2 Top Biotech Stocks To Buy Now

Investing in any speculative business carries high risk, but with that risk comes the potential of life changing returns. Personally I prefer a get rich slow approach, via investing in good, or better yet, great businesses with outstanding risk to reward profiles.

I scour the market looking for companies with low risk and high returns. Modern financial theory says such investments don’t exist, but 25 years of investing and research has convinced me they do.

Value fund manager and author, Monhish Pabrai, holds a similar view. He wrote about the low-risk value method to high returns in his enjoyable and easy to read investment book The Dhando Investor. Pabrai succinctly encapsulates my investing approach with his catchy phrase, “Heads I win; tails, I don’t lose much!

Build Your Foundations First

Many investors focus on the possible returns from their investments. They concentrate on the upside potential. They’re fixated on the dream of a big score. Whereas I prefer to focus on the downside and let the upside take care of itself.

But I realise that’s a boring approach.

Over lunch last week, I asked an intelligent friend why people prefer to chase the big winners and risk wiping out, instead of following a sensible and virtually guaranteed path to wealth. After all it’s not hard to spend less than you earn and invest the rest in a sensible fashion. His answer, of course, was immediacy.

Everyone wants the big score and they want it now! It’s why lotteries are such a huge success and why most people speculate in sharemarkets rather than follow a sensible albeit dull investment path.

Before I unveil two speculative biotech stocks that have the potential to deliver life-changing returns I want to share with you where I think this type of high risk potentially huge return investment fits in to your portfolio.

These investments should only comprise 0-10% of your portfolio, and only be a part of your portfolio once you have built solid core and growth levels for your own investment pyramid.

The role of the core and growth layers is to make sure you’re well positioned for a comfortable future. Once those layers are in place, it is then appropriate to speculate, to give yourself a shot a life changing riches.

Why Biotech

As I’ve said I prefer to invest rather than speculate; however, even I enjoy the thrill and excitement of the occasional high-risk high-reward investment. But if I’m going to bet even a small percent of my hard earned money on a long shot, I want to do it in an intelligent way. In short, I want the odds stacked in my favour.

You may have heard of the term black swans. The black swan theory was developed by Nassim Nicholas Taleb and popularised in his book The Black Swan. As Wikipedia says, Taleb developed the theory to explain the disproportionate role of high-impact, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance and technology.

In short, unexpected stuff both happens and has a greater impact than anyone envisions. In our post GFC world most people focus on the destructive ramifications of black swans, but as Taleb explained, black swans can also be positive events.

Biotechnology is a sector where positive black swans occur. As Taleb said about biotech, “there is a small probability that the sales in that industry may turn out to be monstrous, far larger than might be expected.” That is, biotech offers a better shot at super-sized returns as it is more prone to fat tails — technical term for black swans. In short the odds are stacked in our favour.

That’s why some of the biggest share market winners of the last two decades are biotech companies. Amgen (Nasdaq: AMGN), Biogen Idec (Nasdaq: BIIB), Genentech and closer to home CSL (ASX: CSL) are all examples of the massive returns available to biotech investors. Mesoblast (ASX: MSB) is another local biotech that is on the verge of greatness and has already been a four bagger for investors over the last two years — increased fourfold in value. Unfortunately, Mesoblast is one biotech that I missed and its share price now has too much downside for my investment dollars.

So without further ado, let’s take a closer look at two biotech investments that have massive upside potential and real life-changing possibilities. For patients and investors alike!

Mega-Blockbuster Potential That’s Ready to Run

Prana Biotechnology (ASX: PBT) is a small Melbourne based biotechnology company in search of a cure for one of the few remaining unmet medical needs with mega-blockbuster potential, Alzheimer’s Disease. A cure for this neurodegenerative disorder would be a massive relief for AD sufferers, their families, and society, as the worldwide annual cost of AD is reported to be $600 billion per year. It would also be hugely rewarding for shareholders of the company that wins the AD development race. And there’s a chance that could be Prana!

A cure for AD is estimated to be worth around $25 billion in annual sales. Consequently it is an area that has attracted significant research. Unfortunately neurological trials are the graveyard of clinical development. Trials have an expensive and difficult development path as highlighted by a number of AD Phase III failures; including Eli Lilly’s Semagacestat in 2010 and Pfizer’s Dimebon in 2012. So far the front runners have all fallen at the final post.

A Quick History

Prana was founded in 1997 to commercialise research into Alzheimer’s Disease and other major age-related neurodegenerative disorders. It listed on the ASX in March 2000 with the ticker PBT and a Nasdaq listing followed in September 2002, ticker PRAN. More interestingly, Prana is Sanskrit for “vital life”, it is the notion of a vital, life-sustaining force of living beings. Yes, I did award bonus marks for a totally cool name!

Prana’s key compound, PBT2, recently commenced a Phase IIb clinical trial for the treatment of AD and a Phase IIa trial for Huntington’s disease. Flipping back to the past, PBT2 successfully completed PIIa trials in February 2008. Investors were expecting a partnering deal to be announced soon after, and rumours about a deal surfaced on message boards towards the end of 2008.

However, it’s now 4 years since the Phase IIa trial, and not only did no deal eventuate, but it took Prana until the end of 2011 to commence recruitment for its next trial.

Looking Forward

Prana commenced recruitment for its 12 month PBT2 Phase II imaging trial, called IMAGINE, in November 2011. This double blind, placebo-controlled trial will enrol 40 patients with early or mild Alzheimer’s Disease in Melbourne. The first patient was dosed in early March 2012.

Due to limited capital, Prana is developing its pipeline at a snail’s pace. So let’s take a closer look at its funds. The company had $5.64 million in cash at the end of June 2012 and $5.45 million in net current assets at 31 December 2011. Operations consumed $3.9 million in the second half of last year, but that was without major trials. Cash burn will skyrocket this year, and while the IMAGINE trial has received funding from the Alzheimer’s Drug Discovery Foundation (ADDF), Prana’s funding position is unclear.

Massive Market Potential

Alzheimer’s Disease is a massive unmet market. Recent reports suggest that there are now over 26 million Alzheimer’s sufferers worldwide.

Current AD drugs provide little more than symptomatic relief. They neither cure AD nor meaningfully improve cognition. Yet, those drugs still ring up around $6 billion in annual sales. So the race is on to find a disease modifying drug.

The market size for AD drugs that do improve cognition has been estimated at $25 billion annually. It is one of the few remaining potential mega-blockbusters and big pharma would dearly love to be first to market with a cure.

PBT2 is well protected by patents, and supported by solid science. Its Phase IIa study was published in The Lancet Neurology journal and there are numerous peer reviewed papers by leading AD scientists demonstrating that  Prana’s approach to finding a cure for Alzheimer’s is sound. PBT2 has been designed to be a disease modifying drug that prevents the formation of toxic forms of the Abeta protein in the synapses of the brain and to improve neurotransmission, resulting in improved cognition.

It’s All in the Pipeline

The Phase IIa results in early 2008 demonstrated that PBT2 was safe and tolerable, and able to modify the course of Alzheimer’s disease by reducing the patient’s levels of amyloid beta, a protein understood to be a significant factor in Alzheimer’s. It demonstrated an improvement in executive function, an important aspect of cognitive performance, and reduced the levels of Abeta in the spinal fluid of patients.

Source: Prana’s website 14 August 2012

To date, Prana’s 800 strong novel compound library has yielded a phase II candidate for Alzheimer’s and Huntington’s with PBT2, Parkinson’s with PBT434 and brain cancer with PBT519.

Prana announced in early January that it has received approval from the United States Food and Drug Administration (FDA) to start recruiting patients for the company’s first clinical trial using PBT2 in patients with Huntington’s Disease (HD). Enrolment of the planned 100 patients in the 34 week, double-blind, placebo-controlled study has recently commenced. HD affects 30,000 people in the US and about 70,000 worldwide.

In August 2011 Prana announced it at had received a grant from The Michael J. Fox Foundation to support the initiation of pre-clinical studies for PBT434.

Competition

As we live longer the number of people suffering with AD is growing. This already large un-met medical problem continues to grow, and with baby boomers now approaching the age of AD onset, a cure becomes all the more important. The potential market is huge and growing.

So it’s no surprise that big pharmaceutical companies are lining up to take a shot on the AD goal. For the sake of sufferers I desperately hope someone scores a goal soon. If it’s Prana all the better!

Competitors include a ‘who’s who’ of large pharmaceutical companies, but it is rumoured there is not a lot of promise among their compounds. Recent research has highlighted that many of the current compounds including Pfizer’s bapineuzumab, which is in phase 3 trials, may be aiming at the wrong target. As Prana’s Chairman and CEO, Geoffrey Kempler, said in the 2011 annual report, “PBT2 is strongly placed to avoid many of the issues that have emerged, as it works in a unique way that is very different to these failed approaches.”

AstraZeneca has one drug in phase 2 and three in phase 1. Roche’s pipeline is more advanced, it has three compounds in phase two trials and a fourth in phase one.

Despite Dimebon’s failure, Pfizer still has bapineuzumab, a beta amyloid inhibitor, in phase 3 trials along with three other drugs and a vaccine in early clinical trials. GSK also have a drug in phase 2 trials.

Foolish Bottom Line

With significant news flow expected over the next year Prana will gain more attention. There will be trial updates, publications and possibly more patents. The news flow should underpin the share price and attract the attention of more investors.

As a valuation benchmark, Pfizer paid an industry high US$225 million upfront with up to $500 million in milestones, for the rights to Medivation’s Dimebon. Prana is unlikely to get such an incredible deal for PBT2 rights, but with a market cap under $50 million any deal should deliver massive upside.

PBT2 is a good asset that has shown promise in trials. The current IMAGINE trial should trigger fresh interest by large pharmaceutical companies. If the trial confirms that PBT2 can improve cognition, this speculative punt should be highly rewarding. 

On Track to Building a Profitable International Franchise

Pharmaxis (ASX: PXS) management aim to build a strong, international, sustainable, and profitable business with multiple products. And you know what? They just might do it!

Pharmaxis is on track to achieve its lofty ambitions. Management has put the foundations in place to build an enduring profitable business, despite the hurdles that European regulators put in its way. We’ll come back to those hurdles, but first let’s take a step back and have a broad look at Pharmaxis.

Ready to Take-off

Pharmaxis was founded in 1998 and is based in Sydney. It engages in the research, development, and commercialisation of treatments for the management of respiratory diseases. With two approved products, the company clearly excels at R&D.

Its first product, Aridol, is a lung function test designed to help doctors diagnose and manage asthma by detecting active airway inflammation. Aridol is a useful product, but it isn’t a game changer for Pharmaxis.

Our black swan has a better chance of appearing courtesy of Pharmaxis’ second product. Bronchitol is a drug designed to hydrate the lungs, restore normal lung clearance, and allows patients to clear mucus.

Pharmaxis is developing Bronchitol for diseases including cystic fibrosis, bronchiectasis and chronic bronchitis. Bronchitol is a proprietary formulation of mannitol (a sugar alcohol) administered as a dry powder. Clinical studies have shown Bronchitol to be safe, effective, and well tolerated in treating patients with both cystic fibrosis and bronchiectasis.

Bronchitol was approved for marketing in Australia in February 2011 and after initially being rejected by a European regulatory committee in May 2011 it was subsequently approved for marketing in Europe in April 2012. That approval was foreshadowed in October 2011 when the Committee for Medicinal Products for Human Use (CHMP) recommending the granting of a marketing authorisation.

That initial European rejection absolutely crushed Pharmaxis’ share price. In 15 minutes its share price plummeted a massive 75%. Ouch that had to hurt!

Investors and management were rightly stunned by the decision as it didn’t seem fairly based or right. Pharmaxis knew that clinicians liked the drug and wanted it on the market. So it elicited peer support and appealed the decision. Pharmaxis won the appeal and the rest, as they say, is history. Although the regulator did extract a pound of flesh, by restricting approval to cystic fibrosis sufferers over 18, compared to six years and up in Australia.

In due course I expect Europe to lower the age to six or less as early treatment plays an important role in lessening the damage caused by cystic fibrosis. Pharmaxis is currently designing a small trial with the aim of reducing the age limit.

A Feel Good Investment

There is another reason why I enjoy investing in bio-pharmaceutical industry. It’s that wonderful warm feeling that comes from supporting a company that makes people’s lives better. Take a look at Pharmaxis’ pipeline below to get a quick perspective on the lives it is trying to improve.

Pharmaxis pipeline June 2012. Source Pharmaxis Apr – Jun 2012 Quarterly Report to Shareholders

Cystic Fibrosis (CF) affects 75,000 people worldwide. Sufferers are born with CF and face the harsh prospect of an all too short 35 years life expectancy. As there have been limited therapeutic advances in the past decade, Bronchitol has been awarded fast-track status in the US, and orphan drug designation in both the US and EU. Orphan drugs are more readily granted marketing approval and receive other important incentives such as extended exclusivity periods.

The bigger market is bronchiectasis, a respiratory disease similar to CF affecting 600,000 people globally. A Phase 3 clinical trial of Bronchitol in people with bronchiectasis found that it delivered a highly significant improvement in users’ quality of life. A second fully recruited Phase 3 clinical trial is studying the effects of Bronchitol on reducing the infectious episodes, antibiotic use, and hospitalisation for patients with bronchiectasis.

Bronchitol’s approval and ultimately becoming the standard of care for bronchiectasis is the possible black swan to keep an eye out for.

It’s Money Time

This year investors will discover how good Pharmaxis is at commercialisation. Yes it can develop drugs, but can it profitably sell them?

As there are a limited number of clinics that treat CF, Pharmaxis decided not to partner with a major pharmaceutical company. It is building its own sales team and is currently launching Bronchitol in Germany and the UK. France will follow late this year once reimbursement is finalised, followed by Italy and Spain in 2013.

CEO Alan Robertson expects the product to do well. His challenge is to get CF sufferers using Bronchitol as early as possible and to keep using it. If his team can achieve this, Pharmaxis will be well on the way to achieving its profitable aim.

The company is currently burning through around $10 million a quarter. Mr Robertson said that is unlikely to change soon as although they are not embarking on any big Phase 3 trials, they are now investing in commercialisation. With $81 million in the bank Pharmaxis has a great shot at becoming profitable without the need for further capital raisings.

Sales have been lower in the first half, but should quickly ramp up in the second half of 2012 as early adopters give Bronchitol a try. Mr Robertson expects 50 to 60 percent of Western European CF sufferers over 18 to be using Bronchitol within three years. That would be a phenomenal adoption rate, but it is possible as there are few options for this life threatening disease.

Pharmaxis has submitted a US marketing application for Bronchitol’s use in CF in patients 6 years and older. The US is the largest single market opportunity for Bronchitol, with around 30,000 CF sufferers managed through 150 hospitals. A US decision is not expected until mid-2013, but with orphan drug status and successful Australian and European registrations, approval appears likely. US approval will be a big win and a strong catalyst for the share price.

Foolish Bottom Line

Pharmaxis is now in a stronger position than it was prior to the initial European rejection. It has two products approved in multiple markets, has filed an application for Bronchitol in the US, secured reimbursement for Bronchitol in Australia (added to the Pharmaceutical Benefits Scheme or PBS), and via a capital raising has strengthened its balance sheet.

Despite all the good news, at $1.09 the share price is still down more than 60 percent from its high of $3.14 and it’s market cap remains 40% less than the lofty levels set in May 2011. That’s great news for current investors who can buy in for both less money and with less risk.

Revenue growth should accelerate over the next few years, with quarterly updates proving regular catalysts for positive re-ratings of the company. That alone makes an attractive story, but with US approval for Bronchitol in CF likely and an expansion into bronchiectasis also on the cards, Pharmaxis investors have a lot look forward to. Management’s vision of a sustainable and profitable business with multiple products is now clearer than ever.

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Last updated: 14th August 2012

This report has been updated by Mike King. Employees and contractors of The Motley Fool, including Bruce Jackson, Scott Phillips and Mike King, may have an interest in any shares mentioned in this free report. These interests can change at any time. The Motley Fool has a clear and concise disclosure policy.