Israeli biotechnology stocks have been experiencing a comeback this year, with the Tel Aviv Stock Exchange’s TA-Biomed index advancing 25%, easily outpacing the 15% gain by the blue-chip TA-25 index.
The biomed index encompasses 22 publicly traded companies engaged in life sciences research and development with a median market value of 250 million shekels ($71.1 million), making them minnows even by TASE standards. But six of the companies are valued at over 1 billion shekels, and the largest, Opko Health, in which Philip Frost, chairman of Teva Pharmaceuticals, owns a controlling stake, is worth 15 billion shekels.
Biomed is a high-risk investment. Their prices will jump in response to any significant milestone, such as the registration of a patent, success in a clinical trial, gaining regulatory approval to sell a drug, a new collaboration with a major drug company or inclusion of the drug in the basket provided by medical insurer.
On the other hand, a clinical trial failure or breakdown in talks over a global marketing venture could lead to the stock’s collapse. At the end of the day, it is an all-or-nothing investment: Either the company achieves tremendous success or the trials fail and it is forced to shut down.
On the the other hand, Israeli biomed stocks are highly liquid - that is, it is relatively easy for traders to get into and out of the stocks, despite their small market cap. The index itself enjoys high trading volumes, compared with other TASE indices and it is comprised of a larger number of companies than those representing the real estate and financial sectors. Moreover, of the 50 companies listed on the TASE with the largest floats (percentage of shares held by the public), 15 belong to the biomed industry. In contrast, the public holds just a 25% stake in publicly traded high-tech companies. Fourteen of the 41 companies that have begun trading on the TASE since 2009 are biomed companies, as are three of the four that started since the beginning of 2012. Of the 153 companies delisted from trading since 2009, not one was a biomed.
Be aware that many biomed companies survive for years by raising capital, investing heavily in research and development and clincial trials long before they see any revenues. The key is how quickly R&D burns through the company’s cash, so biomed startups need to periodically find investors to finance them and accept the risk, in exchange for a chance at a large profit at the end of the road.
Not easy to analyze
As a result, analyzing such companies isn’t easy. Their areas of expertise don’t have much in common and their potential value can hardly be gleaned through their cut-and-dried financial reports. The reported information doesn’t provide a full picture of the company’s future potential or its chance of success in trials. Conventional accounting presents a problem.
Instead, a biomed company’s value is based on its stage of development and investors need to keep up-to-date with reports on its progress. Many of these companies have little or no revenues and huge losses.
“In order to develop a clinical product, biomed companies must endure a series of clinical trials that could extend over many years,” explains accountant Yisrael Gewirtz, a partner at Fahn Kanne & Co. - Grant Thornton Israel. “The companies require long-term funding until they manage to complete product development and receive recognition for the trials from the competent authorities of each country.”
While quarterly financial reports don’t provide a full picture, investors also need to be cautious about reports frequently appearing on regular trading days. These reports often generate expectations about success in clinical trials and the progress of development. Investors aren’t always able to get to the bottom of such reports and understand their meaning.
The process of developing a clinical product and gaining regulatory approval is difficult to fully grasp. Each trial contains many stages, and success at one stage doesn’t ensure success for the overall trial. Information contained in company news releases is often meaningless.
Reports of failures such as the death of a clinical trial participant can also be misleading. Some trials are meant from the outset to provide treatment on a compassionate basis for sufferers of terminal illness. The medication might still succeed in treating a condition suffered by the patient whose own life was already beyond saving.
Gewirtz points to six areas that biomed investors should focus on. These include the company’s strategy, budget, stage of clinical trials, its adherence to the trial protocol, regulation, and medical insurance coverage.
“It’s important to know whether the company has a solid strategy concerning the clinical trials in defining their purposes and goals,” says Gewirtz. “Information on this appears in the company’s periodic reports under ‘business goals and strategy’ or ‘products under development.’ The lack of a clear strategy could cause the dispersal of the company’s resources among trials that have no synergy between them.”
Two companies are mentioned by Fahn Kanne as having failed, in their opinion, at the strategic stage. One was Glycominds, the developer of a unique technology for diagnosing multiple sclerosis at an early stage and predicting its severity based on blood testing. The company’s management erred in believing that the test’s high production costs would be covered by sales. Glycominds sales amounted to only 2.5 million shekels and the company accumulated losses of 120 million shekels by the end of 2012.
The second company was Ultrashape, the developer of a medical device in the field of aesthetics for slimming and contouring the body. The company tried to conquer the world of beauty through the Far East, starting with Japan, Thailand, and South Korea and intending to penetrate China.
This proved to be a mistake. Asian countries are well populated but their obesity rates are low. Only 4% of the populations of Japan and South Korea are overweight, and the rate in China is 2%. The company also failed to win marketing approval in the U.S. and quickly collapsed.
Another issue requiring examination is whether the company has enough funding to complete its trials or a plan to raise the capital needed. “Lack of funds means a lack of ability to complete the clinical trial, and everything invested in the trial to date will be lost,” they explain at Fahn Kanne. The company’s cash flow position compared to its budget targets can be checked in its periodic reports in the chapter on finance or the chapter entitled “financial information on the company’s field of activity.”
It is also important to understand which stage the company’s clinical trials have reached. In most cases, marketing approval is only granted after all stages of the trials have been completed. Information on how the trials are progressing and when they are expected to end can be found in the company’s reports in the chapter “stages of drug development” or “clinical trials at company sites.”
Many companies fail during the third and final phase of clinical trials. Pfizer, for instance, developed a drug for Alzheimer’s and reported a wealth of positive indications in earlier clinical phases involving animals and small groups of patients. But in the end the U.S. Food and Drug Administration wouldn’t grant its approval for marketing the drug.
Another important item of information is whether the trial is being conducted on a full or limited basis. Companies sometimes decide to proceed with a limited trial, mostly due to budget considerations, in order to gain an indication of the treatment’s effectiveness and raise more money.
But a limited trial won’t provide conclusive evidence about the product’s effectiveness or lead to regulatory approval. Gewirtz points out that the relevant information can be found in the company’s reports under the chapter on the drug’s stages of development or the discussion of risk factors.
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