Taking Stock

Since the days when investment wizard Peter Lynch dazzled wall Street with his simple strategy of “buy what you know,” the idea of investing in your own experience has become conventional wisdom on Wall Street, with Mac users buying Apple stock, khaki-wearers buying the Gap, and Netizens buying, well, every .com stock in sight. And while investing in your own health is clearly a more serious matter than picking up shares of Starbucks because you like the coffee, the fundamental idea is the same: Your concerns and interests are likely the concerns and interests of others, which means that some company, somewhere, must be figuring out how to make money off them. Successful investing, in turn, means finding those companies.

Oddly, though, before the nineties – the mid-nineties, really – you wouldhave had a hard time finding any public companies that saw the women’s-health-care market as a significant business opportunity. Only in the past three or four years, in fact, has something we can call a women’s-health-care industry come into existence, and it is an industry that is still very much in its early stages. There are probably fewer than twenty public companies specializing in women’s health care (that is, “pure play” companies), and many of them are micro-cap companies, with market capitalizations below $100 million. It is, needless to say, a risky field for the individual investor.

At the same time, giant drug companies – including Merck, Lilly, Johnson & Johnson, and American Home Products – have come to recognize that the aging of the baby-boomers will create a massive demand for products ranging from postmenopausal drugs to mammographies to drugs that can fight breast, cervical, and ovarian cancers. That recognition has led them to establish separate business units dedicated to women’s health care.

From an investor’s perspective, then, the women’s-health-care field is rather dramatically divided, with a set of tiny, pure-play companies on one side and a set of giant, diversified drug companies on the other. That division is also characteristic of the biotech field as a whole, but women’s health care has yet to have a pure-play company break out, as biotech firms like Amgen and Biogen have.

In typical biotech fashion, most of the pure-play companies went public all at once, in a boomlet in early 1996, when the overall stock market was ravenous for initial public offerings (IPOs). Among others, Cytyc, ESC Medical Systems, Biopsys, Digene, and Trex Medical all went public in 1996, and investors snapped them up, so much so that at the end of that year, Fortune decreed that the women’s-health-care field was “poised for greatness” in investment terms.

Well, that prophecy proved singularly unprophetic – or at least it has so far. In retrospect, it seems clear that most of these companies went public far too soon. Many of them had no real revenue streams, and their major products had yet to make it through the FDA approval process. The chance to raise capital via an IPO is, of course, nearly impossible to resist, but these companies were a long way from being powerhouses like Microsoft. After meandering through 1997, almost all of these firms – with the notable exception of Cytyc (which makes a new test for cervical cancer) – peaked near the beginning of 1998. The chaos of the summer devastated these companies’ shares, as it did those of most small-cap stocks, and they’ve made only tentative recoveries since. ESC Medical Systems, for instance, which makes lasers for cosmetic and clinical applications, has watched its stock fall from $38 to below $7, while shares of Biofield, maker of a non-mammographic test for breast cancer, now trade at about 33 cents a share (down from a 52-week high of $5), and those of HumaScan, which makes a similar test, can be picked up for less than a dime. Last spring, HumaScan’s stock was at $13 a share.

As sobering as the past year has been for investors in these companies, though, women’s health care obviously remains a field with enormous growth potential. Four years ago, it would have been hard to find a stock analyst who followed the industry. Today, several major investment banks have analysts who track the field, including Melissa Wilmoth at Salomon Smith Barney, co-author of an influential 1997 report, The New Women’s Movement, which argued that the women’s-health-care industry was on the verge of exploding.

Of course, when it comes to biotech- medical-device companies, it’s important to remember that anything can – and often does – go wrong. Consider the obstacles: Only after passing clinical trials, getting FDA approval, and persuading insurance companies to reimburse for the product can a company really test consumer demand. And, of course, that demand is filtered through individual doctors. That a woman wants a particular test doesn’t mean that her gynecologist will offer it. (Companies have to spend millions marketing drugs to doctors.)

The real problem for investors is that there is no reliable way to figure out which products will be able to get over all those obstacles and which will not. Disappointments are a permanent feature of the biotech landscape, even for larger companies, and a distressingly familiar problem for smaller ones.

Trex Medical, for instance, one of the two women’s-health-care companies that Wilmoth has a rating on (it’s a hold), had been counting on its new digital-mammography technology to be a major future revenue source. The company was far ahead of its competition and expected to roll out a full line of mammography systems. Digital mammography, which Salomon calls “a breakthrough technology in early breast-cancer detection,” offers the promise of a dramatic improvement in the quality and speed of diagnosis over conventional mammography, and it’s also safer, since it requires less radiation. If it works as it’s supposed to, digital mammography will make it much easier to detect breast cancer in younger women.

The FDA, though, is apparently unconvinced that the Trex system will work as promised. Although the FDA did not reject the technology, it essentially returned it to Trex and said, “We need more information.” The technology may still be approved, but in the meantime the company’s stock has plummeted from a 52-week high of $19 a share to around $8 a share.

“There’s just no way to tell what’s going to happen in clinical trials or with the FDA,” Wilmoth says. “That’s the basic problem with this sector, and you have to have a tolerance for that kind of risk.”

What that means is that even people who would like to invest in their own health should not invest only in their own health. Small biotech companies are the very definition of speculative investments, so if you want to invest in them, make sure you’ve also got some blue chips in the portfolio. Wilmoth puts it bluntly: “No one in their right mind should ever have a portfolio made up of just pure-play women’s-health-care stocks.”

Why buy them at all? Well, the potential payoffs are obviously huge, especially for small companies, where one widely adopted medical device or drug can drive growth for years. The drug company Immunex, for instance, has seen its stock price more than double in the past year, thanks to expectations for its new anti-arthritis drug Enbrel. And investors who bought Biopsys – whose mammotone system uses a single needle to perform minimally invasive biopsies – when it went public almost doubled their money a year later when the company was bought by Johnson & Johnson.

Biopsys is clearly the biggest winner to date in the women’s-health-care field. And although some still hold out high hopes for Trex, the most interesting pure-play company out there right now may be Cytyc, whose ThinPrep alternative to traditional Pap smears is finally finding a market. Technologically superior and significantly more accurate than current tests, ThinPrep could reduce the number of women who die from cervical cancer each year by improving early detection of the disease. But since the test is more expensive than the traditional method, Cytyc has had a hard time getting labs to invest in the technology because insurance companies have been dragging their feet on offering reimbursement for the test. Recently, though, that seems to have changed.

“Reimbursement is starting to come through for Cytyc, and all I can say is God bless them,” says Wilmoth, who adds that her father is a physician who has wanted to use the ThinPrep test but hasn’t been able to because the lab he uses doesn’t own the equipment. “They’re finally getting labs to invest in the technology, and building up enough of a critical mass from insurance companies. It’s a complicated dance. In order to convince the labs there will be enough volume coming from doctors, you have to get reimbursement in place, and to do that you have to convince the insurance companies that this is something that has to be covered.”

One other company that’s worth watching is a small, privately held firm called Biex, which makes a saliva test that can effectively tell a woman whether she’s going to have a pre-term delivery. A woman who gets two positives on the test – which can be taken at home – is eight times as likely to have a baby in the following two weeks as a woman who gets two negatives. Biex nearly went public last year, but when the overall market’s appetite for new issues waned, so, too, did the company’s chances of an IPO. Somewhere down the road, though, you may get a chance to own shares in the firm.

Of course, if you’re going to own shares in any company with a commitment to women’s health care, your best bet is almost certainly one of the bigger drug companies, which offer the chance to invest in what you know and the protection of a diversified product base. Among midsize companies worth looking at, Genentech makes Herceptin, which has had good clinical results in fighting advanced breast cancer. And generic-drug-maker Barr Laboratories owns the rights to distribute tamoxifen, a 25-year-old drug recently shown to also be effective against breast cancer.

Among the true powerhouses, Johnson & Johnson, with its recent acquisitions of Biopsys and Gynecare (which makes products to treat fibroids and excessive menstrual bleeding), is moving strongly into the field, and its reputation as an aggressive acquirer means that more purchases may be in the offing. American Home Products has Premarin, the No. 1- prescribed drug in the U.S., and Merck has Fosamax, the first real alternative to estrogen for osteoporosis. Eli Lilly, meanwhile, is probably the leader in the field, in terms of both its broad-based commitment to research and the long-term prospects for Evista. In targeting both osteoporosis and breast cancer, Evista is a potential blockbuster. And if the blunt but accurate formula demographics + demand = dollars really means anything, it’s that Lilly’s future is especially bright.

Taking Stock