Still alluring, still risky

February's successful cloning of a sheep immediately sent the stock of PPL Therapeutics, the start-up company in Edinburgh that has the technology rights, up more than 16 percent in London. And the stock of Genzyme Transgenics, which, like PPL, wants eventually to extract valuable drugs from the milk of genetically programmed livestock, jumped more than 11 percent in this country.

On this news, many investors may have been tempted to dive into what sounds like a promising field. But they may also have heard biotechnology analysts warn that it is foolish to pay much attention to feats whose commercial benefits are so speculative and distant.

"The impact of cloning sheep, for the next few years at least, is zero," said Peter Drake, an analyst at Vector Securities, which specializes in research and financial services on biotechnology and health care. Such is the trouble many investors perceive with biotechnology stocks in general. Like PPL and other cloning ventures, hundreds of companies in the industry have big dreams, limited capital and business plans that project years of research and operating losses before they become big profit makers. Is there any way to invest directly in this industry and avoid big risks? The short answer is no. True, biotechnology is turning out commercial products -- a big contrast to the early 1980s -- but it is still no industry for the passive or the safety-minded. "The allure is that doubles, triples, even quick quadruples are not out of the ordinary," Drake said. "Then you have to be ready to move to the sidelines." Since 1983, the stock indexes that track the industry have gyrated; only twice have they risen for two or more consecutive years. So far, even mutual fund investors have ridden this roller coaster. The Fidelity Biotechnology Select fund, for instance, was down 18.18 percent in 1994, up 49.10 percent in 1995 and up 5.61 percent last year. Still, biotechnology is maturing. And that means the emergence of somewhat safer, if less explosively rewarding, ways to play the field. There are roughly 1,300 biotech companies in the United States, more than 300 of them publicly traded, and there are 700 in Europe, where about 30 have issued public stock, said G. Steven Burrill, a San Francisco-based consultant who prepares an annual industry overview with Kenneth B. Lee Jr., a biotechnology specialist at Ernst & Young. While most of these ventures are start-ups like PPL, biotech now boasts established companies like Amgen, Biogen, Genentech and Chiron, which offer highly profitable products and have more on the way. The biggest star is Amgen, which uses genetically engineered bacteria to produce human proteins that are used in blockbuster drugs for kidney dialysis and cancer treatment. Amgen had earnings of $680 million on sales of more than $2 billion last year and has a market value of more than $15 billion. These companies can give investors a smooth ride, at least relative to the industry's big ups and downs. Amgen stock, which closed last week at $57.75, has not fallen below $50 since late 1995. When Chiron's genital-herpes vaccine -- a drug it had hoped might produce 10 percent of its future revenues -- failed in trials last fall, shares fell just 17 percent. Such a setback would have caused a steeper drop at a start-up and perhaps threatened its viability. But many analysts saw Chiron's bad news as a buying opportunity, citing the many other drugs in its pipeline. Companies on the cusp of prosperity offer the best shot at large near-term gains with somewhat limited risks, said Michael Murphy, an investment manager and publisher of a medical biotechnology newsletter. "There are about 100 biotech drugs in late clinical trials, about to go to FDA or before FDA for final approval," he said. Many of those drugs belong to established biotechnology companies or traditional drug giants. But some are in the hands of newer ventures like Protein Design Labs, whose stock jumped 61 percent last September when it announced that the human antibodies it produced in mice had substantially reduced rejection rates in kidney transplants. But the downside among these companies is frightening. Regeneron Pharmaceuticals' shares plunged 43 percent in January when its new drug to fight Lou Gehrig's disease failed late in clinical trials. In theory, these risks would be eliminated for an investor rich enough to buy up shares of the whole industry, at least according to the "Merck analysis." That is because this analysis, introduced by Burrill and Lee five years ago, suggests that biotechnology as a whole is undervalued. Merck, the largest health care company, and the entire biotechnology industry now have roughly similar market capitalizations; Merck's is just over $100 billion and the domestic biotechnology industry's is close to $80 billion. But biotechnology companies are spending close to $8 billion annually on research while Merck spent $1.5 billion last year. That huge difference in spending translates into a likelihood that the biotechnology group will produce much greater profit growth than Merck in the future and ought to be more highly valued, Burrill said. Of course, there are good reasons that Merck is now worth more than the entire biotechnology industry. Merck had net income last year of $3.88 billion, while biotechnology lost more than $3.5 billion. And Merck has a bigger pool of potential investors because many pension funds and other institutions cannot invest in small, unprofitable companies. An additional weight on biotechnology stocks -- one that suggests another way for investors to limit risk -- is that Merck and the rest of "Big Pharma" stand to capture a lot of biotechnology's profits. Most biotechnology companies lack the capital to fully develop a drug, which can take 10 years and $300 million. As a result, they routinely sell off some of their long-term potential to big drug companies in return for capital or other support. Consider Centocor Inc., which was created in 1979, went public in 1982 and nearly folded in 1993. It finally achieved profitability late last year on the strength of royalties from Reopro, an anti- clotting drug. But Eli Lilly is sharing in this success, marketing the product in return for 50 percent of the profits. Indeed, many biotech companies are already controlled by industry giants. This includes large companies like Chiron (a 6 percent-owned affiliate of Novartis of Switzerland) and Genentech (66 percent owned by Hoffman-LaRoche). These alliances open a path for conservative investors to gain indirect exposure to biotechnology. In fact, many mutual funds mix its start-ups and Big Pharma in their portfolios. A number of health care mutual funds, notably Invesco Strategic Health Sciences, have increased the biotechnology component of their holdings. Even Fidelity Biotechnology, which focuses on pure biotechnology companies, tempers its volatility by taking stakes in Schering- Plough and other traditional health care companies. Analysts cite Novartis and Glaxo Wellcome as drug giants with major investments in biotechology that should produce clear benefits to earnings in the next few years. But such investing reduces both risks and benefits. For instance, in December 1995, when Centocor announced the results of clinical trials that sharply expanded the potential market for Reopro, its shares jumped more than 30 percent. The shares of its partner, Eli Lilly, rose less than 8 percent. And despite the emergence of this and other "safe" ways to play biotechnology, the industry's high-risk, high-reward side is still the key for many people. "The point for individuals is that you are investing in venture- capital-type markets and you'll get paid for taking those risks if you do it well," Murphy said.

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