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BIOTECH STOCKS BOOM IN 1986: MARKET EXPRESSES RENEWED CONFIDENCE IN DNA INDUSTRY WITH STOCK GAINS FOR EIGHT FIRMS OF MORE THAN 100%, CETUS LEADS

Executive Summary

Wall Street's expressed renewed faith in the emerging biotech industry by running up the market valuation of eight biotech stocks by over 100% during 1985. Led by Cetus' 200%-plus price gain (up 17-3/4 to 26-1/2), five of the nine biotech stocks listed on the "F-D-C" Monthly Index of O-T-C stocks doubled their value in 1985. Just behind Cetus were Biogen (up 165.9% on a 17-3/4 point gain to 26-1/2), Teva (up 154.5% on 2-1/8 advance to 3-1/2), Immunex (up 122% to 13-7/8 on a 7-5/8 jump) and Genentech (up 35-1/2 to 69-3/4). In addition, Hybritech (up 14-1/2 to 31) came close to giving investors a 100% return in 1985 via the firm's announced plans to merge with Lilly. Given a lift by the biotech stock performances, the "F-D-C" O-T-C Monthly Index Composite of 38 drug, diversified and distribution stocks closed the year at its highest point since "The Pink Sheet" began to follow O-T-C stocks in 1970. The "F-D-C" O-T-C Composite's 56% gain in 1985 easily surpassed the bull market performances of the S&P 400 (up 25.9%) and the Dow Industrials (up 27.7%). While the biotech stocks posted the most spectacular gains in 1985, the bull market had a broad impact on the O-T-C index stocks, boosting all four industry components of the index to all-time high marks during the course of the year. Overall, advancing issues outnumbered declines for the year by more than four-to-one as 31 index stocks finished on the plus-side and seven stocks lost ground. Lilly And Bristol Pay Big Prices, Growth Hormone Reaches Market, And Interleukin-2 Draws Publicity Three events in the second half of 1985 combined to accelerate first half gains by biotech stocks and re-focus "Street" attention on the group as viable growth stocks. In late September, Lilly announced that it had reached an agreement-in-principle to acquire Hybritech, marking the first consolidation move in the nascent industry. Merger activity further intensified when, a month later, Genetic Systems agreed to merge with Bristol-Myers. Further consolidation in the biotech industry, however, may be discouraged by the web of development, licensing and equity arrangements entangling most research-stage biotech firms, and the potentially prohibitive cost of acquiring a biotech firm. Lilly's $375 mil. sweetened offer for Hybritech and Bristol-Myers' $300 mil. purchase price for Genetic Systems have set the benchmark prices for future acquisitions. In October, Genentech received FDA approval to market its recombinant human growth hormone Protropin, which became the first recombinant therapeutic agent to be developed, manufactured and marketed by a start-up biotech firm. Genentech's second recombinant product to reach the market after human insulin (marketed by Lilly), Protropin is being detailed to hospitals by Genentech's 15-20 person sales force. By lending credence to the commercial potential of the biotech industry, the Protropin launch gave a big boost to Genentech stock (up 20 points in October and November to 65) and carried over to the other biotech stocks. And finally, in early December, a Natl. Cancer Institute study of interleukin-2 in a variety of cancers reported in the New England Journal of Medicine gave the "Street" the "breakthrough" that investors have been betting on since biotech firms first started going public in 1980. Cetus, the supplier of the recombinant interleukin-2 to the NCI research team, received wide exposure in a Fortune magazine article, headlined "Cancer Breakthrough" that publicized the results of the study in late November. Cetus jumped 11-1/4 points (up 74%) during the last two months of the year. Among the leaders on the high tech end of drug research, Cetus is also looking to build its drug business in the generic business via a joint venture agreement in September with Ben Venue Labs to develop and market generic anticancer agents. In Cetus' quarterly report for the period ended Sept. 30, the firm said that the joint venture has already submitted two ANDAs and expects to market its first product by this summer. Wide press coverage of the NCI study results gave a quick boost to other biotech firms developing an interleukin-2 product. Immunex, which has licensed its interleukin-2 to Roche, reaped the biggest gain from the attention. During the last two months of the year, Immunex jumped 7-7/8 points (130%) to 13-7/8. Collaborative Research, which is developing natural interleukin-2, moved up 18% in December on a 3/4 point gain to 4-3/4. AIDS Research And Kodak Investments Help R&D Stocks In 1985; Generics Repeat As Winners Although not in the interleukin race, Genentech also received a boost from good news coming out of the clinic. Early reports of recombinant tissue plasminogen activator efficacy as a thrombolytic agent contributed to the stock's 17 point gain in the first couple months of 1985. Equity sales to Boehringer Ingelheim and to the public, as well as the completion of an R&D partnership offering, helped raise approximately $140 mil. during the first half of the year to maintain Genentech's R&D momentum. The firm's longer term development projects include tumor necrosis factor, which entered the clinic in September, and a recombinant hepatitis vaccine moving into Phase II/III. Biogen picked up momentum in October when the company's year-long interregnum following the resignation of former CEO Walter Gilbert came to an end with the accession of James Vincent to the top spot at the firm. Another developer of recombinant interleukin-2, Biogen also moved on the NCI study report. During the last three months of 1985, Biogen vaulted 65% on a 5-3/4 point move to 14-5/8. Biogen began 1986 on an upbeat. Its alpha-interferon was reported showing good results in Schering's testing versus the common cold. Start-up R&D firms not involved in biotechnology also had good news for the "Street." After 15 years in development, Viratek's Virazole (ribavirin) received approval from FDA for respiratory syncytial virus (RSV) at the end of 1985. A published report of Virazole studies for RSV in the Journal of the American Medical Assn. in early December helped lift Viratek 2-1/2 points in December to close the year at 21-1/2, just a half-point off the stock's high point of 22. The AIDS therapy search and Kodak investing also focused the market's attention on R&D firms in 1985. In early October, Kodak, which has an equity position in Viratek, agreed to sponsor Virazole clinical trials in AIDS. And earlier in the year, FDA announced that it would make Newport Pharmaceutical's antiviral isoprinosine available to AIDS patients under a compassionate IND. Newport reported to FDA in August that early study results indicated that isoprinosine might have some efficacy in delaying the progression of AIDS. The firm said at that time that it hoped to file an NDA for an AIDS indication by the end of 1985. The revival of investor interest in the biotech and R&D firms was just part of the story in the record breaking 78% move by the Pharmaceutical Component. Also fueling the Component were the generic issues, which performed nearly as well in 1985 as they did in 1984, despite increasing Wall Street concern that the stocks were being overbid. Strong sales and earnings growth among the generic firms was complemented by key approvals for generic forms of major post-1962 drugs, including Ayerst's Inderal (propranolol) and Ativan (flurazepam) and Roche's Valium (diazepam). Zenith (up 13 to 24-3/4) and Mylan (up 5-1/2 to 18-1/8) were two of the three firms to receive the initial FDA approvals to market generic Valium on Sept. 4 (Lederle was the third firm). Mylan also received ANDA approvals for propranolol and flurazepam during the year, and turned in outstanding sales and earnings results through the year. The firm's most recent quarterly report for the period ended Sept. 30 showed sales up 86% and net earnings climbing 155%. Most of the generic company's growth, however, is coming from its branded triamterene/hydrochlorothiazide, Maxzide. Marketed by Lederle, the Dyazide competitor contributed 35% of Mylan's total fiscal 1985 sales of approximately $53 mil. Mylan's fiscal 1986 sales, if growth continues at its current rate, could top $80 mil. LyphoMed Leads Generic Stocks With 96% Stock Gain; Glaxo Puts Back-To-Back Big Years Zenith's performance in 1985 was a barometer of the generic industry as a whole. The stock advanced strongly during the first six months, continuing the rapid pace established in 1984 with the evolution and final passage of the ANDA/patent restoration bill. By the end of April, the company's market valuation had doubled, and in May the stock took a 9-3/4 point jump for an additional 30% increase. A big correction came at the end of the summer -- ironically at the same time the company received its diazepam approval -- when the issue plunged almost seven points in September. Propelled by strong third quarter sales and earnings reports, however, the company made up the loss in two months, and finished the year with a 90.4% increase. LyphoMed (up 8-7/8 to 18-1/2) led the generic stocks with a 96% advance in 1985. The company roughly doubled its sales volume with the purchase of Invenex Labs and the Bristoject product line from Bristol Labs during the summer, using a 1.5 mil. share public offering to cover the cost of the acquisitions. Partner Fujisawa purchased an additional 500,000 shares in a private transaction to maintain its 26.5% interest in the company. The "Street" also took a positive view of LyphoMed's three-year $40 mil. agreement with Voluntary Hospitals of America, announced in November. For the second year in a row, Glaxo was among the top performers on the O-T-C Index. The value of Glaxo American Depositary Receipts nearly doubled in 1985 (up 9-1/2 to 22-1/8), fueled by the continued growth of the firm's Zantac franchise in the U.S. and the company's fourth major drug approval in three years. Zantac sales in FY 1985 (ended June 30) were up 87% to $250 mil. in the U.S. During the summer, Glaxo launched its new injectable antibiotic Fortaz (ceftazidime) -- the latest in a string of new Rx products introduced by the British firm to the U.S. market in recent years that also includes Zantac and Zinacef in 1983, and Trandate in 1984. Glaxo also curried "Street" favor in 1985 by selling off its less profitable Vestric whsle. business in the U.K. Despite a price run-up of 120% in the last two years, Glaxo finished 1985 carrying the ValueLine investment service's top timelines rating. Glaxo's U.K. compatriot on the O-T-C Index, Beecham, did not fare as well given the bullish climate in the U.S. in 1985, advancing 14% on a 5/8 gain to 5-1/8. The British firm took steps to improve its U.S. consumer products position during the year by outbidding American Home Products for Revlon's Norcliff Thayer div. Beecham paid $360 mil. for Norcliff Thayer. Contract mfrs. K-V (up 89.2% on a 4-1/8 point gain to 8-3/4) and Paco (up 37.7% on a 5 point gain to 18-1/4) each benefitted from corporate strategies that will take the two firms into R&D, licensing, and marketing activities. In December, K-V announced an agreement with an undisclosed Japanese firm to develop an anti-inflammatory in its KV/24 sustained release technology. And Paco said in its recent annual report that it expects its ophthalmic R&D to begin to generate new products in the current fiscal year ending in August. The Wholesaler Component rebounded strongly in 1985 with a 31% surge after posting a modest 5.3% advance in 1984 and a decline of 12.3% in 1983. Over the last eight years, the wholesalers have turned in an outstanding market performance, advancing at an average annual rate of nearly 40%. For five years, between 1978 and 1982, the Wholesaler Component led all other Index groups. In general, the wholesaler issues have benefitted from the industry-wide consolidation now occurring, and increased hospital business stemming from the cost-pressures associated with the DRG environment. The rapid pace of consolidation in the drug whsle. area, led by aggressive and growing FoxMeyer, and the two drug whsle. giants, McKesson and Bergen-Brunswig, has put a premium on the handful of publicly traded regional whslrs. Merger rumors in June involving Northeast-based whslr. Ketchum (up 5 to 15-1/4) led to a public denial by the company that it was in negotiations. Owens Minor's Valuation Increases From $31 Mil. To $69 Mil. The Whslr. Component's big winner in 1985 was Owens Minor, up 118%. The only loser on the Component was Bindley Western. Richmond-based Owens Minor benefitted from strong operating results. For the first three quarters of 1985, the firm reported a 25.1% jump in net earnings over the previous year on a 21% volume increase. The regional whslr. also holds a strategic position in the consolidation trend. With its drug business's strong local base in North Carolina and Virginia, expanding medical/surgical business throughout the southeast, and a blossoming drug packaging business through its Vanguard subsidiary, Owens Minor has a valuable distribution mix. Bindley Western's stock price began to lose ground toward the end of the summer after company executives and documents were subpoenaed in connection with a federal drug diversion investigation. Eventually three one-time Bindley executives, including a former president, pleaded guilty for their roles in an illegal diversion scheme. Predictably, the market reacted negatively to the federal investigation, despite Bindley's solid sales and earnings growth during the year. The stock, which had traded as high as 15-1/2 during the year, dipped below the $10 a share price range at roughly the same time the wholesaler reported a nearly 14% net earnings increase for the first nine months of 1985. Bindley Western may be one of the market's best values going into 1986. Two wholesalers, Alco Health Services and Moore Medical, appeared on the "F-D-C" O-T-C Index for the first time in 1985. Also Health, spun-off from Alco Standard in an inaugural offering last summer, acquired Ohio-based Meyer and Southeastern Wholesalers of Valdosta, Georgia during 1985. In September, Also Health reported strong fourth quarter sales and earnings, helping it close out 1985 trading near its yearly high. Moore Medical, formerly Optel, had a strong fourth quarter, jumping 5-1/8 points (30%) to close at 22-1/8. The Chain Component's 23.1% advance was heavily skewed by Medicine Shoppe (up 5 to 24), which moved up 26.3%. The only othr chain, Begley (up 3/4 to 16-1/4), showed a more modest 4.8% gain. The other drug chain on the "F-D-C" O-T-C Index at the beginning of the year, Hook Drugs, was delisted following its acquisition by the Kroger supermarket chain in February for approximately $160 mil. Rite Aid initiated the courtship for Hook in January with a $31 a share offer for the 300-store Indiana-based chain, which was over 17 times earnings and represented a near 40% premium on the stock's going rate. Hook rejected the initial offer as well as a sweetened $36.50 as share bid in favor of "white knight" Kroger's $37 a share offer, which was over 20 times earnings for the most recent 12 months. Charts omitted.

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