Investors in the drug development sector have often had to suffer plummeting valuations, with blue-sky proclamations regarding ‘blockbuster’ drugs giving way to the business realities of cash burn rates and licensing deals that never emerged. Although the sector has had its successes, it has earned the reputation of being about as high risk as they come.

So-called ‘big pharma’ companies are desperate to boost their depleted development pipelines. They can do this through licensing deals, which remain the lucrative holy grail for smaller developers, or premium-priced bids for small biotech companies with products that have survived part of the risk-laden journey to regulatory approval. Given their strategic value, is now the opportune moment to pile into shares in smaller drug development companies?

If you think the answer is yes, you need to proceed with caution. ‘Valuations in the sector have been falling,’ concedes Gary Waanders, life sciences analyst at Nomura Code Securities, ‘but you should still pick your stocks on fundamentals. Look for companies that are near to product approvals and launches.’

Needless to say, you must pick companies with sufficient cash to further the development of their drugs, if not as far as commercialisation then at least through sufficient regulatory hurdles so that the product, or the company itself, becomes attractive enough to a larger player.

With pipeline paucity increasingly apparent, Waanders says larger players ‘are looking for earlier-stage deals, and are paying for late-stage products. So you should be looking for companies that have the ability to do good deals on the products that they have in development.’

Trio leads the way

Three larger ventures on the Main Board are Antisoma, Oxford BioMedica and Renovo, where strong price performances have mirrored the subsequent delivery of lucrative deals.

Cash-rich cancer drug developer Antisoma is coming off the back of a breakthrough year in which it licensed its ASA404 drug (and a follow-on compound) to Novartis in a deal worth up to $890 million (£438 million) in potential milestone payments.

Gene therapy counter Oxford BioMedica has landed a lucrative landmark deal with Sanofi-Aventis for cancer vaccine TroVax, while Renovo, a developer of drugs to prevent scarring, recently announced upbeat Phase II results for lead drug Juvista, the worldwide development and commercialisation rights (save for the EU) for which it has licensed to Shire.

Sub-£60 million hopefuls Counters capitalised at less than £60 million offer huge promise. Among them is Minster Pharmaceuticals, a specialist in neurological and psychiatric disorders, which is benefiting from the growing awareness of the prevention of migraines as a preferable alternative to ‘acute’ treatment. Wheels are in motion on Phase II ‘b’ trials for its lead drug, Tonabersat, in the US and chief executive Paul Sharpe reports ‘significant’ levels of interest in it from potential licensing partners.

The company raised £17 million in March to speed the development of Tonabersat and schizophrenia treatment Sabcomeline and, while losses widened to £2.74 million (£1.8 million) in the year to March, the year-end coffers were flush with £16.5 million cash. With Sharpe insisting ‘the business is fully funded until the middle of 2010’, Minster is a star in the making, although liquidity issues and insufficient awareness of its potential have held back the price.

Phoqus, an oral drug delivery specialist quoted on AIM since 2005, offers recovery potential under Dr Richard Mason, a former Cambridge Antibody Technology high-flyer whose services as chief executive were secured earlier this summer.

Finding the funding

The company recently filled its coffers with a £5 million funding to progress its lead drug, Chronocort, which has the potential to treat adrenal insufficiency (failure of the adrenal glands to produce sufficient steroid hormones) as well as congenital adrenal hyperplasia (CAH), a disease of the adrenal cortex caused by a deficiency of the stress hormone cortisol and an excess of androgen. Pivotal third-phase studies for the drug are scheduled for 2008 and upbeat news from those should act as a boon to the depleted shares.

Autism treatment developer Neuropharm, meanwhile, is advancing through collaboration after losing an annual £3.2 million. Floated on AIM in March at 127p, its lead project uses a formulation of the genetic compound fluoxetine and is advancing towards US registration through a series of collaborative deals. Chairman Graeme Hart says Neuropharm is on track to seek approval from the US Food and Drug Authority (FDA) in the fourth quarter of next year for a product launch towards the end of 2009 at the earliest. At 185.5p, the shares have done well and should trade higher, as long as the treatments work out.

Blockbuster potential

Analysts like the look of well-funded ImmuPharma, which claims to be behind drugs with a low risk of development failure and ‘blockbuster’ potential in niche markets. Products are being developed for three different medical conditions including Lupus, a life-threatening auto-immune disease without a cure.

Augmenting the shareholder value potential of the business is the fact that, aside from its leading drug candidates, the company has a drug development pipeline emanating from a ‘virtual chemical library’ of hundreds of thousands of molecules, as well as a technology for converting ‘peptides’ – molecules smaller than proteins – into drug candidates.

This article is from the November 2007 issue of What Investment.