#$nbi

I am pleased to share, in the article below, some key highlights from detailed analysis on the biotechnology sector by Michael Gregory, CIO and head of Highland Alternative Investors, as well as head of HealthCare Credit and Equity. Mr. Gregory leads a dynamic Highland Capital team that is responsible for $3 billion in healthcare assets under management.

The biotechnology sector has seen soaring returns over the past three years, with the S&P 500 Biotech Index up 183% vs. the S&P 500’s 54%.  Despite this outsized performance, biotech could see growth for years to come.  

The sector has entered a Golden Era of Innovation.  New therapies are giving hope to patients with once fatal illnesses.  Consider recent Hepatitis C treatment advances that can cure up to 90% of those affected. Or major developments in therapies for patients with cystic fibrosis and different forms of cancer. The positive effects of these treatments should be felt for generations to come.  And the companies at the heart of these disease-altering discoveries could continue to generate significant investment returns.

Not all biotech companies will reap the rewards of this Golden Era.  Some may find their old models no longer work. The challenge for investors is to differentiate the winners from the losers. This may mean finding a strategy that goes beyond picking mutual funds or biotech funds.

 Key Factors

 There are three key factors driving the biotech revolution:

·         Science

·         Economics

·         Regulations

The science category comprises the crucial advances that allow disease to be understood and treated – specifically, in recent years, the ability to sequence a patient’s entire genome at a relatively inexpensive cost.  Increased Web connectivity and collaboration also help fuel the pace of new discoveries.

Legislation supporting economic motivators for biotech companies -- such as tax incentives, clinical research subsidies and increased market protection from competition -- has allowed drug development for underserved communities to be a viable model.  

Finally, a favorable regulatory environment has led to a marked increase in FDA approvals.

The last four years have seen, on average, a nearly 40% increase in the num­ber of new drug approvals compared to the previous decade. An increased rate of approval could mean an increase in corporate and institutional capital allocation to the sector. The more transparent the environment, the more favorable for all parties involved – and the more innovation for the industry as a whole.

Biotech stocks are over-valued! Drug prices are not sustainable! Investors won't digest more IPOs! The biotech bubble is about to POP! Nationwide Insurance killed a cute kid during the Super Bowl!!!

You've heard these concerns and more but one month into 2015, investors continue to climb the wall of worry, pushing the major biotech stock indices higher and higher.

Here's where we stand with January trading under our belts.

Biotech stocks are outperforming the broader market by a healthy margin, just like they did in 2014. [If you're wondering, the XBI and NBI were up 15% and 8% in January 2014, respectively.]

Here's a snapshot of what's buzzing in biotech:

1. Gene therapy is super-hot. Spark Therapeutics priced its IPO on Friday at $23 per share, opened at $45 and closed at $50. Spark is developing one-time treatments for genetic diseases. The company's lead program is in a late-stage study for a rare form of blindness. 

Bluebird Bio remains the most talked about and best-performing gene therapy stock (even if the $2.7 billion valuation is cited as evidence of an over-heated biotech sector) but there isn't a laggard in the bunch over the past three months, with the possible exception of Avalanche Biotechnologies. 

Pay close attention to the gene therapy stocks, including newly IPO's Spark, for the rest of 2015. 

2. Hepatitis C drug marketing battle rages on. Abbvie shares were weak Friday on lower-than-expected sales guidance for Viekira Pak. The company said it expects sales of the hepatitis C therapy to achieve an "exit rate" of $3 billion by the end of 2015. Enanta Pharmaceuticals shares fell Friday in sympathy. Enanta receives a royalty from Abbvie based on Viekira Pak sales. 

Gilead Sciences reports fourth quarter and 2014 earnings on Tuesday after the close. 

Here's how the three big Hep C stocks have performed since Abbvie secured Viekira Pak approval on Dec. 19:

3. Big-cap biotech performance: Biogen Idec staged a fourth-quarter earnings relief rally Friday to gain the top spot. Investors had been worried that Biogen's multiple sclerosis pill Tecfidera might under-perform in the fourth quarter, but the company pulled out better-than-expected sales. Celgene, Alexion Pharma and Amgen all reported fourth-quarter earnings and 2015 guidance basically in-line with expectations.

Let's play. 

I published my 2015 biotech stock predictions today, including a couple of M&A gems: Gilead Sciences will buy Bristol-Myers Squibb. Pfizer will acquire Biogen Idec -- and move its corporate headquarters to the center of the biotech universe in Cambridge, Mass! 

If I'm right, you can all buy me a beer. I prefer double IPAs.*

It's really difficult to predict M&A activity but that doesn't stop anyone from trying. As a biotech investor, there's nothing more thrilling than waking up one morning to find a stock in your portfolio has just been acquired for a 50% premium. 

In 2014, the total value of M&A deals in healthcare (public and private companies) reached a record $86 billion. Eighty-nine deals were completed in 2014, the second highest total in the past 15 years, according to figures compiled by BioCentury. 

Will M&A deal flow continue higher in 2015? "Inversion" type acquisitions motivated by the desire to leverage lower tax rates overseas seem to be off the table, but that might lead Big Pharma to look again at buying smaller companies based on science and strong drug pipelines. {Hence, my Pfizer-Biogen prediction.]

Shire has $1.6 billion in cash from Abbvie following the aborted merger last year, leading to much speculation that the company will go on a shopping spree in 2015. NPS Pharma, a potential Shire target, hired Goldman Sachs to help sell the company, the Wall Street Journal reported Monday.

Large-cap biotech companies are sitting on mountains of cash in their balance sheets, which needs to be deployed somehow. Share buybacks are popular in biotech as a means to boost shareholder returns (dividends are not) but I also expect to see a lot of that cash used for M&A deal making. 

On Tuesday, Gilead acquired a liver disease program from a privately held German company. While this deal was relatively small, it does bolster the consensus buyside investor view that Gilead will be an active acquirer of assets in 2015. 

J.P. Morgan offered some thoughts on "hot" therapeutic areas for 2015 M&A activity in its biotech sector outlook reported published yesterday:

"Special Protocol Assessment" is one of those buzzwords biotech investors see and hear about often. Biotech companies love to tout "S-P-As" or "SPAs" in press releases or SEC filings. Listen to conference calls, and you'll often hear investors ask management, "Do you have an SPA for that clinical study?"

So, what's an SPA and why is it important to biotech companies and investors?

Simply stated, a Special Protocol Assessment (SPA) is a written agreement between the FDA and a drug or biotech company covering the design and conduct of phase III clinical trials. FDA agrees to a company's request for an SPA when the design, endpoints and statistical plan for a proposed clinical trial are sufficient to form the basis for an approval filing.

Little known fact: When the FDA and a company reach an agreement on an SPA, they high-five each other, just like you do with your dog.

Biotech companies desire SPAs because it's like getting a Good Housekeeping seal of approval on their phase III trial design.

Investors like SPAs because it reduces (but doesn't eliminate) the risk that clinical trials produce results which don't meet FDA's standards for approval.

A common mistake made by investors is believing an SPA is an infallible, iron-clad contract forcing FDA to approve a drug if the clinical trial yields positive results. Not true. 

A clinical trial with positive results, conducted under an SPA, does not guarantee a drug's approval. The FDA can still reject if it finds problems with the data. In fact, the FDA can even unilaterally rescind an SPA (just ask Amarin.)

On the flip side, positive clinical trials conducting without an SPA can, and do, lead to FDA drug approvals.

Still confused about SPAs? Here's some guidelines to think about when researching biotech and drug stocks:

1. SPAs are most important for clinical trials with uncommon or unique clinical endpoints. If a company says its clinical trial design or endpoints have never been used before, you really want them to have an SPA agreement with the FDA. If company management tells you they don't have an SPA, ask why. If they tell you an SPA isn't necessary, ask why while running away.

2. SPAs are largely unnecessary for clinical trials designed with frequently used endpoints. The best example is a phase III study of an experimental cancer drug using overall survival as the primary endpoint. Survival is the gold standard measure of efficacy in cancer drug trials, so an SPA is superfluous. 

3. A company may not publicly disclose if/when FDA turns down a request for an SPA agreement covering the design and conduct of a clinical trial. It's always best to ask management. Hopefully, they'll tell you the truth.