The hottest sector in the drugs business

‘Orphan’ drugs - a little-known but fast-growing area of the pharmaceuticals industry, could produce excellent returns for investors, says Matthew Partridge.

When you think of the pharmaceutical and biotech industries you think of cures for big high-profile conditions, such as heart disease.

There's clearly a lot of money to be made from that sector.

However, another part of the drugs business is growing even faster. And it's one that every investor in the pharma industry should get to know about, if they want to make the best returns.

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Welcome to the world of orphan' drugs

How orphan diseases became big business

Orphan' diseases are rare illnesses, usually with few effective treatments. As a group, they'll affect one in ten people during their lifetimes. That's a huge number. But each individual disease might only affect a handful of people.

As a result, in the past, companies neglected them. The market for the cure was too small to cover the costs of research. And in purely practical terms, in many cases there simply wasn't enough data available.

Governments have long tried to encourage the development of such drugs. The earliest orphan drug' legislation designed to drive research into conditions that only affect a few people - is about 30 years old.

However, it's only in the last few years that the sector has started to draw serious attention.

For one thing, advances in the science of genetics have made useful small-scale studies into these diseases far easier to conduct, with better results. While the US Supreme Court recently banned firms from patenting genes, the underlying treatments developed from such research remains protected.

For another, regulators in Britain and the US have greatly stepped up their efforts to get orphan drugs approved. Regulators are willing to demand fewer trials and paperwork, which saves on costs. They are also willing to accept more significant side effects. More grants and subsidies are available too.

Finally, there's not much competition in this area. If you have the only available treatment, then clearly, you have a lot of pricing power. So a company can now make as much money from a successful orphan drug as from a treatment for a more mainstream condition.

The size of the market now stands at around $50bn. And it's still growing at a rate of around 20% a year. Geoffrey Hsu of the Biotechnology Growth Trust thinks this is one of the most dynamic areas in healthcare.

So how do you buy into the market? I've got two suggestions below. This is a highly risky area, but I've picked the safest' way to buy in, as well as a far more speculative option. As tends to be the case with the most interesting healthcare business stocks, both are listed in the US.

Two ways to buy into the orphan drug sector

The safe' way to buy into the orphan drug boom is through BioMarin (NASDAQ: BMRN). BioMarin focuses on rare conditions that are caused by genetic diseases. It already has four products on the market for Flling's disease, Hurler syndrome and Lambert-Eaton syndrome so this isn't a one-product, one-chance'speculative biotech.

BioMarin has six other drugs in the pipeline. Of these, the most interesting is BM-673. This drug aims to stop the DNA repair process in cancer cells. Not only would this kill them, it would prevent them from spreading. While there are similar drugs being tested by other companies, early trials suggest that this one lasts the longest, and is the least toxic.

Trials are currently limited to specific types of breast cancer that have recurred after treatment (hence the orphan' designation). But clearly, if it works for these types of cancer, the hope is that BM-673 could eventually have a much wider application across other cancers.

BioMarin has yet to make a profit, but its revenues have grown by 70% in the past four years. JP Morgan estimates that they will nearly double by 2017.

As I said, this is a high-risk sector, but if you're looking for a relatively diversified way to play it, this is the one.

A much riskier investment is BrainStorm Cell Therapeutics (OTC: BCLI). This one is traded over the counter' in the US, which means if you want to buy it, you'll need to have a broker who can trade in these stocks.

Brain Storm's success or failure hinges on a single product, NurOwn. This is a treatment for motor neurone disease (MND), which uses adult stem cells. MND (known as ALS or Lou Gherig's Disease in the States) is a degenerative disease involving creeping paralysis that affects 120,000 people worldwide.

While a few patients, such as the physicist Stephen Hawking, have lived for over 50 years, half die within 14 months of diagnosis. There is currently just one drug available, and its effects are very limited. In the late stages of the disease, patients typically need intensive care, costing, in the US, up to $200,000 a year.

NurOwn takes adult stem sells from the patient's bone marrow, treats them, and then injects them into the wasting muscles. This avoids the need for surgery, or for extra drugs to suppress the immune system. The hope is that this will encourage the neurones, which MND destroys, to regrow.

This may sound a long shot, yet initial results have been encouraging. Early trials have shown that even at small doses, the progress of the disease was slowed down to a significant extent. It is hoped that higher doses will have an even bigger impact.

Overall, the results have been so encouraging that the company has already started phase two trials in Israel. It is working with the ALS Association to launch several trials at higher doses in the US, including at the world famous Mayo Clinic.

In the longer run, BrainStorm hopes that its treatment if successful could then be adjusted for other conditions, such as Parkinson's disease, and multiple sclerosis. The company has enough cash to tide it over until the product hits the market, while its management has a track record of success.

Make no mistake this is a high-risk punt. You could lose everything, or it could pay out big. But if you're looking for something to add to the speculative end of your portfolio, it's one to keep an eye on.

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri