It was just a frog -- a pickled one, yet -- but it had a sly smile on its face, as if it knew how hard I'd have to work for my B minus in 10th-grade biology. I thought of that amphibian the other day while struggling through another biotechnology article, this one on protein kinases as targets for anticancer drugs. Some of you may trip over similar memories when you try to gauge whether the vaunted biotech revolution is the great investing story of the age or the next Internet bubble. Buy what you know, goes the adage, and what does the average business owner know from drug development?

Maybe more than you think. Not about the science (which is, yes, daunting and crucial) but about the business dynamics at work. Underlying the buzz about future Alzheimer's therapies and pig-liver transplants is one of the great entrepreneurial sagas of all time, now in a pivotal chapter. After more than two decades of hype, hope, disappointment, and progress, the hundreds of mostly small, money-burning companies that make up the biotech industry are experiencing a decisive shift in their relationship with the giant, rich pharmaceutical companies that still capture most of the revenues in the drug business. "It's an inflection point," says Steve Burrill, CEO of Burrill & Co., a biotech-focused merchant bank in San Francisco.

A little context: The organizations known collectively as Big Pharma -- Pfizer, Merck, Novartis, and others -- undertake the whole lengthy, risky process of creating and selling drugs, from basic research and clinical testing to government approvals and (last but far from least) marketing. In the late 1970s the early biotech start-ups came on the scene believing that a fresh approach to research and manufacturing -- based on new biological insights instead of the chemical-industry methods that had shaped Big Pharma's research and development -- would provide the foundation for big new companies. During the next decade or so Genentech, Amgen, and a few other pioneers actually did go on to fulfill the vision with products and profits. But as late as the mid 1990s most biotechs had yet to move beyond discovery work. They survived only through their alliances with Big Pharma, which was happy to pay entrepreneurs to scout out opportunities. Then the big guys could develop, market, and -- to the disappointment of many a biotech investor -- claim most of the profits from the leads.

But if biotech's business models stalled, its science did not -- and the potential payoffs loomed ever larger. Venture capitalists and Big Pharma kept funding new biotech companies. Every few years a wave of start-ups went public, culminating in a veritable tsunami in 2000. That year, the sequencing of the human genome so dazzled investors that biotech companies were able to raise a record $32 billion through initial public offerings and secondary offerings. Alas, in some ways it was the same old biotech story. Investors paid up for nifty ideas (the fad this time was genomics) and then turned tail when they saw the hurdles to commercializing them. Against the general bear-market backdrop, the whole biotech sector sank; the Nasdaq Biotechnology Index fell from an all-time high of 1,620 in March 2000 to 608 a year later.

When the tide went out this time, however, it revealed something fundamentally different. Though the public's ardor for biotech had cooled, Big Pharma's had not. It is making more deals with biotechs than ever -- 425 last year, up from 373 in 2000 and 230 in 1999, according to Burrill -- and the deals are coming more and more on biotech's terms, with higher up-front payments and richer splits. It's not hard to see why. Big Pharma's R&D pipelines are sputtering, even as patent protection expires on such key moneymakers as Bristol-Myers Squibb's anticancer drug Taxol. Meanwhile, biotech has grown increasingly prolific; biotechs have developed some 30% of the pharmaceuticals in human clinical testing, up from 7% just 10 years ago. For new partnership deals some small biotechs are now looking to Big Biotech. And in acquisitions that include stock (such as Amgen's $16-billion December purchase of Immunex) Big Biotechs' lofty multiples give them a buying advantage over Big Pharma.

Hence the inflection point. "Five years ago," says Burrill, "the market cap of the entire biotech industry was about half that of Merck and Pfizer combined. Today, at about $400 billion, it's about equal. In five years I think it'll be three to five times. Now, Merck and Pfizer are great companies, but if you can own the whole biotech industry for what it costs to own them, what would you rather own? I'd argue, the biotech industry."

I would, too. So how do you buy an industry? Some people use biotech mutual funds. But I've come to believe that the best vehicle is a relatively new product called an exchange-traded fund, which in this case provides an efficient way to buy all 70 stocks in the Nasdaq Biotechnology Index. (See "One Stock," below.)

But note the emphasis on "industry." Individual companies often get upended by research or regulatory setbacks. Just ask ImClone, which had to renegotiate a rich deal with Bristol-Myers Squibb after it saw its application for a promising anticancer drug bounced by the Food and Drug Administration in December. Even as a whole, the industry is too volatile to entrust with a big chunk of your net worth. However, it is a place where anyone with an eye for business trends should place a thoughtful bet.

Financial writer Kenneth Klee graduated from high school in 1971 and went on to get a B minus in college biology, too. Shortly thereafter he switched to journalism.

One Stock

In this case -- as I argue in my column -- it's not a stock but a fund: the Nasdaq Biotechnology Index Fund (ticker symbol: IBB), a fund that trades like a stock and is marketed, along with 76 other such funds, by Barclays Global Investors. This one tracks the 70 stocks that make up the Nasdaq Biotech Index, which are weighted by market cap, meaning that the fund holds lots of giant Amgen (16.1%) and only a smidgen of tiny VaxGen (0.1%). Minimum purchase is one share, so you can get started for less than $100. To learn more, go to, click on sector/industry, then on health care, then on Nasdaq Biotechnology Index Fund.

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