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Is the Biotech Rally for Real? Don't Hold Your Breath

While companies like Vanda Pharmaceuticals (VNDA) and Human Genome Sciences (HGSI) posted phenomenal gains in 2009, biotech as a whole didn't rally as hard as the broader markets. So is the best is yet to come, or have we not yet endured the worst?biotech forecast
Christopher Raymond, analyst with Robert W. Baird & Co., believes a "broader-based, sustainable biotech rally" is just beginning. In a recent research note, he pointed to positive signs like the explosion in financings and the fact that biotech mutual funds are buying more than they're selling:
Fund flow for 2009 YTD has been significantly negative -- 32 of 49 weeks, in fact -- amid the broader macro recovery. However, the last five weeks of fund flow have been positive, representing inflow of more than $650 million.
Other factors in biotech's favor? Raymond points to compelling valuations, strong fundamentals amid the large-caps -- except Genzyme (GENZ) -- and the hope of healthcare reform resolution.

Yet not everyone is convinced it will be sunshine from here on out.

In fact, almost everyone agrees the wave of biotech bankruptcies that occurred last year is just the tip of the iceberg. Why? As one buy-sider explained, lots of microcap biotechs got pulled up by a retail rally and were able to buy themselves a little time. But many did financings with terms -- like heavy warrant coverage -- that will make future fundraising difficult. So it's do-or-die time for a lot of folks.

Biotechs also have a habit of raising debt and securing it with stock. But when their stock drops, they get sucked into a spiral of issuing new debt to pay off the old. As BioWorld columnist Karl Thiel explains:

Let's just say that a sizeable number of companies have underwater convertibles and, short of a capital-increasing event like commercialization or a partnership or buyout, must count on the capital markets to avoid default.
Time will tell, but the rally and the consolidation may happen in tandem. After all, as Bob More of Frazier Healthcare Ventures told BioWorld Insight: biotech has always been an "exceptions business." The folks that make it are the exception, while the folks that fold are the rule. It takes both sides to tango.

Weather image by WikiCommons user Zeimusu, CC2.0

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