Concepts Conquer Again: The Biotechnology Stocks Bubble

Concepts Conquer Again: The Biotechnology Stocks Bubble

What electronics was to the 1960s, biotechnology became to the 1980s. This technology promised to produce a group of products whose uses ranged from the treatment of cancer to the growing of food that would be hardier and more nutritious because it had been genetically modified. In its cover story “Biotech Comes of Age” in January 1984, Business Week put its imprimatur on the boom. “The fundamental question – Is the technology real? – has been settled,” the magazine reported. The biotech revolution was likened to that of the computer. The magazine reported that gene-splicing progress “has out-distanced the most optimistic forecasts” and projected dramatic increases in the sales of biotechnology products.

Such optimism was also reflected in the prices of biotech company stocks. Genentech, the most substantial company in the industry, came to market en 1980. During the first twenty minutes of trading, the stock almost tripled in value, as investors anticipated that they were purchasing the next IBM at its initial public offering. Other new issues of biotech companies were eagerly gobbled up by hungry investors who saw a chance to get into a multi-billion-dollar new industry on the ground floor. The key product that drove the first wave of the biotech frenzy was Interferon, a cancer-fighting drug. Analysis predicted that sales of Interferon would exceed $1 billion by 1982. (In reality, sales of this successful product were barely $200 million in 1980, but there was no holding back the dreams of castles in the air.) Analysts continuously predicted an explosion of earnings two years out for the biotech companies. Analysts were continuously disappointed. But the technological revolution was real and hope springs eternal. Even weak companies benefited under the umbrella of the technology potential.

Concepts Conquer Again: The Biotechnology Stocks Bubble. Photo by Elena

Valuation levels of biotechnology stocks reached levels previously unknown to investors even during the most pathological phase of the growth-stock boom of the 1960s. Speculative growth stocks might have sold at 50 times earnings in the 1960s. In the 1980s, some biotech stocks actually sold at 50 times sales. Students of valuation techniques were fascinated to read the rationalizations of security analysts for such excessive valuation levels. Since biotech companies typically had no current earnings (and realistically no positive earnings expected for several years) and little sales, new valuation methods had to be devised. My favorite was the “product asset valuation” method recommended by one of Wall Street’s leading securities houses. Basically, the method involved the estimation of the value of all the products in the “pipeline” of each biotech company. Even if the planned product involved nothing more than the drawings of a genetic engineer, a potential sales volume and a profit margin were estimated for each product that was even a glint in some scientist’s eye. Sales could be estimated by taking the “expected clinical indications” for the future drug, predicting the potential number of patient users, and assuming a generous price tag. The total value of the “product pipeline” would then give the analyst a fair idea of the price at which the company’s stock should sell.

None of the potential problems seemed real to the optimists. Perhaps FDA approval would be delayed. (Interferon was delayed for several years.) Would the market bear the fancy drug price tags that were projected? Would patent protection be possible since virtually every product in the biotechnology pipeline was being developed simultaneously by several companies, or were patent clashes inevitable? Would much of the potential profit from a successful drug be siphoned off by the marketing partner of the biotech company, usually these potential problems seemed real. Indeed, the biotech stocks were regarded by one analyst as less risky than standard drug companies because there were “no old products which need to be offset because of their declining revenues.” We had come full circle – having positive sales and earnings was actually considered a drawback because those profits might decline in the future.

From the mid-1980s to the late 1980s most biotechnology stocks lost three quarters of their market value. To be sure, the crash of 1987 didn’t help. But biotech stocks generally continued heading south even as the market recovered in 1988. Market sentiment had changed from acceptance of an exciting story and multiples in the stratosphere to a desire to stay closer to earth with low-multiple stocks that actually pay dividends. A good example is Cetus Corporation, which soared from 14 to 40 during 1986 as the company launched a successful public relations campaign to hype its stock. Cover stories were run in both Fortune and Newsweek indicating that Cetus had achieved a breakthrough with its anti-cancer drug. Interleukin-2 (IL-2). But when the product had not yet been approved by the FDA in 1988 and when IL-2 was also successfully patented by a Japanese company, the stock retraced its steps and closed the year around 10. Investors eventually decided that publicity was no substitute for products.

Biogen, founded by Nobel laureate Walter Gilbert, went public in 1983 at $23 per share. Excitement abounded about its alpha-interferon product, its international flavor (it was based in both Geneva, Switzerland, and Cambridge, Massachusetts), and the brilliance of its founder. Disillusionment set in when a bitter patent fight with Genentech and Gilbert’s penchant for running the company like a Harvard-sponsored research project disillusioned investors (Gilbert later resigned). The stock sold at less than $5 a share in early 1988 before recovering in 1989 on hopes that the company might develop an AIDS drug.

Perhaps the worst horror story was that of Genex. Genex appeared far less risky than the typical biotech company, which chased the glamorous drug business. Instead, Genex devoted its efforts to a more prosaic end. It bet the store on the development of specialty chemicals for the low-calorie artificial sweetener market. It gambled everything on the development of an intermediate chemical for NutraSweet – and lost. The stock fell from over $20 a share to under $1.

Even Genentech, the industry leader – the company described as the Tiffany of the industry – was caught up in the boom and bust in biotechnology stocks. Genentech is the most substantial company in the industry. It has delivered the goods. Of the thirty drugs in the United States with sales of $100 million or more during 1988, Genentech had contributed three – all genetically engineered. Moreover, it had a self-proclaimed “blockbuster” product, t-PA, which it said could save lives by quickly dissolving blood clots that cause heart attacks. Genentech management was even more successful, however, on the publicity front. Indeed, critics have argued that t-PA really stood for “tremendous publicity assault.”

Genentech began its publicity assault for t-PA with full-page ads in medical journals even before the product gained FDA approval. Company personnel celebrated approval of the drug by donning “Clot-Buster” T-shirts and putting on such an elaborate fireworks display over San Francisco Bay that air traffic had to be halted for ten minutes. Co-founder and chief executive officer Robert Swanson loved a party. (He regularly presided over Friday afternoon beer bashes at the company called ho-hos. These parties were enlivened with pie-throwing and water-pistole fights and sometimes culminated with Swanson putting on a grass skirt and performing the hula).

Swanson, a venture capitalist by training, also mesmerized Wall Street and the business press. Projections of billion-dollar sales and $5 a share earnings for t-PA were happily encouraged. Everything having to do with Genentech bred excitement. How well the company was actually being managed was more questionable. As one competitor put it, “When you start believing your own bullshit- that’s lethal.”

It certainly proved so for Genentech’s stockholders, who may have needed t-PA themselves at the end pf the eighties. The shared sol at $65 in 1987. In 1989, the stock sold at $18. What investors forgot was that even if all Genenech’s claims came true and Genentech came to be known as a successful pharmaceutical company, the stock would sell at the typical multiple applicable for drug companies. P/E multiples of 100 or more would not be sustained. But, in fact, the projected blockbuster sales and earnings never were achieved. Even t-PA proved disappointing as the product was hurt by competition from a similar and much cheaper drug. Being in the right industry at the right time is no guarantee of investment success when it’s tulip time in the stock market