Waiting on the science

By Roger Armstrong

Friday 1st March 2002

The share market has marked down promising biotech stock Genesis, but a bit of patience could reward investors

Back in 1994 when Genesis was formed, biotechnology and venture capital were as unfamiliar concepts in New Zealand as nouvelle cuisine was in the 60s.

That it was able to get off the ground at the time was a miracle that owes much to the persuasive powers of Genesis chief executive Jim Watson and to the personal backing of two Brierley Investments staffers, John Beattie and Herman Rockefeller, who grafted the necessary money together from friends, family and associates.

Today, Genesis stands as the respected forefather of New Zealand's fledgling biotech industry. The canny management of its meagre money over the years - it prospered on only $18 million of capital in the six years prior to its initial public offering in 2000 - shows Genesis to be an astutely run affair. There are several other pointers suggesting a well-run company: the partnerships it has forged with market-leading New Zealand primary-based firms and overseas biotech concerns, the staff it has attracted and the underlying science it has achieved. It appears to be making all the right moves.

Unfortunately, this has not won it a lot of respect from the New Zealand share market. Punters are obviously more comfortable dealing with utilities or basic manufacturers than companies trying to reshape the world with science. Local investors not only struggle to understand the complexities of biotechnology but also to accept the long lead times and frustrations involved.

Genesis shares, which for many years traded on the informal "grey" market, listed in September 2000 at around $7, but have been scythed down to the $3 level ever since a disappointing trial result early last year. Like most biotech companies, Genesis is showing some volatility in its profit results - the latest figures show a net loss of $9.6 million for the year to December, compared to a profit of $723,000 in 2000 and a prospectus forecast loss of just $9.1 million.

With about $50 million in the bank, compared to its market capitalisation of $80 million, the market is attributing a derisory $30 million value to the company's "science". When it first listed at around $7, the market was effectively valuing the intellectual property at four times that level. Arguably, the market has taken an extreme view thanks to just one trial result. But Genesis has more than one egg in its basket.

Genesis has two arms. The company started off with its major project being the mapping of radiata and eucalyptus genes in a joint venture with Fletcher Forests. It has since undertaken similar plant-based gene mapping with grasses (with Wrightsons), fruit trees (with Hort-Research), the Lactobacillus microbe (with the then Dairy Board) and the botrytis fungus (with Landcare). These have been good projects for Genesis in its early years, with the joint venture partners providing the funding, allowing Genesis to conserve cash while building up its knowledge base.

"Gene mining" in the plant area is still some time off producing any commercial projects of note, and I suspect that's why the share market is attributing zero value to this side of the business. This is a good thing for potential investors though, as they can only gain from the commercial possibilities that may one day result from this huge body of work. (Genesis has the largest database of forestry genes in the world.)

Share market watchers are currently concentrating on the health side of the business, where Genesis has carved out a niche developing therapeutic vaccines - not for infectious diseases, but for immune disorders and inflammatory skin conditions.

The most advanced human health project is the development of the therapeutic vaccine PVAC for the treatment of psoriasis, a flaky skin disease affecting 1–3% of the population. This is a huge potential market, with currently available treatments all relatively toxic and expensive.

Genesis' share price fell sharply following publication of the phase two trial result for this product in January 2001, which showed only moderate success in terms of treating the condition. However, the data in fact showed that the problem was in treating chronic sufferers who had previously received heavy-duty immunosuppressive therapies. Good results were achieved in patients who had more recently acquired the condition.

Genesis has agreed to terms with the US Food and Drug Administration (FDA) for a second phase two test. Patients who have not had previous heavy-duty immuno-suppressive treatments will receive longer treatment at higher doses, given that toxicity was shown to be low in the previous phase two test. It hopes to begin trials next month.

The market waits, but its reaction to the first phase two test suggests a lack of stomach for the inevitable delays and frustrations in bringing a new drug to market. Genesis says the timetable for gaining approval has always been 2004.

Because of the delay with the phase two trial, Genesis is unlikely to be the first company with a fancy new psoriasis treatment, but it may be the one with the least toxic solution. Just how much eventual success could be worth to the company is hard to judge. If you were to speculate, it could be something in the order of adding $10 to the Genesis share price. That's serious upside, if the company gets it right.

Genesis' second most developed health product is the AVAC asthma therapeutic drug, being developed in partnership with SR Pharma. Phase one testing showed low toxicity, and the company is moving towards phase two testing to gauge efficacy. Genesis and SR Pharma are also cooperating to explore the use of AVAC in treating eczema (atopic dermatitis).

Both these areas have large potential markets, because of the current absence of a blockbuster drug. The potential value creation from success in either of these two endeavours is probably higher than that for PVAC.

Both the PVAC and AVAC products are based on Genesis' research on a bacterium, Mycobacterium vaccae, which produces proteins of some interest in treating the many autoimmune and inflammatory disorders.

Take at look at these figures. The drug Enbrel, which generates sales of $US750 million a year in treating rheumatoid arthritis, is now being tested for treating psoriasis sufferers, with good early results. Amazingly, Enbrel was nearly thrown away by developers after its first phase two test because it was initially aimed at a condition on which it had little effect. This goes to show the patience needed when developing new therapeutic products. Even if PVAC is unsuccessful in treating psoriasis, Genesis may still strike gold with this line of research.

Genesis' other health initiative, Biostore, is a substance able to induce dormancy in cellular products to allow stability when cooled, frozen or freeze dried. Genesis will probably aim Biostore at the blood products market but the possible applications are wide. Its first commercial application has been a deal with Australian veterinary and animal health products manufacturer, Jurox, which wants to freeze-dry nucleated cellular products and later revive them in a novel vet application. Genesis gets royalty income based on Jurox's commercial success. While the deal is small, it proves Biostore is of interest. It could come to market quickly given that there is no genetic research or complex approval process involved.

Genesis will look to partner with substantial international firms to give Biostore some momentum. The market is focused on PVAC and AVAC, but this could easily be the product that propels the share price out of the doldrums in 2002.

On limited resources, Genesis hasn't restricted itself to low-return areas of human health and plant science. Instead, the company has aimed its sights much higher at some fairly large targets and found good partners. Now all it needs is for the science to produce the goods.

If - and there's always an if in biotechnology - the science turns out to be half as good as the company's financial acumen, Genesis should have a profitable future. But investors need to think in terms of decades rather than months when waiting for results.

Roger Armstrong has no conflict of interest

Roger Armstrong
finn.ltd@ihug.net.nz

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