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Just what the doctor ordered

All the signs are that the biotechnology sector is in the best shape it has ever been

The biotechnology sector has experienced extreme highs and lows over the past year. Genentech has performed excellently due to research and development success while the sector has suffered negative sentiment created by the withdrawal of Tysabri, a drug to treat multiple sclerosis, early in 2005.

Genentech has dominated media coverage of the sector, with continuing success in its oncology franchise, Genentech’s drug, Rituxan, used to treat certain types of cancer, showed a positive result in rheumatoid arthritis patients.

The implications of the Tysabri withdrawal – the first major biotech product withdrawal – have been far-reaching for the sector. Expectations for this product had been high and the removal of the drug from the market depreciated the shares of Biogen-Idec and Elan Pharmaceuticals, with declines of 43 per cent and 68 per cent respectively on the day of withdrawal. March witnessed panic selling, creating a great buying opportunity and, since April, there has been a very strong and positive move for the sector.

The selling pressure in March led to large-cap biotech stocks trading at the cheapest valuation levels seen in the past 10 years. The sector is now in the best position it has ever been in terms of new products, R&D productivity, revenue and earnings.

At the small and mid-cap end of the spectrum, the weakness experienced at the end of the first quarter again offered a great buying opportunity.

Many companies have continued to show positive developments in terms of product approvals and R&D productivity, especially in clinical data for late-stage drug candidates.

Pharmaceutical companies are still highly active in terms of in-licensing products from biotech companies and these deals are shifting favourably for biotech companies, due to the need of pharmaceut- ical companies to improve weak pipelines.

Recent examples on the in-licensing front include Merck’s deal for an anti-depressant product with Dov Pharmaceuticals and Johnson and Johnson’s deal with Basilea for their antibiotic.

There has also been a pick-up in merger and acquisition activity this year.

The acquisition in June by Pfizer of the US biotech- nology company Vicuron highlights both the potential for M&A and the current discount that the biotech- nology stocks trade at. Equally Shire Pharmaceu-ticals acquired US biotech-nology company Trans-karyotic Therapies for a significant premium.

It is important to consider the prospects for the sector in relation to the current conditions that large-cap pharmaceutical companies face. R&D productivity for pharmaceutical companies continues to decline since the peak in the early 1980s.

With fixed patent lives of approximately 20 years, many blockbuster products are beginning to lose their intellectual property protection. This has left pharmaceutical companies with weakened pipelines.

With many large pharmaceutical products set to lose patent protection over the next few years, the harsh competitive environment in the generic industry and weak pharmaceutical pipelines might lead to biotech companies being purchased by large pharmaceutical companies.

Moreover, the tax breaks that global US companies can use in 2005 is likely to fuel further acquisitions.

These factors are creating a very positive outlook for the biotechnology sector. Attractive valuations, particularly for small and mid-cap companies, strong fundamentals and the potential for M&A activity are likely to act as a major catalyst for the biotech market.

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