Decoupled moves in Biotech indices highlight opportunities and challenges

After a significant and equivalent downside move in March, both indices have turned positive with an explosive move since middle of July. I speculate that the March downside move was a response to concerns over Obama's health care proposal and its impact on Medicare. However, upon further examination, the adjustments in Medicare rebates would translate to no more than a double digit change in revenues. Moreover, the biotech story is in large a product story where launch of a new product has a much higher impact on revenues than any adjustments in rebate system which can be overcome with cost and price adjustments and while keeping healthy profit margins.

The explosive returns in July are rather interesting and may be indicative of things to come. The divergence in the charts of two indices (30% return for BTK vs. 10% for NBI) underlying story of the biotech industry. This trend indicates a value disparity between mid-large cap biotechs and smaller companies. The BTK move can be contributed to recent earnings and product advancement reports coming out of Celgene (CELG), Gilead (GILD), Amgen (AMGN) and other pharma companies that highlight decent earnings growth despite a challenging environment in addition to value added product development successes.

The M&A activity over the last few quarters have just contributed positively to perceived value of these stocks as the recent acquisition of Medarex (MDRX) highlights a larger trend of big pharma acquiring biologics assets and capabilities. This has resulted in speculative run-ups in shares of other companies such as Elan(ELN) and Seattle Genetics (SGEN) who have biologic portfolios. This trend, however, could reverse as rapidly if no new deals are announced in the next few months.

The muted returns in the NBI index highlights the financing concerns that still remain for smaller companies which may cause a wave of consolidations, bankruptcies and asset sales at depressed values.

My favorite large cap names are Genzyme (GENZ) and Amgen(AMGN) and Biomarin (BMRN) and Vertex (VRTX) among mid-sized companies.

Disclosure: The author has no direct stock or option positions in any of the stocks mentioned in this article.