Is The Biotechnology Bubble Turning Into Mania?

 Disclosure: I own shares of AMGN

For more than three years, the big run in a number of small biotechnology stocks that have little or no revenues had all the elements of a bubble.

Now, there are signs that the bubble may be turning into mania, and will eventually burst.

Every stock market bubble is different, and can be easily confused with healthy bull markets. But all stock market bubbles follow a certain profile. First comes ‘investor hype’ over a popular theme -- an emerging industry that promises to change the world and bring big returns to those who invest in it.

Somewhere down the road come ‘the role models’—companies that made it big carrying this theme—turning investor hype into contagion.

Then comes easy money by accommodative central banks to provide ‘the “air’ -- financing for the bubble to grow bigger and bigger. Flurries of IPOs that double, triple, or quadruple the day they make their market debut -- and sky-high M&A premiums -- turn investor hype into mania.

Investing in this theme reaches a cascade, as no investor wants to be left behind.

Finally, the bubble soon bursts, as early investors have already cashed out, and there are no more investors to join the party.

Apparently, the ongoing run up in biotechnology has all these elements.

Investors are excited about the big promise which the field proffers – that it can cure the ills of humanity.  An aging baby-boomer generation and universal healthcare coverage make it easier for biotechnology companies to monetize this promise.

The trouble is, however, that many biotechnology companies that command a market valuation of several billions of dollars have little or no product revenues.

Puma Biotechnology , for instance, has a market capitalization north of $7 billion, though it has no revenue.

Intercept Pharmaceuticals has a Market Cap to revenue ratio of 372.41. Isis Pharmaceuticals and Pharmacyclics have somewhat better ratios.

*To be acquired by AbbVie

Source: Finance.yahoo.com

Then comes a host of biotechnology companies that also command a multibillion dollar market valuation -- but derive a lot of their revenue and profit from blockbuster products that sell for tens of thousands of dollars per treatment (e.g., Gilead Sciences, Regeneron Pharmaceuticals, and Amgen).

Gilead Science, for instance, is currently trading at a forward PE of 9.67, and has close to $25 billion in revenues.

Apparently, when investors buy shares of Puma Biotechnology and Intercept Pharmaceuticals they are betting on the next Gilead Science or Amgen.

That’s how biotechnology investing has turned into a hot theme in the mass and social media.

Source: Finance.yahoo.com

Adding to the hype are two more factors: an ultra-low interest rate environment (which has lowered the cost of holding all these triple-digit trading biotechnology stocks) and astronomically high M&A premiums.

Considering all these factors, the biotechnology bubble may soon turn into mania, as a critical mass of investors rush to buy “hot” biotechnology stocks for the promise they hold -- rather than for the fundamentals they display.

Those of us who have been around Wall Street long enough know all too well that, when money becomes tight and investment promises aren’t fulfilled, bubbles and manias end.