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Baby bio grows up

Biotechnology stocks seem to be the next big thing in investment opportunities. A few months ago, dotcoms were the main headline-grabbers but after a marked decline in fortunes, biotechs appear ready to fill the gap.

A succession of high-profile mergers and acquisitions, combined with an increased number of drugs reaching the market, as well as the breakthrough in the human genome project, have ensured a consistent level of press coverage for the biotech industry.

Biotechs are forecast by many to be the next high-profile, high-growth area of the investment market but does this, as with dotcoms, mean we will eventually see a spectacular burst bubble?

There are compelling investment parallels to be drawn between biotech companies and dotcoms. Both are risky options. Both have seen dramatic rises in share values.

Buying into dotcom and biotech stocks can be viewed as an investment in loss-making concerns where capital growth is achieved by assumption of future profitability.

The value of biotech shares lies in their drug pipelines rather than in dwindling reserves of cash. The shares will technically have a cash value but this will be subjected to cash burn as the cost of research escalates. This means the average investor will have difficulty predicting which drugs will make it to the market.

There are other differences. Unlike dotcoms, biotechs are far from the new kid in town. Biotech shares underwent a period of price stagnation at the end of the decade but the companies still grew and continued to bring products forward, albeit slowly, resulting in the current level of buoyancy in some stocks.

Significant increases in the number of companies with products in the last stage of clinical development have kickstarted something ofa renaissance.

Some biotech prices have begun to gain ground rapidly; doubling or even tripling in value in some cases.

In addition, the combination of increased numbers of biotechs with drugs ready to go to market and pharmaceuticals with patents reaching the end of their lifespan will herald still further feverish merger activity.

It is also true that the biotech industry has a validhistorical model on which to base assumptions of future profitability. In this important respect, these companies are unlike dotcoms.

However, the sequencing of the human genome has changed the rules of the game. Since the biotech sector is drivento a much larger extent bynews flow and relies on technological breakthroughs to advance profitability, the mapping of the human genome has caused the share price of many stocks to fluctuate sharply.

With detailed genetic information, scientists will have access to a far greater number of biological targets, allowing them to tackle the root causes of disease instead of merely treating symptoms – with far-reaching implications.

The future earnings of biotech products are assessed on the basis that they will have very high profit margins by virtue of possessing a virtual monopoly until expiration of patents.

There has been considerable controversy over the awarding of patents for gene sequences and it is not yet clear what the future holds.

The last time genomics hit the headlines, back in March, biotechnology stocks fell sharply after joint speeches by Bill Clinton and Tony Blair stating the human gene sequence should be public knowledge rather than patented by individual companies.

Biotech shares depreciated across the board, regardless of their actual involve- ment in genomics.

This was very much a function of the indiscriminate buying that happened as the dotcom brigade rushed to invest in the sector in the hope of even more fast bucks. Investors should be aware that many biotech stocks have much more to their profiles than genomics.

Like dotcoms, biotechnology companies can offer the chance to earn a quick buck but they also suffer from volatility and illiquidity.

Buying into both dotcom and biotech stocks should be viewed as an investment in loss-making concerns, at least in the short term.

This should not deter potential investors from viewing the biotechnology sector as a sustainable investment option but they should certainly take a diversified portfolio approach to exploit the clear and often favourable long-term possibilities.

Paul Mumford, Senior fund manager, Cavendish Asset Management

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