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Why These Risky Biotech Stocks Are Now A Buy...


As the market continues to flirt with all-time highs, a considerable amount of churn is taking place beneath the surface. Investors are increasingly flocking to companies that are seemingly big and safe, while shedding exposure to smaller and riskier names.

It's a logical move, considering the current bull market is getting along in years. Indeed, I extolled the virtues of mega-cap stocks back in August, and you can still find some great bargains among America's largest companies.

Yet if the market is going in this direction, it also means that smaller stocks are falling to levels that hold real appeal. And in no sector is this divergence more apparent than in biotechs. The biggest biotech stocks appear fully priced -- while their smaller brethren are now far from their 52-week highs.

These large biotechs have posted very strong gains over the past few years, and no longer sport the low price-to-earnings (P/E) ratios that they did a few years back. New drug launches are expected to help some of them post solid sales growth in 2013 and 2014, but it's hard to find a combination of impressive growth and in-check valuations in this group.

Of course, smaller biotechs toil in a completely different world. They typically don't have drugs on the market yet, and they represent heightened risk simply because they still have more regulatory hurdles to come with the FDA before they can no longer be called "pre-revenue."

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Yet it's hard not to notice that many of these smaller biotechs were much in favor a few quarters ago and are now deeply out of favor, even though almost nothing has changed in terms of their outlooks.

Take IPO Regulus Therapeutics (Nasdaq: RGLS) as an example. The developer of microRNA-focused drugs went public in the fall of 2012; by this past spring, it was seen as one of the more promising young companies in its field. Partnerships with industry heavyweights such as AstraZeneca (NYSE: AZN), GlaxoSmithKline (NYSE: GSK) and BiogenIdec (Nasdaq: BIIB) holds out the promise of solid royalty streams as Regulus hits various milestones its clinical trials. And a move to bolster the balance sheet in June through a $40 million secondary offering means Regulus has enough cash on hand to last until 2017 anyway. (The company expects that it will have $110 million in the bank at the end of 2013.)

So what's wrong with Regulus? Well, the fact that the company has no drugs in late-stage clinical trials and is instead very active in pre-clinical testing means that investors will have to wait several years for any sort of payoff (unless those major partners decide to deepen their relationships with Regulus, which would be a huge vote of confidence).

The lack of near-term catalysts wasn't a problem for investors earlier this year, but once some investors began to lose interest in this risky asset class, a herd mentality set in. In effect, investors have no desire to be patient if they think other investors won't either.

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Yet you can look at this from a different angle: a company that was valued at $450 million earlier this summer and is now valued at just over $200 million -- and that can be seen as a long-term opening, especially with all that cash in the bank and big biotech partners lined up.

Some other biotech companies that I'm watching:

Threshold Pharmaceuticals (Nasdaq: THLD)
I've written about this cancer fighter on several occasions, most recently in the spring of 2012 when shares were surging.

In fact, shares surged at that point from $3.29 to an eventual $9, but are almost all the way back down to $4.40. Shares were on the mend this summer, rising back to $6, but the small-cap biotech sell-off has pushed shares back down.

As is the case with Regulus, Threshold is unlikely to have a drug on the market in the next 18 to 24 months, which initially was of little concern for investors when the Merck deal was announced. Yet it's notable that the company has stood by the timelines it established for investors back in late 2011 and early 2012 in terms of clinical trial progress.

Stocks like Threshold need catalysts to garner investors' interest, and an upcoming presentation at a medical conference could do the trick.

To me the secondary appeal is that $91 million in in the bank and the quarterly burn rate is $5 million to $6 million. That leaves an ample runaway for Threshold to complete its trial work, and if its TH-302 drug makes it through the trials and gets the green light from the FDA, then Threshold's revenue and profit potential would push this stock sharply higher.


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Synergy Pharma (Nasdaq: SGYP)
Lastly, with around $90 million in the bank, Synergy Pharma is amply funded to complete its current clinical trials. As I explained back in March, this company appears to have an even better drug in its hands than rival Ironwood Pharma (Nasdaq: IRWD). After my profile, shares moved a bit higher, but they've been in freefall ever since. The key culprit: fading investor enthusiasm for any companies that won't generate revenues for at least a few more years.

This recent article on Seeking Alpha neatly summarizes the rise and eventual fall of this stock, and also delves into upcoming catalysts.

Risks to Consider: Investors need to track the quarterly cash burn rates. If they start to rise, then the balance sheets could eventually grow weak. For now, though, that's not a concern for these companies.

Action to Take --> Unless and until these companies announce setbacks in the drug development programs, you shouldn't let the wobbly stock charts deter you. Though the current market environment currently favors large, steady biotechs, the real values are emerging at the smaller end of the spectrum.

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