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Derek Lowe The 2002 Model

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Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: Twitter: Dereklowe

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February 25, 2007

Biotech's Net Loss?

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Posted by Derek

The other day I made a quick comment that I wasn't sure which would have a higher rate of return - biotech stocks or lottery tickets. Some folks liked the comparison, and others didn't, naturally. But there are some points worth thinking about in it.

For one thing, we have to distinguish between the gains realized by the companies themselves, versus those realized by their stocks. The former figures have already been calculated fairly recently (2004) by David Hamilton in the Wall Street Journal (subscriber link here), and I wrote about their figures at the time.

The best estimate was that since the first biotech company went public, total operating losses in the industry have amounted to some 40 billion dollars. Genentech and Amgen do what they can with all the black ink that they generate, but they're overwhelmed each year by the tide of the red stuff. I can only imagine what this figure would be if it included non-public biotechs, every single one of which (as far as I know) has run at a loss. After all, when you start to look like you're going to turn a profit someday, you're already public, right?

During this period, investors have put about 100 billion into the public companies, so we know where 40% of that money has gone, at any rate. Ah, but you're saying, these investors got stock in return, and how's that done, eh? Undeniably, some of the issues have made people fantastic amounts of money - Amgen, for example, has returned several hundred-fold on an investment at its IPO price in the early 1980s, although surely no human being has held it for that entire time. Of course, somewhere around 15 or 20 per cent of all the biotech companies that have gone public over the years turn out to have returned nothing at all, having disappeared in a blizzard of worthless stock, so that does cut into things. Still, biotech has been up over that time - but compared to what? As a whole, the article suggested, the sector has failed to even come close to the S&P 500's rate of return over the last 25 years. (And I'm not sure if that comparison includes transaction costs, which because of all the turnover in the sector would skin you alive over time).

So, how's that lottery ticket comparison look? If you're looking for the next Amgen or Genentech, well, those are two stocks out of several hundred that have gone public. Those are far better odds than the jackpot in a state lottery, true (although the jackpot has an even more insane rate of return). How about the overall odds of winning, though? Looked at more broadly, most state lotteries will cause you to lose about half of every bet that you put into them (a rate which casino operators can only envy). The figures above suggest that (on an operating basis), biotech has done worse, splitting about 41/59. On a stock investment basis, it appears that you'll make money overall, but not as much as you'd make by parking the same cash in the indices, and I'd call that a loss, myself. You may not think so, but if you don't, please send the difference to me so I can give it to Vanguard myself.

I should mention that the original WSJ article is itself full of comparisons to casinos, Las Vegas, and lotteries. The point, unfortunately, is well taken. Next time, we'll talk about probability of ruin, and things will really start looking grim.

Comments (14) + TrackBacks (0) | Category: Business and Markets | Drug Industry History


1. milkshake on February 26, 2007 7:45 AM writes...

The non-public biotech startup at which I had my first US job consumed 40M and was sold for 58M. Not a stellar success but the site still exists, 15 years later, as a part of Sanofi. So it was not a complete loss (but overall it was rather ho-hum outcome). Marion Merrel wanted to have a combichem and this little company was cheap enough - more than for them build their own site. And the investors were eager to sell... We almost got bought by Pfizer the year before but luckily Pfizer re-considered few days before the deal was supposed to be signed. We had only few months worth of money when Marion-Merell came to the rescue.

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2. Kay on February 26, 2007 7:53 AM writes...

That's why I am only invested in growing large-caps whose pipelines are brimming with large-market opportunities with unmet needs and no competition.

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3. KinasePro on February 26, 2007 7:57 AM writes...

I wonder how a similar analysis would go only looking at 'little pharma' styled biotechs. Seems to me the technology companies burn cash like wildfire, but the more traditional 'med-chem factories'(TM) may have a better balance sheet.

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4. TW Andrews on February 26, 2007 9:35 AM writes...

Does this consider the big-pharma (and/or Amgen/Genentech) stock which I'm sure many of the original biotech investors recieved as their companies have been steadily purchased by larger players?

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5. Bill on February 26, 2007 11:15 AM writes...

The biotech industry is not the only industry with a negative cash flow. The steel industry took almost a century to show a net positive return. The personal computer industry is probably still negative. I think its just part of the life cycle of an industry, although the cycle times are getting shorter.

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6. Max Power on February 26, 2007 3:48 PM writes...

Looks like the NYT article about Xoma hit home...

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7. Palo on February 26, 2007 6:13 PM writes...

The biotech phenomena is simply a game of capitalism at its usual. Lots of people investing in many small ideas hoping one of them hits it big. I don't see a big difference with pharma funding dozens of research projects with its own teams only to see a tiny fraction producing results. And each little team is as big or more than a typical biotech. Derek, you yourself told in the past the story of how you were asked about "what you do", describing the puzzled faces of your audience when you tell them you haven't discovered anything 'useful' yet. Investors in big pharma put up with the dozens of failure drugs hoping for the successful one. If you take small biotech as if it was a big whole enterprise, I don't think you see anything terribly different from pharma's successes and failures..

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8. X-Man on February 26, 2007 11:02 PM writes...

I think we're entirely too hard on the biotech industry. What's being argued over are asset prices (did/does the market properly value Company A's pipeline?) but all but the worst biotechs are generating assets with their research.

In contrast, there's plenty of other industries absolutely destroying value just by being in existence, like the airline industry.

Like I said the other day, the current valuation of AMMGN + DNA make the total investment in the industry a net positive (though this doesn't account for the time value of the money). I'd be real curious to know if the net value creation of the airline industry is a positive number.

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9. Headcount on February 27, 2007 1:20 PM writes...

Brrr, I'm cold! Better go throw some more reckless investor $$$ into the furnace.

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10. Still Scared of Dinosaurs on February 28, 2007 10:31 AM writes...

I've always thought the AMGN+DNA story worked in line with the lottery ticket metaphor...small numbers of big payouts and a lot of losers. And I think we should be hard on biotech. I just left a small one with fantastic technology but led by people who had no idea about drug development. The world would be a better place if the original federal + university-funded discoveries had been immediately placed in the public domain.

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11. MTK on March 1, 2007 8:25 PM writes...

I'm not a subscriber to WSJ, so I have not read the article, so at the risk of talking out my butt...
the flaw in the analysis is that it only takes into account publicly traded biotechs.

There are essentially three exit strategies for a start-up; IPO, acquisition, or insolvency. By not taking acquisition into the equation, it misses quite a bit. As an example, Merck just acquired Glycofi, a privately held company, for $400 million.

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12. Derek Lowe on March 1, 2007 9:27 PM writes...

I'd like to know what the statistics are on buyouts versus bankruptcies in the business - that would really help put some bounds on things, but I wonder if anyone has the numbers? And there's also the fact that not all buyouts happen at a premium. There are a few fire sales going on, too.

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13. RI Pete on March 2, 2007 11:38 PM writes...

As fate would have it, Amgen and G-Tech(a global lottery company) have adjacent sites here in Rhode Island.

As far as industry losses go, I wonder if 100+ years ago all the auto companies that came and went also dug a huge hole for that industry before it matured a bit. Ditto for railroads a bit earlier...

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14. belg4mit on March 24, 2007 8:56 PM writes...

Separating things into odds and "rate of return" (you mean payout) is probably not the best way to look at it, instead consider the expected value. If I put $1 into the lottery (for simplicty, a scratcher) my expected value is say 1/10,000,000. I am therefore a sucker for playing if my goal is to make money (and not the thrill of suspense). On this basis, most any startup's IPO (but especially BioRandomTech) are also stupidity taxes.

Expected value is a simple microeconomic concept that helps to get ahndle on this sort of thing. Another example is (if you happen to watch it, blecch) "Deal or No Deal." The "banker" (seems to) always gives an offer less than the expected value so it generally makes no sense to take it (unless you really need the money, etc.)

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