Breakthrough biotech

Biotech is unquestionably important and increasingly exciting, but its complexity makes it pretty inaccessible to the average investor. In fact, the first hurdle to overcome is understanding what biotechnology actually is. The main difference between biotech and its older cousin pharmaceuticals is that the former involves the manipulation of living organisms to create treatments. Put simply, it is biology, where pharma is chemistry. The techniques used in biotech create large molecule treatments that would be impossible to make with the traditional chemical techniques of pharma and this has allowed scientists to develop a new generation of therapeutics.

So while scientific breakthroughs have been exciting, in Britain biotech hasn’t enjoyed a huge amount of commercial success. That’s not to say it can’t be a very lucrative market and evidence for this is clearly shown across the pond. US group Amgen (US:AMGN), which is considered one of the first generation biotechs, raised $42.3m (£31.9m) when it joined Nasdaq in 1983. Just over 20 years on and Amgen has a market capitalisation of $122bn, which places it in the list of the top 10 pharma and biotech companies globally. Gilead (US:GILD) - with a market capitalisation of $138bn and annual sales in 2015 of $32bn – is also in among the giants, having achieved huge success with its hepatitis C drug, Sovaldi.

The stateside environment has long promoted growth of innovative entrepreneurial companies, and many took to the stock market in the early 1980s (around the time Apple became public) when excitement surrounding all types of technology was very high. In the UK, commercial biotech was much later in getting off the ground, and it was only after favourable tax regimes for entrepreneurial companies – a UK government response to the success that was being seen in America – and easier access to venture capital came along in the 1980s that many entrepreneurs (and later investors) began to see the appeal in the biotech sector.

Today, UK biotech is on the cusp of a major breakthrough phase. Many companies have links with concepts born out of universities, but are led by chief executives with the commercial acumen that comes from experience in big pharma. This means that while the science is more impressive than ever, sensible business decisions including diversification, partnering and consolidation have made the companies doing it more investable.

A diversified company is a strategy shown to be crucial last month when biotech darling Circassia (CIR) announced that its allergy treatment Cat-SPIRE had failed a clinical trial. In 2014 the group became the biggest biotech float in the UK when it raised £200m. A further £275m fundraising a year after gave it substantial funds to plug into commercial trials – however, management also sought to diversify by buying new businesses, some of which already had approved products. This meant that Circassia was not left empty-handed by the failure of the trial. Of course, this case does highlight the risk of the sector as companies are so heavily reliant on clinical trials outside of their control. But it also demonstrates how far biotech has come in recent years and why now is a good time to get involved.

In this feature I have set out to uncover trends for helping UK investors find value in what is one of the most risky, but potentially most lucrative areas of the market. To do this I have compiled recent scientific, financial, shareholder and director information from all of the UK’s listed biotech and pharma companies to pick out those that may have the greatest potential to make big money for investors. Of course, it is important to note here that due to the risky nature of these companies, one biotech stock is not enough. So here are my top picks for diversified investment in biotech and pharma.

1. Follow the leaders into 4D Pharma

Sometimes a biotech company will join the market and see an immediate share price rise, often for no clear reason. However, in an analysis of director remuneration I have noticed that the majority of the companies most heralded by the stock market in recent years are run by directors who take only small salaries. The majority of British biotechs are lossmaking, so managing costs well is incredibly important. Therefore small expenditure on staff is certainly important and when management seems to be involved for belief in the project rather than immediate personal financial gain, the investment proposition is more enticing.

To this end, there is also a link between share price rises and director shareholdings. In fact, four of the five biggest biotech risers during the biotech bull markets of 2014 to mid-2015 all had directors with a 10 per cent-plus shareholding. That shouldn’t come as a real surprise. Small-cap chief executives – in fact all chief executives – are notorious for their ability to glorify their own company, but it becomes much easier to believe management claims if they have their own money invested.

4D Pharma (DDDD)is an excellent example of this, with the chairman, chief executive and chief science officer all owning at least 10 per cent of the shares. 4D was swept up with vigour by investors when it joined Aim in 2014 and within a year of joining London’s junior market had seen a 10-fold increase in its share price.

4D Pharma specialises in biotherapeutics, a novel scientific discipline that involves developing therapies for a range of diseases through the utilisation of live bacteria. Recently the company has commenced its first human trials for treatments identified by its technology platform, MicroRx. With a total of 15 projects in the pipeline, the ability to identify new projects very quickly and a healthy cash balance, this certainly looks like an attractive proposition.

2. ReNeuron has the institutional backing

The hefty capital expenditure associated with developing new therapies means that most biotech companies burn through cash quickly. Last year the average research and development (R&D) expenditure of all UK biotechs was £6.6m, and many of those aren’t even undergoing expensive clinical trials yet. Two of the UK’s biggest biotech hopefuls, Circassia and GW Pharmaceuticals (GWP), spent £47m and £75m respectively on R&D last year. Therefore the ability to raise extra funds is pretty crucial and for that having strong institutional backing makes the process a lot easier.

Many biotech companies have institutional backers who are regularly able to help with new financing rounds, and of these our favourite is ReNeuron (RENE) - backed by Invesco, Aviva and Woodford Asset Management (which holds a 35 per cent stake). But it’s not just for the ability to raise money that we like companies backed by funds – institutions have specialist knowledge and can dig into the science of the companies much better than the average investor.

ReNeuron is certainly one of those where expert knowledge comes in handy. It specialises in stem-cell therapeutics, which in itself needs a bit of explanation. Starting out as the equivalent of a blank piece of paper, stem cells have the ability to transform into many different types of specialist cell. Utilising such cells for treatment can prove to be very effective and the most common type of stem cell therapy is bone marrow transplants. ReNeuron is working on novel therapeutics in a varied clinical programme, which includes treatments for retinitis pigmentosa (a genetic condition that can lead to blindness), critical limb ischemia (a severe obstruction of the arteries that reduces blood flow to the limbs) and stroke-induced motor disability.

3. C4X boasts a strong CV

Many a biotech firm is founded by an academic and C4X Discovery Holdings (C4XD) is no exception, founded by Charles Blundell when he was a scientist at Manchester University. While the wealth of scientific knowledge that comes from these founders is ultimately the lifeblood of the company, quite often the academics lack business direction, meaning the companies can falter when it comes to commercialisation.

Not a problem for C4X. The group’s current chief executive, Clive Dix, has an impressive track record when it comes to making money from commercial pharma and biotech. Dr Dix was an academic before moving to GlaxoSmithKline as a research director. Since then he has racked up quite a bit of experience in taking small companies with exciting growth possibilities, building them up and selling them at their next inflection point. Last year he sold painkiller specialist Convergence Pharma to US biotech giant Biogen for $200m.

Another difference between C4X and other biotech companies is that it was not founded by a biologist or chemist, but a physicist. Dr Blundell and his partner at Oxford found a way of mapping the three-dimensional shape of molecules (which previously had only been able to be drawn in 2D) using nuclear imaging. C4X is now using that technology to discover new treatments that are specific to individual genetic faults and the company acquired a mathematical group that has created an algorithm to identify those faults. It’s a completely new way of looking at medicine and has even persuaded Dr Dix out of retirement – definitely a bonus.

4. GW Pharma is almost ready to sell

The journey from drug idea to usable treatment is a long one. Firstly there comes the research, where companies have to identify gaps in the market where there is a need for new treatments. Then there is pre-clinical development which involves laboratory and animal studies, before the human trials – which are separated into three different stages – can start. As the journey to commercialisation progresses, the stages become both more costly and longer in duration, but by the time a drug reaches the third and final clinical stage, the company can start to think about commercialisation.

GW Pharmaceuticals (GWP) has a drug candidate known as Epidiolex, which is targeting two severe forms of childhood epilepsy. The drug is currently undergoing two Phase III clinical trials, and has already successfully completed two more. It is therefore an exciting time for the company as it inches closer and closer to drug launch. Management has started compiling data for its new drug application, which it expects to register with the US regulatory body, the Food and Drug Administration (FDA), by mid-2017. It will then be able to launch the drugs through its already established commercial platform. GW Pharma is in an incredibly exciting position and definitely the closest the UK has come to replicating the US success of Amgen.

5. RedX Pharma is well diversified

As indicated by the unfortunate Circassia, drugs can fail clinical trials. In fact, as former Financial Times editor Geoffrey Owen and biologist Michael Hopkins state in their book Science, the State and the City: “the majority of clinical trials fail”. Therefore it is a very sensible idea to have a number of different drugs projects to fall back on.

RedX Pharma (REDX) is a good example of a company that has this diversification, with three separate business divisions – oncology, immunology and infection – and a number of drug development programmes in each. This well-stocked pipeline is a result of RedX’s efficiency when it comes to discovering and developing new drugs. Due to its size and flexibility the company has been able to progress its treatment ideas to the proof of concept stage (when a drug is verified as one that has a real chance of working) much quicker than big pharma can. For example, its leukaemia treatment was granted proof of concept after just 20 months and cost £1.7m, compared with a traditional big pharma timeline of four years and £6m.

This is also advantageous for RedX’s long-term strategy. Rather than taking its drugs all the way through to commercialisation, management plans to sell its assets to other pharma or biotech companies when they have built up value. This means the company won’t have to worry about developing its sales pathways, or even cope with the costs of late-stage clinical trials. Of course, drugs increase substantially in value the closer they get to approval, so it will be up to chief executive Dr Neil Murray and his experienced team to decide when a treatment has reached the right level to get a good price. It’s a strategy that certainly suits the current market, with many large pharma companies constantly looking to stock their drugs pipelines by acquiring drug ideas from smaller biotech groups.

Breakthrough biotechs: the numbers

6. Motif Bio could be an acquisition hopeful

To this end, there is also serious scope for the acquisition of a whole company if it has technology or a drugs pipeline that's attractive to big pharma. Mergers and acquisitions have played a massive role in shaping the landscape of the life sciences industry recently; AstraZeneca (AZN) has been on the acquisition war path, with three big purchases in two years; Shire (SHP) has recently completed the $32bn takeover of Baxalta; while US-giant Pfizer (US:PFE) has been on a desperate (and as yet unsuccessful) acquisition hunt for quite some time.

Buying shares in a company before acquisition can be a great opportunity as big pharma is often willing to pay handsomely to secure a deal. For example, Shire’s recent acquisition valued Baxalta’s shares at a 37 per cent premium to its share price before the deal being struck. Of course, identifying a potential takeover target with confidence is nigh on impossible, but there is currently a major blank spot within big pharma that could imminently need filling – antibiotics.

These disease-destroying medicines have for far too long been abandoned by large companies as they do not provide such lucrative sources of income as cancer and respiratory treatments or vaccines. However, major health concerns surrounding a lack of new antibiotics has led to suggestions that large companies not engaged in antibiotic development should be fined. Should this be the case, big pharma may look to consume a company already engaged in such drug development and Aim-traded Motif Bio (MTFB) could be a prime target. Motif Bio is currently undergoing recruitment for its Phase III trial on iclaprim, an antibiotic that, if granted approval, will be the first completely new class of antibiotic for 30 years.

7. Could Horizon, Avacta or Bioventix be the next Abcam?

Abcam (ABC) joined Aim in 2005 and has been one of the junior market’s best ever performers. The reason it has been so loved is its simplicity. When it founded it was essentially an ‘Amazon’ for scientists. Researchers from industry and academia could go to Abcam to source their antibody needs – antibodies are crucial components for many therapies, diagnostics and research purposes – and the company grew through building up its catalogue of the molecules. The business model promotes extremely high cash generation and offers an opportunity to invest in the fast-growth biotech sector without the risks. More recently, Abcam has started the development of its ‘home grown’ antibodies business, and as it initiates this next phase of growth it remains a top biotech pick.

But while I continue to believe in the Abcam growth story, new investors have missed the boat on the real value opportunity. That said, I have identified three more companies that have the potential to be the next Abcam.

The first is Bioventix (BVXP), which also operates in the antibodies market. Out of a humble laboratory complex in Farnham, the scientists at Bioventix are creating a pretty special type of antibody from sheep. Sheep antibodies are advantageous in medicine as they come from a more complex organism than mice or rats (from where traditional antibodies are derived). Like Abcam, Bioventix doesn’t need to bother with the complex clinical trials process, but merely provides endless numbers of top-quality antibodies to its big medical device partners. Interestingly, Bioventix could also be another takeover candidate as Abcam has recently been buying new technologies to expand its product offering.

Avacta (AVCT) is another interesting proposal. It owns the technology that allows it to create affirmers – man-made proteins that provide an alternative to antibodies for treatment, diagnostics and research. It is structured in a similar way to Abcam was in the early days and is selling its affirmers to academics for research purposes. But the overall goal for the company is to operate in the much more lucrative drugs market. It is currently working on developing afirmas for use in therapies in which antibodies are currently not that effective.

Horizon Discovery (HZD), another scientific tool company, has been compared by many an analyst to Abcam – however, unlike the latter it is far from simple. At its heart Horizon owns a series of tools that allow for the specific editing of genes. Using this technology, the company has created a suite of cell lines that act as “patients in a test tube” and identically model disease causing genetic mutations. Horizon licenses these cell lines out to companies involved in treatment and diagnostics and the company believes that it owns more than 90 per cent of the engineered cell lines available globally. This market-leading position stands Horizon in good stead to expand in the rapidly advancing genetic engineering marketplace. The company is also involved in custom-made cell lines for academic reference standards – the first company ever to do this.

8. Optibiotix has the upper hand on regulation

Clinical trials and medical regulations are a real headache for both pharma and biotech companies and reliance on getting the go-ahead from regulatory bodies is one of the main reasons the sector is so risky. Aim-listed Optibiotix (OPTI) offers a chance for investment in the sector without the regulatory concerns. The company is involved in microbiome modulation, a fast-growing strand of microbiology which involves the manipulation of the good bacteria in human digestive systems to bring about health benefits. Optibiotix owns two scientific platforms for microbiome modulation, but rather than develop medicines it is attempting to derive science-based food products that offer health benefits. While not such a lucrative market as drug development, the major benefit of developing food products is that approval does not rely on clinical trials.

The group’s first product, known as SlimBiome, is a weight management formulation. Optibiotix is currently working with KSF Acquisition, the group behind the brand Slim Fast, to develop the SlimBiome concept into weight management drinks and yoghurts. Other current product lines include a cholesterol-reducing strain of bacteria and special calorie-free sugars, which all offer the opportunity for Optibiotix to tap into the vast weight management market. But chief executive Stephen O’Hara sees the benefits of the technology stretching beyond weight management – he believes the group’s two operating systems could be adopted for the skincare, healthcare-acquired infections and wound-care markets, worth a combined $221bn a year globally.