In my previous post I discussed a useful valuation metric applied to development stage biotech companies. I also stated that we would look at the results from a small study I completed on the change in total market cap of the companies comprising the two biotech indices over the past two years.

The purpose of the research was to get an idea of where the biotech industry lies in terms of valuation over a specified period of time. I gathered all the component companies market cap values for each of the appropriate indices in order to calculate a total value for each index. In the study I also wanted to determine the total change in market cap of the 15 companies comprising the AMEX Pharmaceutical Index (DRG) for reasons I will discuss in my next post.

The two biotech indices again are the NBI and BTK. The NBI is currently comprised of 156 companies while the large cap BTK includes 20 companies. Remember, that for our purposes, we specifically want to determine the total change in market cap of the small cap biotechs. Although some investors like to refer to the NBI as the small cap biotech index and the BTK as the large cap biotech index, it’s not accurate to make any assumptions in valuations simply by using index values. This is because all the companies that comprise the BTK are also included in the NBI (except Genentech). In order to extract and analyze the information that’s of value to us, I subtracted out the market caps of the large cap biotechs in the NBI so that we can truly isolate the approximately 136 companies that remain in the NBI. Hopefully I haven’t totally confused readers at this point.

Now lets take a look at the graph and table and try to make some sense out of the information.

Change in Total Market Cap of Healthcare Industry Indexes

Lets look at the values of the indices:

  • BTK - during the two year period the results indicate the index increased 3%.
  • NBI - during the two year period the results indicate the index decreased 5%.
  • NBI minus BTK- during the two year period the results indicate that after subtracting out the market cap of all the large cap biotechs the remaining value of the companies in the index lost a whopping 24%. It should be apparent by now that any loss in value to any company comprising the NBI was attributed solely to the small cap companies of the NBI. In fact, the total combined market cap of the small caps decreased about $28 billion during this period from $117 billion in August, 2006 to $89 billion in June, 2008. Now you can see why solely looking at the NBI as a measure of how well the small caps are doing is very deceiving as the index was only slightly lower (down 5%) than it was two years ago. That’s because the NBI is a market cap weighted index (actually a modified model) which dramatically overweights the large cap biotechs in the NBI. Any losses sustained to the small cap biotechs (in this case, $28 billion) aren’t reflected significantly when viewing the index as a whole. The current combined market cap of the small cap companies is slightly lower than it was during the bottom of the bear market in 2002 which needless to say is quite low.
  • DRG- during the two year period the results indicate the index decreased 19%. The 15 companies in the index also sustained a combined loss in market cap of more than $230 billion, more than ever lost in the history of the industry. Of course there’s no secret as to why the industry is in the gutter- patent expirations on blockbuster drugs that once brought billions in revenue.

The two bits of information that I find important and interesting are the loss of market cap amongst the small cap companies comprising the NBI and the massive loss in market cap sustained by the pharmaceutical companies in the DRG. I will save the discussion on the usefulness of this information for my next post.