By Sam Subramanian

The trident of new targeted drugs, shortening cycle-times, and consolidation provide a powerful case for investing in the biotechnology sector.

New Targeted Drugs Research to conquer cancer has gained momentum, thanks to the promise of ‘targeted drugs'. Targeted drugs take on the molecular mechanisms involved in the growth of cancer without hurting the surrounding healthy tissue, and offer the possibility of making the disease a manageable, chronic condition.

Tarceva, an experimental drug developed by OSI Pharmaceuticals is one of the more high-profiled targeted drugs. The drug shows promise in extending the lives of lung cancer patients when used in combination with Genentech's (NYSE: DNA) Avastin. ImClone's (Nasdaq: IMCL) Erbitux is another targeted drug that is in the limelight.

Shortening Cycle-Times Aided by an efficient Food and Drug Administration, companies are making strides in reducing cycle-time. Efforts to improve the FDA's efficiency are paying off with the time required for FDA review being shortened. Last year, Millennium Pharmaceuticals (Nasdaq: MLNM) received approval for Velcade within four months of filing.

Companies for their part are also aggressive in reducing cycle-time. Genentech, for example, was ready to launch Avastin literally within hours of getting FDA approval. Helped by favorable test results, Elan (NYSE: ELN) and Biogen Idec (Nasdaq: BIIB) filed for their multiple sclerosis drug, Antegren, in May 2004, a year earlier than expected.

Consolidation The organic growth of biotechnology companies has proven to be a long and uncertain process. Driven by the need to reduce risks, derive scale advantages, and enhance domain expertise, biotechnology firms seek to merge between themselves. Last year Biogen and Idec, merged to form Biogen Idec. Recently, QLT (Nasdaq: QLTI) and Atrix (Nasdaq: ATRX) have agreed to merge to move closer to becoming a fully integrated biopharmaceutical company.

Major pharmaceutical firms faced with the double whammy of weak drug development pipelines and upcoming patent expirations are looking to purchase biotech firms to rev up their growth engines.

Recently, Belgium based UCB (UCBBt.BR) offered to buy U.K.'s largest biotech firm, Celltech (NYSE: CLL).

So how does one play the biotech cycle?

Investing in biotech stocks has never been for the faint-hearted. News from clinical trials can make or break a company's share price. Many biotech companies have high cash burn rates. Even the profitable ones have relatively few marketed products. As such, it makes sense to invest in a basket of biotech companies rather than one single entity.

Today's marketplace offers several opportunities for investing in the biotech sector.

First, there is Fidelity Select Biotechnology (Nasdaq: FBIOX), an actively managed, no-load sector fund. With over $2 billion in assets, this is by far the largest open end mutual fund that focuses on biotechnology. As of March 31, 2004, FBIOX held 60 stocks with the top 10 holdings accounting for about 64% of the portfolio.

There are two exchange-traded funds (ETFs) that focus on the biotechnology industry: iShares Nasdaq Biotechnology (AMEX: IBB) and Biotech HOLDRS (AMEX: BBH).

The iShares are designed to track the Nasdaq Biotechnology Index that includes over 100 biotech companies that trade on the Nasdaq. The Biotech HOLDRS represent an undivided beneficial ownership in the common stock of 18 who-is-who type biotech companies. The top 10 holdings in the BBH account for nearly 95% of the asset compared to 37% in the IBB.

Among the options available, Fidelity Select Biotechnology and iShares appear more attractive. First, they offer better diversification. Second, exposure to development stage companies is higher. Some of the development stage companies have appeal as takeover candidates whereas the industry leaders in the HOLDRS are more likely to be buyers than sellers.

About the Author:

Sam Subramanian is Managing Principal of AlphaProfit Investments, LLC, an investment research firm that publishes the AlphaProfit Sector Investors' Newsletter and operates http://www.alphaprofit.com. Sam owns shares in Fidelity Select Biotechnology.

Source: Biotech-About.com, http://biotech.about.com/od/investingmethods/a/bl_Subramanian.htm;