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12.31.14 | The Life Sciences Report

Making predictions for the New Year may feel as productive as peering into a crystal ball. But in the life sciences, hard science and long experience back prognostication. The biotech market enjoyed a stellar 2013 and withstood a solid check in early 2014 before rebounding, essentially following the upward trend that most experts forecast. What is in store for 2015? The Life Sciences Report turned to newsletter writer John McCamant and WBB Securities’ Steve Brozak for insight.

Consider the statistics. In 2013, most major biotech indices, such as the NASDAQ Biotechnology Index (NBI) and the NYSE ARCA Biotech Index (BTK), posted healthy double-digit gains. It appears 2014 will end on the same upward trajectory: Year-to-date, the NBI is up about 34%, and the BTK is up about 48%. As 2015 approaches, the question on every investor’s mind is: Can the market continue its bonanza-style growth? And which companies or sectors will be the most attractive and lucrative?

Steve Brozak of WBB Securities and John McCamant, editor of the Medical Technology Stock Letter, have some ideas.

A Brief Glance Back

Reflecting on the previous couple of years, McCamant believes that buoyant 2013 was an “outlier. . .a make-up year” in which financing finally caught up with the growing sector. He doesn’t think that kind of growth will be seen again. He describes 2014, with the market’s brief retreat early in the year, as “rational.”

“Biotech dominated the capital markets in 2014,” Brozak observed. He points to the number and quality of initial public offerings (IPOs) as an indication of the sector’s power. “The IPO market has been strong, with 100 deals completed year-to-date and roughly $8.7 billion ($8.7B) raised so far. As a group, the average return from these IPOs alone is approximately 28%.”

When IPOs slacked off a bit early in 2014, “we saw merger and acquisition (M&A) activity increase with a string of so-called tax inversions,” Brozak said. “These deals only reignited the IPO and secondary markets. Since then, M&A has also been on fire, with a series of large transactions. Even failed mergers help to drive the rest of the market in 2014. For instance Pfizer Inc.’s (PFE:NYSE) failed pursuit of AstraZeneca Plc (AZN:NYSE) earlier in the year—a merger that would’ve been historically immense—opened the door to larger transactions later in the year, like Medtronic Inc. (MDT:NYSE) and Covidien Ltd.’s (COV:NYSE) $43B merger.

McCamant believes biotech will continue to build on fundamentals that have been, and will continue to be, excellent. “The science is first class, the companies execute much better, and the regulatory environment is the best it has ever been,” he said, pointing to the growth of companies like Gilead Sciences Inc. (GILD:NASDAQ) and Celgene Corp. (CELG:NASDAQ) as “validators” of the sector’s underlying fundamental strength.

Follow the Money

Asked where technology is headed in 2015, Brozak said, “We just need to look at what the IPO market is funding. It’s perverse, but Wall Street basically dictates what science receives support through the funding process. In our analysis, we see that fundraising in the immuno-oncology and immunotherapy space has been prolific, and 2015 seems to be the year of PD-1 (programmed cell death-1), T-cell therapy and cancer vaccines. Many of the new companies working in these spaces now need to perform in the clinic as well as in the market.”

McCamant agrees with Brozak on the prospects for immuno-oncology—enabling the body to fight cancer using its natural defenses. This will continue to be “a red-hot space” in 2015, he predicts. Vaccines, antisense and gene therapies also top McCamant’s list. With regard to gene therapy in particular, the newsletter writer observed: “Twenty years ago was too soon. Now, it’s primetime.”

Immunotherapy Takes Center Stage

“In the immunotherapy space we follow Celldex Therapeutics Inc. (CLDX:NASDAQ),” Brozak said. “The company just announced it has completed enrollment for its Phase 3 cancer vaccine program in glioblastoma multiforme (GBM). To date, Celldex’s lead program in GBM has shown some very good data in interim Phase 2 trials in patients with advanced disease. The product, rindopepimut, is currently being studied in an international Phase 3 trial called ACT IV for newly diagnosed patients, and a Phase 2 trial called ReACT for patients who have a recurrence of GBM.”

Celldex also has a monoclonal antibody program being studied in the METRIC trial in triple negative breast cancer; this showed promise in an earlier study, according to the analyst. “There are few options for oncologists to turn to in treating [this disease], and this could be a very important drug candidate for cancer care physicians and their patients. Both of Celldex’s primary products manipulate a patient’s immune system to fight cancer,” Brozak said.

Big Pharma dominates the development of PD-1 pathway inhibitors, according to McCamant, but he likes the prospects of smaller companies targeting other pathways. Five Prime Therapeutics (NASDAQ:FPRX) has “a library” of proteins, which form the foundation of its platform and can be used to develop new cancer therapies. The company has entered into collaborations with Bristol-Myers Squibb Co. (BMY:NYSE), which is helping to fund Five Prime’s research and development. He also likes Incyte Corp. (INCY:NASDAQ), which has an orally available compound targeting the IDO pathway and “strong intellectual property.” Isis Pharmaceuticals Inc. (ISIS:NASDAQ) is also working in the immuno-oncology field, and has entered into a collaboration with AstraZeneca.

Vaccination Proclamation

Vaccines are made to prevent disease, rather than treat it, McCamant said. The ongoing Ebola outbreak in West Africa has generated significant interest in vaccine development, and the idea of prevention, as opposed to treatment, is the best way to stop the disease, he explained. He expects that anyone who goes to an area where Ebola is a threat will receive a vaccine, a “traveler’s market” that will be worth $500 million to $1 billion.

Novavax Inc. (NVAX:NASDAQ) is moving forward with a vaccine for Ebola, which “is a free wild card,” McCamant said. The company has a number of arrows in its quiver, including vaccines that target seasonal and pandemic flu and respiratory virus syndrome, which can be devastating for infants and the elderly. The company’s VLP technology puts it ahead of the competition, enabling the company to develop a “functional vaccine” within 30 days of receipt of the virus’ sequence.

With regard to the Ebola vaccine, McCamant noted that Novavax’s product, currently in Phase 1, is the “best for multiple protection” from both the current strain and previous strain. The benefits of the Novavax vaccine are multiple, given that, with its platform technology, the company can potentially produce “millions of doses in a matter of months,” and that those vaccines won’t need to be frozen, like current vaccines, but require only refrigeration, much easier to accommodate in Africa.

Playing the Field

“While there are a number of other good companies developing technologies in the immuno-oncology and immunotherapy spaces, we tend to focus on other names that could help balance out overall investment strategies,” Brozak said. “We feel that there’s a great deal of value to be unlocked in other niches of the biotech industry not being followed by the masses.”

He went on to note that, “While a great deal of attention has been paid to Ebola this year, we need to keep in mind that, according to the Centers for Disease Control, 53,826 people died of complications of influenza, which may include bacterial coinfection and pneumonia, in 2013. Coupled with a rise of bacterial ‘superbugs’ resistant to current antibiotics, we are seeing increased interest in biotechs developing new antibiotics.” For those reasons, WBB Securities continues “to be bullish in the antibiotic space, and Cempra Inc. (CEMP:NASDAQ), based in North Carolina, continues to be a top pick.”

The company “has several near-term catalysts, including data from its lead product in a Phase 3 clinical trial anticipated sometime in the first quarter of 2015,” Brozak said. “The Phase 3 uses Cempra’s powerful antibiotic candidate, solithromycin, against community-acquired bacterial pneumonia (CABP). [The oral form of the antibiotic] has demonstrated incredible potency across an array of pathogens that cause CABP. If the previous data hold up in the anticipated release, it should be a good day for patients and investors.”

Brozak also likes Seattle-based Omeros Corp. (OMER:NASDAQ) “Omeros just received CMS (Centers for Medicare and Medicaid Services) reimbursement approval for Omidria, its first U.S. Food and Drug Administration (FDA)-approved drug. Omeros actually received better pricing than the Street had anticipated,” he said. “Management teams that underpromise and overdeliver are ones to watch.”

The drug, used during ocular surgery to dilate pupils and prevent pain, replaces what eye surgeons presently must order from drug compounders, a solution that isn’t reimbursable. “This is a highly inefficient and risky way to treat your patients. We just saw 14 people who worked at the Framingham, Massachusetts, compounding facility that provided surgery drugs tainted with meningitis bacteria criminally charged. Contaminated products were used in thousands of patients, caused sickness in more than 750 people, and killed 64 people. The same types of facilities currently provide ocular surgeons with essential drugs used during eye surgery. With Omeros’ product, surgeons will receive a better product from a single-source, FDA-regulated company.

Brozak said investors may be surprised with NeoStem Inc. (NBS:NASDAQ), a biotech engaged in regenerative medicine. “We also look for companies with good fundamental science whose stories were misinterpreted by Wall Street,” Brozak said. “NeoStem released results from a Phase 2 cardiac trial last month that were promising and indicative of a Phase 3, but Wall Street may have misunderstood and discounted the potential in this case. We think 2015 holds a great deal of promise for the field of regenerative medicine, with companies like NeoStem at the forefront.”

“Even the types of progress we’re seeing in immuno-oncology, and all the investor hysteria for chimeric antigen receptor (CAR) and T-cell therapy, is only possible because of what early pioneers have been doing in the regenerative medicine and stem cell space,” Brozak continued. “Our understanding of cancer and immune cells is derived from the work that scientists at labs and companies like NeoStem have been conducting in regenerative medicine. These newer platforms we are hearing about—CART, T-cell and PD-1—are derived from decades of observing and learning from human stem cells, because cancer cells are very similar.”

But, according to Brozak, investors do not realize how interrelated the scientific discourse is. “Investors tend to compartmentalize, and are not tuned to the finer frequencies. In NeoStem, you have a company that understands stem cell science, with candidates in both the regenerative medicine and immunotherapy space. In 2015, we anticipate that the FDA will allow a Phase 3 trial in cardiac based on the Phase 2 data that was received incorrectly by Wall Street. We also expect the launch of NeoStem’s Phase 3 immunotherapy trial in melanoma, which utilizes a patient’s own tumor cells to fight advanced disease. This therapy could potentially be combined with other immunotherapy regimens to enhance the immune system’s response to seek out and destroy cancer cells throughout the body.”

Brozak also advises investors to “Keep in mind that NeoStem has some of the best minds in immunotherapy working for its subsidiary at Progenitor Cell Therapy, a contract manufacturing organization that has wide expertise in manufacturing and clinical trial management for other immunotherapy companies.”

Onward and Upward 

Given that biotech industry indices in 2014 “more than tripled the performance of both the Dow Jones Industrial Average (DJIA) and the Standard & Poor’s 500,” Brozak is bullish on prospects for 2015.

“Year to date, the S&P Biotech Select Industry Index has grown 34.31%, while the DJIA and the S&P 500 have only appreciated 2.97% and 6.7% respectively, meaning that in 2014, biotech has outperformed the market by an even larger margin than in 2013. This conveys the strength of the healthcare sector and shows that a stable framework is in place for further expansion,” Brozak said. “Currently, healthcare is in the midst of liquidity levels that are unparalleled in recent times, so the first half of 2015 is likely to be characterized by the perpetuation of current trends in biotech.”

While Brozak doesn’t know exactly when, he does knows the biotech boom will slow down and come to an end. “Right now we’re also very concerned with what is happening geopolitically, especially in Russia with the destabilization of the ruble, a collapsing energy market and turmoil in the Middle East. These are events that may profoundly impact capital market activity and the ability for companies to perform.”

When asked about the sector’s long-term prospects, Brozak went on to say, “Sometime early in the second half of 2015, investors should anticipate a correction in the biotech space. There will be a setback. Maybe one of the newly IPO’ed companies will report poor clinical trial results or, more likely, something won’t work the way the market wanted it to, and we’ll see an industry-wide correction. There were a few times this almost happened in 2014, but there was always another catalyst—the announcement of a megamerger or excellent results reported in a small immunotherapy trial—which helped the sector recover. When the market hits 20,000, investors should expect it to cool off. . .and even that milestone could be the catalyst for a correction. No matter the cause, a correction will be a good time to invest in biotechs, with excellent scientific prospects during the retrenching.”

Looking forward, McCamant also offers some cautions. He advises investors to “watch for a frothy IPO market” and agrees that biotech won’t be immune to a downturn in the overall market, should that happen. He also doesn’t like the tendency to “finance til we puke,” another potential hindrance to the sector’s overall robustness.

But on the upside, McCamant likes the prospects for smaller biotech companies, noting that big pharmas are looking to acquire “strings of pearls,” smaller, nimbler companies with compounds and platforms that will bolster their pipelines. “Competition is heating up,” he said, adding that “bidding wars” may be in the offing.

Demographics also point to continued growth in the sector, with aging baby boomers primed to bolster market growth. “Health will always come before wealth,” McCamant observed. “The sector is hitting on all cylinders.”