Take Lipitor – the world’s best-selling cholesterol drug – for example. Each $3 Lipitor pill only costs Pfizer about $0.25 to make. So the company collects 90% profit margins.

One way the drug industry has learned to reap those outsized rewards with less risk is through “me-too” drugs. Me-too drugs are essentially copycats – like generics but with fat margins.

For example, after Pfizer’s (PFE) Viagra wowed the market, Eli Lilly (LLY) and Bayer jumped into the fray. Now the market has three drugs – Viagra, Cialis, and Levitra – to treat the same condition. Viagra and Cialis fetch more than $1 billion per year. Levitra, the laggard, still generated $500 million in 2007 sales.

But the me-too well is running dry. These days, the FDA won’t approve new drugs unless they offer a clear advantage over what’s already on the market. Recently, me-too drugs vying to compete with Merck’s Januvia (a diabetes drug) and Gardasil (a cervical cancer vaccine) faced serious setbacks. Neither drug satisfied the FDA’s higher standards.

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Now a new class of drugmakers is taking a slightly different tack: They pick existing drugs and make them better. So a company might make a drug available as a pill rather than an injection. Or it might change a three-pill daily regimen into a once-a-day routine.

These so-called “specialty pharma” companies start with what works and go from there. With thousands of drugs on the market, specialty pharmas have no shortage of lucrative products to choose from. Here’s an example of how it works

Until recently, many schizophrenics had to struggle with a complex dosing routine that included capsules of Risperdal (a popular treatment option). So Alkermes (ALKS), one of the biggest specialty pharma outfits, collaborated with Johnson & Johnson, Risperdal’s maker, to create Risperdal Consta.

The new version is a bimonthly injection, and it generates more than $1.2 billion in revenue a year. Besides Alkermes, investors can choose from a handful of pure-play specialty pharma outfits

Specialty pharmas boast profit margins almost as big as the brand-name drug business 70% or higher. And by modifying drugs the FDA has already cleared, they take on much less risk.

Recently, the industry has far outperformed the general market These five stocks are up 3.5% over the last three months, while the S&P is down 8%. I’ve been busy digging through the short list in search of the best company. If you are looking for a low-risk way to get in on the lucrative drug business, this is a great place to start.

Good investing,

George Huang, editor, S&A FDA Report

Source: Where to Earn Monopoly Profits, Minus the Risk

How to Short Sell a Biotech

Dr. George Huang

“I believe the investors who bought the stock near $2 yesterday just fed quarters to the slot machine...”These were my words of warning to S&A FDA Report subscribers back in early May. The company in question is Discovery Labs (DSCO), an incompetent biotech trying to win approval for its lead drug Surfaxin.

Investors crush biotech stocks when FDA decisions don’t go their way. Our FDA Report strategy is to take advantage of the market’s harsh reactions by picking up good companies on the cheap. Trading biotechs during such turbulent times can be very lucrative, if you know what you’re doing…

When we looked back at the last seven years, we found high-quality biotechs can generate one-year average returns of 75% after a negative FDA decision. Of course, low-quality companies usually only have farther to fall…

At the end of April, the FDA rejected Discovery Lab’s Surfaxin for the third time in as many years – setting the drug’s hope for approval back several months. The company’s stock fell 50% that day.

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Like many FDA Report subscribers, I was itching for a juicy trade. And on May 5, Discovery said it wouldn’t need to conduct any more clinical trials. It claimed that after resolving minor manufacturing issues, final approval would come in September.

But I knew more trouble would come. You see, the company didn’t have any of the qualities we look for in a good biotech trade: a low price, a promising pipeline, an easy answer for the FDA, and good management…

At about $200 million in market cap, and about $50 million in cash, the company was not cheap. I knew Discovery would need another round of financing before it recorded any revenue from Surfaxin, which is the only substantial drug in its pipeline.

Given its clinical data portfolio, Surfaxin – which treats respiratory distress syndrome in premature infants – unquestionably works. The problem is, Discovery can’t manufacture the drug to the FDA’s liking. All three rejections focus on the company’s inability to meet FDA manufacturing standards.

And after three rejections, and promises of quick approvals each time, I don’t trust Discovery’s management one bit.

You would think after the third setback, the market would be thinking the same thing. It wasn’t. Gullible investors flocked back and drove the stock up 30%.

Then sure enough, last week, the other shoe dropped. After speaking with the FDA, Discovery learned it wouldn’t even be able to submit its response until September, let alone have the drug approved as it originally announced.

Investors who were tempted into buying the stock after the setback are already down about 15%. But I believe more pain is in store for Discovery shareholders…

Surfaxin may or may not get approval by December. But in this difficult market, an approval will likely meet with a yawn. Any setback, on the other hand, will no doubt lead to another massive drop. The downside risk is way too high. Any hint of another hiccup, and Discovery will find its shares cut in half.

When we pick up bruised biotechs, we only buy if we see four things: a good price, quality managers, plenty of drugs in development, and an easy resolution to the FDA’s concerns. With Discovery, we found just the opposite…

The company has questionable management, shaky finances, and no drug pipeline. Throw in a picky FDA unlikely to accept whatever Discovery has to offer, and you have the perfect recipe for another share-price meltdown.

Good investing,

George

Source: How to Short Sell a Biotech

That $900 million prize pool might sound like a lot. But as a whole, ticket buyers are basically trading in dollar bills to get $0.60 back. That doesn’t sound like a good trade to me. And when you throw in the odds of any particular individual winning – from 1 in 9 on the best scratch-offs to 1 in 175 million on the Mega Millions – the prospect looks even worse.

To consistently make money, the key is to risk capital only when the odds and payouts properly compensate you for the risk you take. The risk of losing your money on the lottery is so great, even huge jackpots don’t adequately compensate you.

Don’t think just because you don’t play the lottery you aren’t taking on those odds… Right now, buying into one industry is like putting your retirement on the Mega Millions…

As my colleague Rob Fannon has mentioned, the world’s largest drugmakers are about to lose billions in sales as their big-name drugs go off patent. So now, instead of streamlining their own research operations and rebuilding their pipelines, Big Pharma is buying up “lottery tickets,” hoping for a quick fix.

Let me show you what I mean…

Last week, Lundbeck, a large Danish drug company specializing in brain diseases, bought a $100 million lottery ticket from U.S. biotech Myriad Genetics. The name on that ticket is Flurizan, Myriad’s Alzheimer’s drug.

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Lundbeck agreed to pay Myriad $100 million upfront, $250 million in milestone payments, and 20%-30% royalties for the European rights to sell Flurizan. That’s nearly twice what any other pharmaceutical company has paid for worldwide rights on a similar drug.

Flurizan isn’t even approved for commercial sale. In fact, so far the drug has practically failed its clinical trials…

In a Phase II trial of approximately 200 Alzheimer’s patients, Flurizan was marginally better than the sugar pills used as a control. But Myriad sliced and diced the data and found in mild Alzheimer’s patients, Flurizan outperformed the placebo. Scientifically speaking, this interpretation is hogwash.

But it was enough to prompt Myriad to go straight into two large Phase III trials. The data from one of those trials is due.

Essentially, Lundbeck gave Myriad $100 million on the off chance the Phase III trials turn out to be positive next month.

Lundbeck’s shareholders should be outraged. My calculations show the Flurizan trial has less than a 30% chance of success… 50% if you want to be very generous. On top of that, for the bet to pay off for Lundbeck (after subtracting expenses and more payments to Myriad), Flurizan needs to generate more than $1 billion in sales. That’s unlikely considering the marginal benefits Flurizan has showed so far.

Judging from those odds, Lundbeck is likely out its $100 million.

Lundbeck isn’t alone. As Rob explained, just about every Big Pharma company is willing to throw millions around, buying rights to drugs with slim chances for success and hoping to hit the billion-dollar jackpot. But if you’ve ever bought a lottery ticket, you know how this story ends…

Some of these biotech “lottery tickets” will turn out to be winners, but most of them will turn out to be foolish bets by desperate players. If you’re investing in Pfizer, GlaxoSmithKline, Merck, AstraZeneca, or their peers, you should know they’re playing the lottery with your money, taking on way too much risk for the potential reward.

But there is an upside… Maryland lottery retailers, remember, made $110 million taking on absolutely no risk. Even when Flurizan fails, Myriad Genetics has a healthy diagnostics business it can fall back on… plus Lundbeck’s $100 million in the bank.

So my advice is to buy the lottery ticket retailers – biotech companies with drugs in late-stage trials. They make money no matter the odds on the tickets… And judging by the Myriad deal, ticket prices just went up.

Good investing,

George Huang

P.S. Myriad shareholders have made about 40% from the stock’s lows this year, so it’s too late for us to profit on Lundbeck’s spendthrift ways.

But I just told readers of my S&A FDA Report about one tiny company holding two $50 million “lottery tickets.” I expect a buyer the next 12 months. Click here to read more.

Source: The $100 Million Lottery Ticket

The Takeda-Millennium deal comes on the heels of another Japanese biotech buyout at the end of last year. Japan’s fourth-largest drug company – Eisai – picked up U.S.-based MGI Pharma for 10 times sales. Apparently, MGI had multiple suitors. It’s safe to assume that Eisai was willing to cough up enough cash to win out.

Both the Millennium and MGI Pharma buyouts highlight the point my colleague Rob Fannon and I have been making repeatedly: Biotech investors are right where they want to be because large drug companies are desperate to acquire biotech assets.

These companies face no other choice with expiring patents, empty pipelines, and tons of cash. The massive premiums on these two Japanese deals prove that certain companies are willing to pay any price to get their hands on biotech drugs.

Heck, there’s even consolidation within the biopharma space. New Jersey-based Celgene, a leading cancer biotech company, acquired fellow biotech Pharmion last November for $3 billion, a 46% premium.So what does it mean for investors? The pool of midsized to large biotech companies with real revenues is rapidly shrinking. With so many mid-cap biotech companies being bought out, even the Wall Street Journal speculates this particular biotech segment may be a lucrative oasis during volatile times.

Here’s how you can get in ahead of the windfall: Search for biotechs with existing or near-term product revenue, a rich pipeline, and an experienced management team. I prefer companies with revenue of at least $200 million or companies with potential blockbusters (sales of $1 billion or more) in Phase III testing. The pipeline should hold at least two drugs in early stage clinical trials. Lastly, management should have experience developing and selling drugs, with emphasis on their track record in dealings with the FDA.

Right now, many biotech companies with market caps between $1 billion and $5 billion fit the description. Start your search there.

Good investing,

George Huang

P.S. I’ve developed a proprietary trading strategy to identify the best biotech acquisition targets with limited to no downside risk. We’ll get to participate in this latest wave of merger mania no matter where the money is coming from.

But the real beauty of this trading strategy is that we won’t have to wait for a large buyout to take place. My approach offers several different exit scenarios, which should net us about 75% a year. Click here to read more.

In the case of Neurocrine’s insomnia drug, Indiplon, the FDA wanted additional animal studies, plus two more clinical trials, which would have cost the company as much as $50 million. To be honest, the new requests were preposterous. But this isn’t the first time the FDA has moved back the goalposts on a drugmaker…

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Back in May 2006, Neurocrine received its first approvable letter for Indiplon, prompting its Big Pharma partner, Pfizer, to cut ties. The stock dropped from $50 per share down to $20. News of the second approvable letter this past December once again sent shareholders running…

In December, I said the FDA would never approve Indiplon. Still, Neurocrine was not worthless. The company had about $4.50 in cash per share, more than 92% of its market cap.

In addition, Neurocrine had a pipeline full of innovative compounds. Its drug for endometriosis (a disease of the uterus) was in Phase IIb clinical trials. And GlaxoSmithKline was collaborating on drugs for anxiety and irritable bowel syndrome, both in Phase IIa testing.

But before I was willing to jump into the stock, two things needed to happen:

1. Neurocrine management had to show some resolve, take Indiplon behind the woodshed, and kill it.

2. The stock needed to get a bit cheaper to provide investors a larger margin of safety.

Both things happened in a hurry…

Long-time CEO Gary Lyons resigned in January – less than a month after sending pink slips to half of the company’s employees. Chief Operating Officer Kevin Gorman took the post and immediately won me over on his first conference call:

“There are no expenditures in our budget for Indiplon going forward…” Indiplon is no longer a threat to the company’s coffers.

The stock popped up in the news, then traded back down to around $4.50 per share – our fair-value estimate – making Neurocrine a true bargain.

One San Francisco-based biotech hedge fund I admire – the Biotech Value Fund – jumped in. The firm scooped up more than 2 million Neurocrine shares during February and March at an average cost of $5 per share.

If you bought in February, when Neurocrine qualified as a “no-brainer” trade, you’re already up about 15%. And I firmly believe that Neurocrine will trade above $8 per share within the next 12 months, a return of roughly 50% on the year.

The Neurocrine story exactly fits the bill for trades I will be featuring in my newsletter, the S&A FDA Report.

Based on our eight-year study, buying the best stocks after they’ve been hit with an FDA setback returns an average of 75% in a year. I’m confident Neurocrine will follow suit.

Good trading,

George Huang, PhD

P.S. If you’d like to learn more about how to find these profitable situations, months before the market reacts, click here.

But on July 1, 2002, the FDA issued told Alkermes it wasn’t ready to approve the drug. The agency wanted some data reanalyzed and repackaged. Investors panicked. Alkermes stock dropped from $16.01 to $5.15 in one day. Shareholders assumed the drug would face a three- to four-year delay.

Wrong.

On April 29, 2003, J&J submitted additional data, and the FDA approved the drug about a year and half later (the drug became a blockbuster in 2007, with more than $1 billion in sales). Alkermes shares soared from roughly $4 to $14 – a 200% gain for investors who bought at the bottom.

The biotech sector sees dozens of similar stories every year…

The stock market is mostly efficient, but occasionally it gets things wrong… and creates a few super-lucrative windows of opportunity. We’ve discovered a way to take advantage of such rare occurrences with biotech companies, specifically in their dealings with the FDA.

Last year, the FDA approved only 19 new-drug applications, down 10% from 2006. The remaining decisions were “negative responses,” which the investing world absolutely hates. In the ensuing frenzy, the market drops stocks 25% on average… without ever bothering to figure out whether they still offer value.

Bottom line is, when the FDA speaks, biotech stocks move, often violently. And I’ve learned that when stock prices react to such announcements, they create enormous opportunities for folks who know what they’re doing…

Here are three ways you can make a fortune from an FDA setback:

1. The “Oops” Factor. Not all drug rejections are created equal. And profits can be made when the market realizes, “Oops, I shouldn’t have unloaded the stock without reading the press release first.”

For example, in June 2006, the FDA told Pozen that it wasn’t ready to approve its migraine drug, Trexima. The stock traded down from $14 to $6 per share. The market wrote off the drug without bothering to find out Pozen’s Big Pharma partner, GlaxoSmithKline, had anticipated the setback and was running additional clinical trials to satisfy the agency’s concerns.

After six months, the market realized its mistake and sent Pozen back to $18 per share – a quick 200% gain.

2. Pipeline Boost. Positive news from a company’s other developmental drugs can get a damaged stock back on the right track. The best example comes from a company called Amylin…

Byetta, the diabetes wonder drug from Amylin, was progressing through early clinical trials when the company received an FDA setback on its lead drug, Symlin. The market was so focused on Symlin’s delay that Byetta was forgotten. But as positive news about Byetta’s progress through clinical trials trickled out in the next 12 months, Amylin shares made 200%-300% gains.

Today, Symlin generates measly sales around $100 million per year… while Byetta is poised to crack $1 billion.

3. Big Pharma Buyout. Faced with dwindling pipelines, expiring patents, and a fickle FDA, desperate Big Pharma companies simply can’t say no to a good, cheap biotech buyout.

At the end of 2006, MGI Pharma received an FDA setback on Saforis, a drug to treat mouth ulcers from chemotherapy. Add on concerns about the stalling growth of its top-selling drug Aloxi at the time, and MGI’s stock was hovering near multiyear lows of three times sales. (Similar companies typically trade at seven to nine times sales.)

In December 2007, Eisai, a Japanese pharmaceutical company, offered to buy MGI Pharma for $41 per share cash, about $3.9 billion. That represented an easy double for traders who got in after the initial setback about one year earlier…

As you can see, investing in biotech is much like investing in the precious metals sector.

It is not for the uninformed… and much of an investor’s success here depends on contacts and sifting through data. (Click here for one resource I use to track what the FDA is doing in the market.)

The hard work can be well worth your time. Many biotechs have the potential to gain not hundreds, but thousands of percent.

Good investing,

George Huang

P.S. I’ve developed a four-pronged strategy to trade on these FDA events. Using this system, you can pinpoint potentially lucrative trades – months in advance. Right now, I’m monitoring a trade I think could generate a minimum of 75% gains in the next year. Click here to find out more.