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I am pharma, hear me roar
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May 11, 1998: 4:12 p.m. ET
Biotechs are on the move. Don't expect pharmaceuticals to stand idly by
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SAN FRANCISCO (The Red Herring) - For those new to the worlds of biotechnology and pharmaceuticals, let us share a curious, revealing convention. When discussing the pharmaceutical behemoths, industry insiders use the term "pharma" as if describing a monolithic entity.
"Pharma is rich," they say in a tone of deference, or "Pharma likes to outsource."
To be sure, pharma is rich and important--particularly to the biotech companies that work with the sector. And as this month's analysts observe, the relationship between the two is gradually shifting. Opportunities still abound in biotech, but investors will need to keep a close eye on pharma and its changing moods.
This is particularly true with genomics companies, which have provided an attractive area for biotech investors over the past few years. Since the initial public offering of genome company Incyte Pharmaceuticals (INCY) on Nov. 4, 1993, says Matthew Murray of Lehman Brothers, the average stock value of the 12 publicly traded genome companies is up roughly 130 percent, significantly outpacing the 55 percent growth of the entire biotech sector over that period. But within the genomics sector, Murray now sees a bifurcation taking place between large-cap and small-cap companies. "Smaller-cap genome companies are only selling information and are not doing any product development," he says. "There's a limit to that service model." As a result of that limitation, some small-cap genome companies are merging with drug discovery companies. (For a closer look at biotech mergers and acquisitions, see "Chemical attraction.")
Even large-cap players like Incyte, the most successful genomics company, will need to broaden their platform, says Murray. He believes Incyte may accomplish this through its joint venture--called DiaDexus--with pharmaceutical giant SmithKline Beecham (the companies are joining forces to develop new molecular diagnostic products). Human Genome Sciences, another large-cap genome company that has partnered with SmithKline Beecham, provides further evidence of the trend.
As genomics companies make this shift, however, they no longer will be able to coexist peacefully with the domineering pharmaceutical firms. "They'll eventually become competitors. I expect a few of the successful genome companies to grow up to be pharmaceutical companies, but it's going to take a while," says Murray.
Collaboratories
Edmund Debler of Mehta Partners advises investors to exercise caution with biotech companies in general, because the pharmaceutical companies have become increasingly adept at adding in-house biotech capabilities. "The distinction between biotech and pharmaceutical companies is shrinking," he warns. "It's going to be hard for biotech companies with limited resources to compete."
Debler says the trend of collaboration between pharmaceutical and biotech companies will continue in the near term, much to the benefit of the biotech stocks. Not surprisingly, biotech stocks tend to rise on the news of such collaborations because the partnership usually is viewed as a validation of the smaller company's technology, he explains. Furthermore, a large company brings marketing muscle. "They have a better understanding of how the commercial endgame will be played out," Debler says. "This is always a concern in biotech: you have a neat technology, but how are you going to sell it?"
But watch your back
David Crossen of NationsBanc Montgomery Securities also believes corporate collaborations will continue--but perhaps not forever. "As the pharmaceutical companies increase their productivity, they'll become more self-sufficient," he says.
Like the other analysts, he sees the relationship undergoing a gradual transformation. "The market is schizophrenic right now because a transition is taking place," Crossen says. "You have huge potential markets with the many untreated diseases, and there's a renaissance in terms of the productivity of research and development."
He says this rebirth is being driven by advances in combinatorial chemistry technologies, genomics, and high-throughput screening. "There's going to be value creation all over the map," Crossen predicts, "and some of these companies will be spectacular successes." But along with all the good news, he issues the following advice to biotech investors: "The biotech market is going to get vastly more competitive, and the pharmaceutical companies will start to exert huge muscle in the marketplace."
Moreover, as Crossen admits, "Even the savviest biotech investors can still be frustrated by the level of uncertainty in this industry." 
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