The biotech industry is rife with small companies that spend millions developing new drugs that may or may not get the green light from the Food and Drug Administration. Many face costly setbacks, like clinical trial failures or regulatory delays, that can rapidly deplete their cash reserves. Even those that are ultimately successful typically don't have enough money to take a new drug all the way from the laboratory to the market.

So how can investors avoid getting burned by companies in this cash-hungry industry?

Follow the money
When analyzing a biotech stock, one of the first things investors need to calculate is how much money the company is spending. This number, called the "burn rate," is the total amount of cash that's spent on operations and capital expenditures. Let's run through an example and look at how much drug developer Keryx Biopharmaceuticals has been spending.

Period

Q1 2013

Q4 2012

Q3 2012

Q2 2012

Operating Cash Flow

($2,138)

($5,566)

($6,848)

($3,800)

Capital Expenditure

($45)

($5)

($16)

($1)

Burn Rate

($2,183)

($5,571)

($6,864)

($3,801)

Ave. Burn Rate (LFQ)

($4,605)

     

Source: CapitalIQ; LFQ = last four quarters; all numbers in thousands.

On average, Keryx has been burning $4.6 million a quarter --- but don't be alarmed. The massive costs associated with drug development make biotechs notorious for their high burn rates, and this number tells only half of the story.

How much cash is available?
Investors also have to gauge whether the company has enough money to support these expenses. Let's peek at Keryx's balance sheet and see how much cash it has on hand:

Cash and Equivalents

$87,343

Short Term Investments

 --

Total cash on hand

$87,343

Source: CapitalIQ; data from most recent quarter; all numbers in thousands.

It looks like Keryx had $87.3 million available at the end of last quarter. Assuming that its average burn rate stays constant, Keryx can comfortably cover its expenses for another year and a half. 

Dilution?
Keryx's strong cash position is in large part due to capital that it raised through a recent follow-on public offering. It issued more than 9.4 million new shares and netted $74.8 million from the offering to help fuel its research and development efforts. And this wasn't the first time the company issued more shares; since the start of 2010, Keryx's total outstanding share count has increased from almost 56.9 million to 81.7 million. This means that investors who jumped into this stock three years ago have seen their total stake in the company drop by about 30%.

Today, however, the real question investors have to ask themselves is whether Keryx can reach its next catalyst without running out of cash and issuing more shares.

Where does Keryx stand?
Keryx has been a hotly debated stock among investors; the company faced a massive setback in mid-2012 after reporting that perifosine, a colorectal cancer drug that it formerly shared with biotech Aeterna Zentaris, failed to meet its primary endpoint in a pivotal phase 3 clinical trial. Keryx's share price took a massive 65% tumble on the news, but the company moved forward with the development of its second drug, Zerenex.

Zerenex, an experimental compound that lowers phosphorus levels in dialysis patients suffering from end-stage renal disease, successfully met both its primary and secondary endpoints in a phase 3 clinical trial in January. Just as quickly as its shares collapsed the previous year, investors saw Keryx's value rebound, and this stock is up almost 190% year to date.

Zerenex is already under regulatory review in Japan, where Keryx is partnered with Japan Tobacco and Torii Pharmaceutical. In the United States, Keryx's management hopes to submit the NDA for approval in the third quarter of this year. Assuming the standard 10-month review period, this suggests that Zerenex could be launched in the middle of 2014 if it gets the FDA's stamp of approval. While this decision will be a catalyst for shareholders, and the company could face a number of challenges in commercializing the drug if it is approved, it looks as if Keryx has plenty of cash to continue its operations and further dilution (before the FDA's decision, at least) looks highly unlikely.

While you can certainly make huge gains in biotech and pharmaceuticals, the best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

The article Is Keryx Biopharmaceuticals Burning Too Much Cash? originally appeared on Fool.com.

Max Macaluso, Ph.D., and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Investment Strategies

What's your investing game plan?

View Course »

Introduction to ETFs

The basics of Exchange Traded Funds and why ETFs are hot.

View Course »

Add a Comment

*0 / 3000 Character Maximum