Biotech IPOs continue to provide excellent returns

Investors in the initial public offerings (IPOs) of Australian biotechnology companies have done well over the past six years -- despite the fact that the shares of most of the newly listed companies are currently trading below the price at which they were first sold.

An investor who put $1000 into each of the 23 core biotechnology companies that went public on the Australian stock exchange between July 1, 1998 and June 30, 2003 would have held a share portfolio worth $54,868 on 1 July 2004 -- an increase of nearly 140 per cent on an initial investment of $23,000. ('Core biotechnology' excludes healthcare facilities, functional foods, and external device companies. The 23 core biotechs were the subject of an extensive ASX-sponsored research project carried out at the Australian Graduate School of Management in 2003.)

The big winners were Chemeq, which has gone from a listing price of 25 cents to a July 1 price of $5.14, followed by Cellestis ($0.25 to $2.37) and Metabolic ($0.20 to $1, prior to a huge jump in the company's shares following the release of an American research report over the July 4 holiday). Genesis Biomedical, Analytica, VRI, and Genesis Research were the big losers, all having fallen to less than 20 per cent of their initial offering price by July 1, 2004.

The most recent financial year saw a dramatic upsurge in biotech IPOs -- 16 core biotech companies listed in 12 months. (For the sake of comparison with the earlier data, this list excludes retractable needle and other external device companies, as well as pure investment companies -- but including these companies would have made the results reported here look better.) Investors who put $1000 into each of these 16 companies at listing would have just about broken even by the end of the financial year -- the $16,000 invested during the year would have purchased a portfolio worth $15,027 at year's end.

The leaders on 1 July 2004 were Tissue Therapies (up from 50 cents to 87 cents) and Biosignal (20 cents to 28 cents), while Cogstate (50 cents to 25) and Rockeby Biomed (20 cents to 10) brought up the rear.

Over the entire six-year period between July 1, 1998 and June 30, 2004, an investor putting $1000 into each core biotech float as it came along would have spent $39,000 to buy a portfolio valued at $69,895 at the end of the financial year -- an overall increase of 80 per cent. Over the same six-year period, the S&P/ASX 200 index rose by a comparatively modest 31 per cent, while the S&P/ASX 'small ordinaries' index rose just 14 per cent.

Beneath the veneer

These gains, of course, were achieved in the face of risk well above that of the S&P/ASX 200. A more relevant comparison might be between the biotech floats and the other floats on the ASX during the same period. As the tables and chart below suggest, in this comparison the biotechs do not shine quite as brightly.

An investor who placed an equal amount into each and every ASX float, regardless of industry, as it occurred during the most recent financial year would have held by July 1, 2004 a share portfolio worth about 21 per cent more than the initial investment. Over that same financial year, the S&P/ASX 200 index rose by 16 per cent, and the 'small ordinaries' index by 21 per cent. All of these investments would have handily outdone the negative 6 per cent return achieved from an investment in biotechnology floats alone. At least over the 2003-04 financial year, investing in biotechnology IPOs was not a winning strategy.

Looking at an earlier IPO cohort -- all of the companies that went public in the 2000-01 financial year -- shows that investing in each of the IPOs would have yielded by July 1, 2004 a portfolio worth about 50 per cent more than the original investment. Investing just in the biotechs that listed during that financial year would have led to a gain of nearly 100 per cent, based largely on an almost tenfold increase in Cellestis and doublings or more in Sirtex and Epitan. The share prices of the remainder of the biotechs that listed during the 2000-01 financial year have fallen, sometimes dramatically, since their initial listing.

Whether the biotechs listed in 2003-04 will resemble the 2000-01 cohort in three years' time remains, of course, a speculative question, albeit one of significant importance to those who hold investments in the newly-listed companies. What the analysis does indicate is the continued validity of two important points. First, all investments in biotechnology are long-term, not short-term. A 'buy and hold' strategy has worked very well over a six-year period, but would have produced poor returns over the most recent single financial year. Second, the shortage of traditional venture capital funding for Australian biotechnology companies has made a listing on the Australian Stock Exchange a source of early-stage capital. Returns on investments in these listings thus resemble typical venture capital returns -- a very few big winners, a few reasonable earners, and a large number of washouts.

Biotechnology investors would be wise to hedge their bets by selecting a portfolio of companies, acknowledging the scientific, marketplace, and financial uncertainties that face these young companies.

Michael Vitale is a professor at the Australian Graduate School of Management, and can be contacted at michaelv@agsm.edu.au. He will be a speaker at a Southern Cross Equities biotech conference scheduled for September this year.