen with Cytori in early 2010, when the company announced good results from a study for a breast-reconstruction treatment that uses stem cells from a woman’s body fat to regenerate breast tissue lost to cancer surgery.
And the stock appreciated handsomely. I had bought in at $2.70 in 2008. It was suddenly selling for $9.50 a share.
I briefly considered selling half and booking profits. But the company was starting to generate press from financial writers. And what they were predicting had my mouth watering.  I read one pitch that said CYTX is a $30 stock within a few years.
So, I held.
Today, Cytori is a $2.28 stock.

In retrospect, I wish I’d trimmed some CYTX  from my portfolio and added another biotech, or two. Some of the other names I'd had on my radar were appreciating when Cytori was in its long slide. There are many small, interesting biotechs from which to build a basket. Here are a few to consider:

Neurocrine Biosciences (NASDAQ: NBIX) -- Neurocrine looks to be on a breakout. It has grown its revenue from just $1.2 million in 2007 to $33.5 million in 2010. It’s on track to more than double that revenue in 2011. And it’s delivering real earnings -- 55 cents per share last quarter. That leaves it selling at a price-to-earnings ratio of 12.
The company is developing therapies to deal with a number of maladies, from endometriosis and uterine pain to anxiety, post-traumatic stress disorder and schizophrenia. It has deals with Abbott Labs, GlaxoSmithkline and other larger pharmaceutical companies to get those products to market if/when they are approved.
NBIX has a healthy balance sheet, with $133 million in current assets to just $52 million in current liabilities. The company reports no long-term debt.
One worry here is that NBIX has had a nice run up. It was selling for $5.53 a share in early October. It’s now selling for about $8.50.

Repligen -- Here’s another tiny biotech that actually reported positive earnings last quarter. Sure, it’s just 2 cents per share, but earnings from these small biotechs are hard to come by.
It may not be exciting medicine, but RGEN develops proteins that help facilitate the production of antibodies. These are used in treatments of various diseases and also in tests that better determine exactly what ails patients. It has maintained better than a 15 percent average annual growth rate in sales over the past five years.
Repligen is another biotech with a healthy balance sheet, with $72 million in current assets and only $4 million in current liabilities. It reports no long-term debt. At $3.72 a share, it sells for just 1.5 times book value. It also earns a coveted 5-star rating from Motley Fool CAPS members.

PDL Biopharma (NASDAQ: PDLI) -- The bet on PDLI is not so much that its share price will appreciate handsomely, but that it can continue to pay out a massive 10% dividend. PDLI already makes plenty of money. It has earnings of 74 cents a share, on a share price just north of $6. It boasted a net operating margin in 2010 of 27%, and it should surpass that figure for 2011.
PDLI collects royalties from larger drug firms that manufacture and sell the drugs it brought to market. Those include cancer-fighting antibodies used in Herceptin, used mainly to treat breast cancer, and Avastin, which is used to fight a number of cancers.
The company is a cash machine right now, and that dividend looks great in a year when the market ended flat. But in order to keep paying that out, PDLI will need to bring more drugs under its umbrella in coming years as patents on some of its drugs expire.

Plenty more to consider
Those companies should give an investor a start on building a good small-cap biotech basket. There’s still plenty of risk. But they offer a good measure of diversification, and they won’t all move in lock-step. But don’t stop there. There are plenty of other interesting small-cap biotech companies out there, and more research to do before buying.

This column was syndicated through the Motley Fool.

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