BUSINESSWEEK ONLINE : JULY 12, 1999 ISSUE
COVER STORY

This Fund Makes Biotech Bets a Bit Less Risky
Franklin Biotech Discovery's favorites are in the black or working on potential breakthroughs

The history of biotech investing has largely been one of high highs and low lows. About 10 years ago, hundreds of startup companies became public. Capital flooded into the sector on the theory that dramatic advances in medical science and blockbuster treatments were just around the corner. But it has taken a lot longer for biotech companies to become profitable than expected. Today, many investors dismiss the sector, pointing out that only a small fraction of the roughly 700 publicly traded biotech companies make money.

Such a broad-brush approach overlooks some important positive trends in the sector, argues Kurt von Emster, portfolio manager of Franklin Biotech Discovery (FBDIX), which is one of the few pure-play biotech funds available. There are now 15 to 20 profitable biotech companies, he says, up from only about eight two years ago. Companies with earnings, such as Amgen (AMGN), Biogen (BGEN), Centocor (CNTO), and Chiron (CHIR), are outperforming the S&P 500. In the next year, five or six more companies should make it into the black, von Emster predicts. "Biotech is finally maturing into an industry with sustainable earnings," he declares.

That may not be true yet for companies that focus on gene therapy . Most of them are where today's biotech success stories were 10 years ago: at a very early stage, where profits are far in the distance. "Gene therapy isn't really ready for prime time," says von Emster. He has a few positions in companies in the sector that are reasonably close to launching a product, but they make up only about 4% of the fund. Among his favorites are Vical (VICL), which he says has made the most progress toward coming to market with a gene-therapy treatment for heart disease, and Transgene (TRGNY), which is working on a system for delivering corrections for faulty genes directly to diseased cells. "Ten years down the road, this is going to be a great area," he says. But for the next five years, "there will be a lot of testing and a lot of talk, but not a lot of market impact."

DARK HORSES. In the meantime, von Emster is dividing his attention between several large, profitable biotech leaders and small, undiscovered companies that are working on potential breakthrough treatments. Recent winners for the fund include QLT Phototherapeutics (QLTI) and Imclone Systems (IMCL), both of which are working on cancer treatments. Other companies von Emster likes with products due out in about a year include Gilead Sciences (GILD), which should have drugs for AIDS, and Aviron (AVIR), which is developing a nasally administered flu vaccine.

For the longer term, von Emster likes Inhale Therapeutic Systems (INHL), which just started trials on an inhaled insulin treatment for diabetics. He expects a product in about two years. Affymetrix (AFFX) is another von Emster pick. "It does for biotech what Intel does for the computer industry," he says. It builds tiny silicon wafers with bits of human DNA that are used by research labs in drug development. Once the whole human genome is mapped and understood, the chips will be used in blood tests to tell individuals if they have the genetic makeup -- and in theory, the propensity -- for certain cancers. "This is a side of biotech that is really on the cutting edge," says von Emster.

Franklin Biotech Discovery's total returns don't look that impressive. The fund was up 11% in 1998 and has gained only 2.5% year-to-date. But it is still a good choice for investors who want a concentrated play in biotech, says Emily Hall, an equity fund analyst with Morningstar. She points out that investors should not compare its returns to those of other health-care funds that hold large-cap pharmaceutical companies, which have outperformed most of the small-cap biotech names. "Biotech is very volatile and when it is out of favor, it can be really out of favor," says Hall. Still, buying Franklin Biotech involves a lot less risk than trying to pick the biotech winners yourself, and von Emster has plenty of experience sorting out the industry.

By Amey Stone in New York

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