Biotechs Struggling To Find A Bottom

The great biotechnology sell-off of 2014 began on Feb. 26 and started as big sell-offs often do: quietly.

The SPDR S&P Biotechnology exchange-traded fund (XBI) peaked at $172.52 and closed at $170.01, off 40 cents from the day before. The next day, the ETF finished at a record close of $170.66 but dropped pretty consistently thereafter. Between Feb. 25 and Monday, the ETF had suffered losses on 20 of 29 days -- and had dropped 22.8% in the process.

It's been a shocking decline but should not have surprised anyone. The ETF had risen 48% in 2012 and added an additional 31% in 2014 before the blow-off erupted.

Since the selling took hold, the slump has battered biotechs of all sizes. Share prices fell steadily through March and into April. It's not clear if the selling is over, although shares of a number of large biotech companies rebounded on Monday, including Gilead Sciences GILD, Celgene Corp. CELG, Biogen Idec BIIB and Regeneron Pharmaceuticals REGN.

One issue that's pressuring the stocks is the big wave of biotech initial public offerings. Some 45% of all IPOs that went to market in the first quarter were biotech companies. Of these, none was actually making money; half had no revenue at all. But, The New York Times noted, the companies were valued at a median of $199 million.

"In social media and biotech, a lot of companies seem to be based on hopes and dreams, not revenue or earnings," Jay Ritter, a University of Florida business professor told The Times.

The calendar of biotech IPOs is still strong, with three set to go to market this week alone. And Yarol Werber, a Citigroup analyst, says 2014 will be the best year for biotech IPOs since 2000.

A second problem is really a PR problem -- but a serious PR problem. It came on March 21 when members of Congress asked Gilead Sciences GILD to explain why it was pricing Sovaldi, its drug for Hepatitis C, at $84,000 for a 12-week course. A number of health insurers, including Medicaid, have balked at the price.

There's nothing wrong with Sovaldi as a drug. It has delivered terrific results in curing patients with the disease. But the prices in the United States have produced extreme sticker shock.

Gilead devised a tiered pricing schedule, based on a country's per capita gross national income. So, it has been selling the drug for as little as $900 in Egypt for a 12-week course. In Germany, the price is $66,000, and it's $57,000 in the United Kingdom.

The stock fell nearly 5% that day, and the selling affected other drug makers as well.

Gilead shares, however, were already falling rapidly. From an intraday peak of $84.88 on Feb. 25, the shares fell as much as 20% through March 28. They've recovered somewhat to $72.23. Gilead has been one of biotech's high fliers: If you'd been smart enough to buy Gilead at the end of 2010, your investment would be up nearly 300% despite the pullback.

A third problem seems to be that a lot of investors know little about biotechs, especially young biotechs, and panic at the first whiff of trouble.

Halozyme Therapeutics HALO is a tiny company working on a drug to fight pancreatic cancer. Last Friday, it halted phase 2 testing of the drug because of possible links to abnormal blood clotting in patients. Its shares fell 27% in response and an additional 2% on Monday to $8.26.

But the shares were already vulnerable. They'd jumped 371% in value between a low of $3.86 in August 2012 and an intraday high of $18.18 on Jan. 24. The decline since Jan. 24 is now more than 54%.

The Halozyme sell-off illustrates something else: why biotech companies go public. They don't sell shares to the public because the owners want to cash out. They sell shares to the public because they need the cash to continue to develop their drugs. And investors have to buy shares knowing it’s quite possible the company won't succeed.

All that said, there's a strong belief on Wall Street and around the world that biotechs aren't about to wilt. The demand for new drugs and therapies is always strong and gets stronger in a recovering economy.

More importantly, many biotechs are founded to start the research and development on a promising idea. Then, they hope that a big pharmaceutical company, like Merck & Co. MRK or Pfizer Inc. PFE will swoop in and buy them out.

It's not that the big pharma companies are predators, however. As Dan Scott, a mergers and acquisitions expert at Credit Suisse in Zurich told CNBC, they just find it easier to buy the growth.