Rational Investor

01/21/2005 12:00 am EST

Focus:

Jamie Dlugosch

Editor, The Rational Investor

Coming in fourth place in Hulbert's 2004 rankings was Jamie Dlugosch, editor of The Rational Investor . He says, "I expect biotech to be one of the more exciting areas for investors in 2005." Here, he discusses two biotech stocks added to his portfolio.

"The biotech sector was unduly punished in 2004. At the same time, these research powerhouses are one year closer to developing market-ready products that may transform how we fight and treat disease. Once again, the luster on the group has begun to fade as the initial euphoria has been replaced with skepticism. This creates opportunities for new investors to participate with the benefit of several years of work and intangible value being created. As a 'Rational Investor', it is difficult to resist a bargain. I have identified the biotechnology sector as one of my favorite investment themes for 2005, and I plan on owning several stocks in the segment as a pillar in The Rational Investor model portfolio. Given the speculation involved in medical research, it seems prudent to have a number of possible winners rather than to roll the dice on one name. Meanwhile, here are two biotech plays.

"ISIS Pharmaceuticals (ISIS NASDAQ) is a typical example of enthusiasm being replaced with pessimism. The shares topped out at just over $22 in late 2001 only to fall dramatically over the next year. ISIS reached a low of $4 and treaded water for the last year. The company specializes in biotechnology research in development of commercial novel drugs to treat diseases. Its main approach is a platform antisense technology that targets disease causing proteins before the body produces them. ISIS has 11 antisense products in its pipeline with ten in human clinical trials designed to assess safety and efficacy.

"Potential areas of use include inflammatory, viral, metabolic, dermatological and cardiovascular diseases and cancer. Clearly, ISIS has huge potential if they successfully develop drugs in any of these areas. Certainly the weakness in the stock from a short-term cash flow can be somewhat justified. The company is losing quite a bit of money, and the losing trend is expected to continue for the foreseeable future. Of course, that should be the natural expectation on such a cash intensive business.

"As Big Pharma has demonstrated, research and development of medicines come at a huge price. The windfall comes when drugs come to market under the protection of long-term patents. With the troubles in Big Pharma, I expect niche players like ISIS to be takeover targets. The large amount of intangible value trading at a discount will attract mergers. It would be extremely rational for a Merck or a Pfizer to come in and buy one of these companies. As for ISIS, I look for the company to continue to recover its lost value. My target is $15, and I would be a buyer up to $7.50.

"Enzon Pharmaceuticals (ENZN NASDAQ) is a biotechnology company that focuses on the discovery, development, manufacture, and commercialization of pharmaceutical products in three areas of therapeutic focus: oncology and hematology; transplantation; and infectious disease. Aside from its research, the company has multiple products already on the market. Sales from such products reached $169 million over the last 12 months. The company is expected to earn $0.24 in its current fiscal year (ending in June). Analysts expect that number to grow to $0.54 in the following year.

"But Enzon's stock has been on a downward spiral over the last five years. The company peaked above $70 in 2000, but dropped steadily as losses mounted. As pessimism rose, ENZN dropped to $10 per share. The shares recovered as profits loomed at the end of 2003, and ENZN climbed back to a high of $18.50. Negativity in the sector pushed the shares back to five-year lows and by the end of 2004, the shares traded for $13.72. ENZN may never see the heady days of the last bull market, but at current levels, today's investor can still make a healthy profit. The stock trades for only 25 times forward earnings, and those earnings are growing 100%+.

"The intangible value of new drug discoveries offers investors the potential for significant earnings growth over the next three- to five-year period. As tough as the last five years have been, ENZN may very well see the reverse. Big Pharma, as mentioned before, may be very interested in acquiring assets such as ENZN. In order to do so, they will need to pay significant premiums to current price. Growth and takeover potential are reason enough to buy ENZN at current levels. Enthusiasm for the sector should return, and my target on ENZN is $30. I would be a buyer up to $15."

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