Following The Insiders

Investing in development-stage biotech companies is a lot like playing the lottery. First of all, it's a challenge trying to divine the company's scientific advantage. And even then, investors are left to sweat out clinical-trial results and the long and costly new drug-approval process of the Food & Drug Administration. News — even rumors — send biotech company stocks sinking or soaring. Since developmental-stage biotech companies have no revenue, there is literally no concrete way to value them.

For these reasons, many investors give the sector a miss — or buy sector ETFs to get some biotech exposure. But what if you had some inside information to improve your odds of gauging a biotech's eventual success? You do, quite literally. The insider-trading data filed via Form 4s with the SEC can be a great handicapper when deciding where to place your bets in this tricky sector. After all, if insiders — people intimately involved with the company — are buying, perhaps something good is on the horizon.

Take Halozyme Therapeutics (Amex: HTI). This biotech is trying to commercialize recombinant human enzymes for use in drug delivery, palliative care, oncology and infertility markets. Its primary products are known by the names Hylenex, Enhanze and Chemophase. We'll spare you the details on the science behind it, but we did take notice when a biopharma businessman named Randal Kirk started buying. Kirk, a veteran biopharma entreprenuer and presently CEO of New River Pharmaceuticals, first announced his interest in Halozyme via a Schedule 13G filing in February, 2006, indicating a 9 percent stake in the firm. Kirk then averaged up the price of his stake by purchasing just over $1 million more of Halozyme in the second half of August of last year, at an average price of $2.50.

After a huge spike in December of last year, Halozyme now fetches around $9, giving the company a market cap of $647 million. The stock-price surge began after Halozyme inked a deal with Swiss pharmaceuticals giant Roche Holdings last December, allowing Roche to test its Enhanze Technology as a new delivery regimen for many of its already-established drugs. Another stock-moving announcement came in February, when Baxter Healthcare (Nyse: BAX) increased its commitment to market Halozyme's Hylenex product later this year.

Follow The Leader

Kirk has a deft touch. He made millions when he sold a pharmaceutical distribution company he co-founded in 1998. He later formed New River Pharmaceuticals (Nasdaq: NRPH), whose stock rocketed from less than $4 in late 2004 to $35 by mid-2006. New River Pharmaceuticals is now close to being bought out for over $60.) So if a guy who obviously knows this industry and has a successful track record was pouring money into Halozyme last year, well, then that's a bullish sign. While some execs had started taking profits, Kirk was still buying Halozyme shares in March, 2007 — as was another vice president at the company.

The insider selling is to be expected after the enormous gains Halozyme has enjoyed. The fact that there are still some insider buyers is more telling. After looking into all the partnerships and clinical progress that has prompted these shares to rise so markedly, the stock is still arguably a decent bet. (It's not a sure thing, of course. Although academic studies have backed up the common sense conclusion that significant insider buying at a firm tends to correlate with market-beating returns by a stock in subsequent months, nobody is suggesting that it is the only metric that should be considered when buying a biotech or any other stock.)

Specific risks to consider with Halozyme are that, for all of the validation Halozyme's partnerships have given to its technology, Roche still has yet to determine that Enhanze has enough promise to justify combining it with one of its blockbuster drugs. Likewise, as good as Baxter is as a marketing partner, if sales of Hylenex don't start strongly later this year, investors may sense that the stock got ahead of itself and bail.

The risk of a Baxter relationship not living up to expectations certainly played out for another biotech with recent insider buying. Shares of Cerus (Nasdaq: CERS) hit $70 in mid-2001 as this blood-safety and immunotherapy firm had winning prospects of getting its “Intercept” blood-cleaning system approved in Europe. Baxter was waiting to sell it if and when it did. European and Canadian approval came in 2002. Alas, boffo sales numbers never materialized. The Baxter subsidiary responsible for selling Intercept was never the main focus of this marketing monolith. So even though Intercept was everything to Cerus, it was a minor item on Baxter's sales list.

By 2006, Cerus regained control of its destiny after negotiating back its marketing rights for Intercept. But its shares had already paid the price for the ill-fated affair. Cerus traded for as little as $1.60 in July 2004, and fell below $6 again earlier this year.

Tellingly, two insiders chose to buy over $160,000 worth of Cerus on Feb. 28, at an average price of $5.38. Insider purchases have been a rarity at Cerus, so even though the combined dollar value of the buys is relatively small compared to transactions at other firms, they stood out bullishly against the barren insider-buying history of Cerus.

There are interesting stories behind the remaining development-stage biotechs on the accompanying insider-buying table as well — along with attendant risks. Again, the positive insider signal should not be used as the sole excuse to buy any of these stocks, but it should be good enough reason to put any research time you have into these names versus biotechs without insider support.

And while the inability to measure earnings growth, margin expansion and other reliable financial metrics makes investing in most biotech stocks a bit frustrating on a fundamental level, there is a bright side. Development-stage biotechs aren't vulnerable to movements in energy prices, interest rates, geopolitics or suprime defaults.

INSIDER INTELLIGENCE:

Biotech stocks that have seen insider buying over the last six months.