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INVESTING IN TISSUE ENGINEERING

Everyone knows that biotech stocks can be incredibly risky investments, even though they may prove to be huge winners, say, when a new drug proves effective. And when it comes to buying the stocks of companies involved in one of the hottest biotech frontiers -- tissue engineering -- the risk increases by an order of magnitude. Think bungee jumping or climbing Everest.

Such companies "have one of the highest risks of product failure," says Alexander K. Arrow, a biotech analyst at Wedbush Morgan Securities, who adds that it's rare for tissue-engineering companies to design a treatment that can make it all the way to market without having to be reengineered along the way. Advanced Tissue Sciences (ATIS), for example, crashed from 7 to 3 1/2 after the Food & Drug Administration failed to approve its new living skin product on June 11. It's now at 4, after trading as high as 18 1/2 last September. CytoTherapeutics (CTII), which focuses on diseases of the central nervous system, has also suffered staggering declines this year. It lost nearly a full point when its collaboration with Genentech (GNE) to work on a treatment for Parkinson's disease fell through at the end of May. A point is nothing to sneer at for this stock: It now trades at only 1 3/8 after peaking at 7 5/8 last October.

BIOTECH ODDITY. Still, the potential market for engineered tissues is vast, and several companies are seeing their first successes. "The technology is just now getting to the point where this can become a viable product," says Arrow, who favors the wound-healing group.

Products don't have to make it all the way to market for a stock to spark. Integra LifeSciences (IART) jumped from 7 to 8 1/4 when it announced in June that it will start clinical trials in September for a product that triggers nerve regeneration. When Atrix Laboratories (ATRX) received preliminary approval from the FDA on Apr. 8 for Atridox, its drug that treats peridontal disease, the company's shares rose 1 1/8 to close at 19 7/8.

One of the idiosyncrasies of investing in biotech is that good news, such as FDA approval, is often followed by a decline in the stock as the drug or treatment is held to a higher standard -- and may fail to live up to expectations. Atrix is now trading only at 14 1/2. And Organogenesis (ORG), which makes Apligraf manufactured skin, has seen its share price plummet since it gained marketing approval in the U.S.

'BROAD PIPELINE.' Such setbacks can create buying opportunities, of course. Arrow, for example, rates Advanced Tissue Sciences an "accumulate," in part because of its recent steep decline. "The company lost more than 50% of its value on this delay," he says, "yet it will not be destroyed by this. The company does not deserve to be cut in half."

Pamela Basset, president of BioTrend Corp., which provides industry research and analysis to pharmaceutical and health-care companies, credits Advanced Tissue Sciences with "a very deep and broad pipeline" of new products and a number of patents to protect those products. "They have a broad base of technology that can apply to a lot of categories," she says. Its product for knee cartilage repair is particularly promising.

Arrow also has "accumulate" ratings on Integra Life Sciences and Ortec International (ORTC). Integra already has a skin product on the market that is used mainly for treating severe burns. Compared with other tissue-engineering companies, it is "relatively low risk," Arrow says. He likes Ortec because it has a lower valuation and is working on a skin product that is similar to, and may be slightly better than the one made by Organogenesis. But Ortec's product is at a much earlier stage of development, and therefore the stock is riskier.

As might be expected, analysts are far from unanimous about the prospects for tissue-engineering companies. Techvest's Michael Ehrenreich thinks the potential of the skin group is overrated. He has "sell" ratings on both Organogenesis and Advanced Tissue Sciences. Use of artificial skin for the treatment of chronic ulcers is "at best a marginal therapy with small market potential," he wrote in a recent report. Prospects for engineered cartilage are much more promising, he believes.

Arrow agrees that Organogenesis is overvalued. It would have to sell huge quantities of Apligraf, its manufactured skin approved by the FDA, to justify its valuation, he says. "We predict a steady erosion of share price over the next several months as the reality of Apligraf falls short of its promise," Ehrenreich wrote in mid-June, when the stock had already fallen to the mid-20s from its Apr. 24 high of 37 51/64. It closed on July 15 at 17 1//8. Ehrenreich is so negative on Ortec's prospects that he is shorting the stock.

CADAVER FEARS. Ehrenreich currently favors Creative Biomolecules (CBMI), which he owns in a portfolio his firm manages. He thinks its bone-mending product has commercial potential because it could eliminate the need for the extra surgical step of harvesting bone to be transplanted to another spot in the body. There are currently other bone substitutes derived from cadavers, but they have limited appeal because patients worry that they'll bring disease along with them. Ehrenreich thinks Creative Biomolocules' product could be on the market by late 1999. The stock has declined from a high of 11 5/8 last October to a current 4 5/16, mainly because of a series of delays, which now "are behind them," Ehrenreich feels. He also likes Protein Polymer Technologies (PPTI), which has a product for the treatment of stress incontinence that is moving into clinical trials. While patients may find the use of cadavers distasteful, some companies have developed effective treatments from that source. LifeCell (LIFC) has AlloDerm, a skin-graft product that is used primarily in reconstructive surgery. "To be fair to the companies, patients' fears are unfounded," says Arrow. "But there will always be fears, and that creates a marketing challenge." Gruntal & Co.'s health-care analyst David Saks rates LifeCell a "strong buy." LifeCell closed on July 15 at 5 7/8, down from recent highs around 8.

A way to bet on such advances without taking a flyer on a bioengineering startup is to invest in one of the pharmaceutical companies that has partnered with one of the smaller outfits. Amgen (AMGN), for example, is putting money into Guilford Pharmaceuticals (GLFD), which is working on nerve regeneration. Stryker (SYK) is funding part of Creative Biomolecules's research into bone regeneration. Medtronic (MDT) is paying LifeCell Corp. for research into lab-grown heart valves. Arrow recommends Johnson & Johnson (JNJ) and Tyco International (TYC), both of which have alliances with wound-care companies (although not the ones manufacturing skin).

The tradeoff is this: With large, profitable drug companies, you won't lose half your investment in one day. If, on the other hand, you want to see your investment double or triple, you'll need the heart of a veteran bungee-jumper.

By Amey Stone, associate editor, Business Week Online



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