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FOOL PLATE SPECIAL
An Investment Opinion by Alex Schay

Biotech: Caveat Emptor

Investing in the biotechnology industry brings with it a peculiar set of volatile traits. However, as with any volatile investment, the potential pay-off is great enough to continue generating a fresh supply of risk-takers. Perhaps in no other industry can expectations shift so dramatically that an investment can turn from promising to valueless in a day's time. Most biotechs early in their lifecycle are forced to find large, deep-pocketed pharmaceutical benefactors willing to put up large sums of cash at the front-end in order to profit from royalties on products sometime in the future. Similarly, biotechnology firms offer equity to investors in exchange for the "prospect" of future earnings. These companies have tremendous working capital needs during their "developmental phase," and many with 5-year plans only have six months worth of cash to realize those plans, flaming out before they can even bring a product to market. Even "tested" firms are not immune to volatility, evidenced by this morning's $8 13/16 drubbing to $43 5/16 of Centocor Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CNTO)") else Response.Write("(Nasdaq: CNTO)") end if %>, a Malvern, Pennsylvania-based biotech.

The company serves as a prime example of the risks surrounding an investment in biotechnology. This firm overcame great odds to bring its products to market. Centocor went through $400 million in the two years before it became profitable in late 1996. Back in late 1991 and early 1992 the company built manufacturing facilities, hired 500 salespeople, and was hell bent on marketing its products by itself. By the time it became profitable it had total invested capital of approximately $900 million on which it had to start generating returns. And generate returns it has, on a trailing basis the company has seen a 12% return on invested capital, largely on the strength of diagnostic product sales and its drug ReoPro, which is used in the treatment of cardiovascular disease to prevent blood clots. Centocor commenced commercial sales of ReoPro in January 1995 for patients who are at high risk for abrupt artery closure following angioplasty, attaining 80% market share in the high-risk angioplasty segment. By virtually all accounts, the company has been a success. Today, however, the company was cut by Merrill Lynch, which lowered both its near and long-term ratings on shares of Centocor to "accumulate" from "buy."

According to early reports, the company's stock is down over 15% due to "less than blockbuster" results in tests where ReoPro and Genetech <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GNE)") else Response.Write("(NYSE: GNE)") end if %> drug Activase were combined. In addition, the company released the results of a trial of its anti-arthritis drug Avakine that raised concerns about possible "serious side effects" of the drug. Mention "serious side effects" in biotechnology and investors start scrambling for the exits. The most important factor for investors to consider when investing in biotechnology is to keep in mind the realities of the drug discovery and development process. Only 5 out of 5000 compounds that enter pre-clinical testing ever make it to human testing, and only one out the five that do are ever approved by the Food & Drug Administration. The biotechnology industry remains risky primarily because anywhere along the way in the development process products can be waylaid, sidetracked, or otherwise completely scuttled. This year, through the end of June, there have been 10 pivotal trial failures and three successes. Companies make tremendous intraday moves based upon results released during this process, making the proverbial restful night's sleep very difficult. Centocor, one of the brighter stories in biotech, is no exception.

UPS

Integrated telecommunications company MCI Communications Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> gained $4 3/4 to $41 5/8 after agreeing, with the blessing of 20% owner British Telecom <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTY)") else Response.Write("(NYSE: BTY)") end if %>, to merge with WorldCom Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %>. WorldCom raised its $41.50 per share stock swap offer to $51 per share. BT will receive breakup fees worth nearly half a billion dollars as well as a nice gain on the MCI shares it holds. WorldCom slid $1 3/4 to $31 3/8 as arbitrageurs moved to short its stock to finance the purchase of MCI stock.).

Group 1 Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GSOF)") else Response.Write("(Nasdaq: GSOF)") end if %>, a provider of software to the direct marketing industry, gained $1 1/2 to $8 1/2 after reporting on Friday morning Q2 earnings per share of $0.14 on revenues of $15.4 million.

Medical laser manufacturer Laser Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LASRF)") else Response.Write("(Nasdaq: LASRF)") end if %> rose $3 7/8 to $27 1/8 after inking a deal to merge with laser maker ESC Medical Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESCMF)") else Response.Write("(Nasdaq: ESCMF)") end if %>. Laser Industries accepted an offer to exchange each of its shares for 0.75 shares of ESC.

Computer touch screen company MicroTouch Solutions <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MTSI)") else Response.Write("(Nasdaq: MTSI)") end if %> regained $1 13/16 to $22 7/16 after last week announcing earnings that fell short of expectations. The company also made a product announcement and a reseller strategy announcement this morning.

Basin Exploration <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BSNX)") else Response.Write("(Nasdaq: BSNX)") end if %> added $1 7/8 to $21 1/2 after picking up in a bankruptcy sale an estimated 30 billion cubic feet (equivalent) of offshore natural gas reserves at a purchase price under $1 per million cubic feet of gas.

Danka Business Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DANKY)") else Response.Write("(Nasdaq: DANKY)") end if %> added $2 5/8 to $38 5/8 after the office imaging equipment distributor signed a strategic alliance with Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> under which Danka will offer the full HP line, but not yet on a worldwide basis. Danka will show HP its stuff only in the U.S. market while worldwide negotiations take place.

Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> gained $1 5/16 to $21 1/16 as expectations are running high for interim CEO Steve Jobs's 2 p.m. EST address to the world on what strategic moves Apple will be making. Apple fans expect that the company's $5,700 PowerBook G3 and its move to kill the cloners will lead Apple back to profitability.

DOWNS

New media marketing company CKS Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CKSG)") else Response.Write("(Nasdaq: CKSG)") end if %> was flattened for a $21 7/8 loss to $14 3/8 after announcing that it expects to report Q4 revenues and EPS well below analysts' estimates. Because of seasonal declines in customer marketing budgets and lower-than-expected development of new business, CKS expects to report Q4 EPS of $0.06 to $0.10, at least 58% below the mean estimate of $0.24.

Medical imaging center management company Medical Resources Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MRII)") else Response.Write("(Nasdaq: MRII)") end if %> fell $2 15/16 to $9 1/16 after pre-announcing Q3 revenues of approximately $60 million, representing sequential growth of about 15%. EPS of $0.16 to $0.19 would be flat to down from last quarter's EPS of $0.19 and below the mean analyst estimate of $0.21. The company's COO and General Counsel also resigned today.

Read-Rite Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %> lost $1 3/4 to $17 1/2 after the manufacturer of disk drive heads and assemblies announced on Friday afternoon that it plans to reduce production of older thin-film inductive heads to speed its transition to magnetoresistive heads, which will result in lower-than-expected earnings and revenues for its first quarter. Competitor Applied Magnetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> also crumpled $2 7/8 to $18 1/2 after being trashed in this weekend's Barron's.

Investors and analysts scurrying to adjust their earnings models on Seagate Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> took that stock price down $1 7/16 to $24 13/16 after an earnings warning on Friday from competitor Western Digital <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %>.

CONFERENCE CALLS

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Randy Befumo (TMF Templr), Fool One
Dale Wettlaufer (TMF Ralegh), Fool Two
Alex Schay (TMF Nexus6), Fool Three
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Brian Bauer (TMF Hoops), Fool Four
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