Biotech HOLDRS (BBH)

Research & development and patent estate are the fundamental keys to the success of the biotechnology sector. The pace of advancing phase-wise drug trials and the concluding FDA approval proves the mantle of the company in the market, further driving the research & development investment.

Biotech Holdrs with a market capitalization of more than $1.46 billion are depositary receipts issued by the Biotech HOLDRS Trust, and represent a beneficial ownership in the common stock or ADS of companies involved in the biotechnology industry. Biotech Holdrs comprises of 18 underlying securities with Amgen, Genentech, Gilead Sciences and Biogen IDEC making up for nearly 63% of the share holding.

With a robust pipeline and a reasonable growth path, Amgen has instituted a buyback program, while emerging as a defensive stock with strong cash flows in otherwise volatile biotech sector. Genentech has a rich product pipeline and has a couple of important FDA submissions lined up for 2007, with no imminent threat of patent expiries coupled with positive phase result of its several investigational drugs. Gilead’s strength lies in its superior HIV medication offering which offers more convenience and greater efficacy. However, Biogen is surrounded with certain issues including the lack of late stage pipeline in CNS space and pending lawsuit against the company alleging illegal discounts to boost sales.

The composition of Biotech Holdrs is an optimum mix of high growth and high value companies, as most of the companies have significant patent estate while others hold a valuable pipeline. Although the return over the past one year has been very dull, standing at -7.3%, the three-year historical return stands at 26%. Also, the constituent companies appear to be trading at a discount to the value of their future product pipeline, FDA filings in 2007 and the consequent revenue stream, making it a likely outperformer.