A healthy diagnosis

Last week, I attended an excellent seminar on healthcare, organised by the stockbrokers Henry Cooke, Lumsden and held at the Royal Society of Medicine. The companies making presentations were an intriguing mixture. Seton Healthcare Group and Westminster Healthcare Holdings are sound, well-managed companies growing at an above-average rate and on relatively attractive prospective p/e ratios. Haemocell, Proteus International and Tepnel Diagnostics are British bio-tech companies with no profits yet, but plenty of future hopes reflected in their market capitalisations, ranging from about pounds 40m to more than pounds 100m.

There is no simple formula for valuing a bio-tech company. One measure that has been recommended to me is to take the market capitalisation, deduct any cash and compare the resultant figure with the total cost of research and development expenditure to date. At least you would then have a fix on how much you would be paying for the money the company has already spent, but there would still be a doubt about whether the management had spent it wisely.

Haemocell has a net asset value of only 35p against a market price of 190p. The company has FDA and German approval for its patented method of recycling and cleaning small quantities of a patient's blood, reducing the risk of rejection and infection sometimes caused by a donor's blood. The Haemocell machine and subsequent disposables will be marketed by an excellent American company, Stryker Corporation. Haemocell capitalises at pounds 39m and has a few other interesting products in the pipeline. For the year ending August 1995, Henry Cooke, Lumsden forecasts EPS of 17.7p, so it can be argued that the shares are reasonable value.

I was not in the least bit impressed by the presentation of Proteus International. The market capitalisation is already over pounds 100m and the chief executive spoke like an uncommercial Martian about 'computer-aided molecular modelling and rational drug design'. No earnings are in sight in the foreseeable future, so investors can probably look forward to a stream of announcements about new highly technical joint ventures and a series of rights issues. Not for me.

The bio-tech company I liked most was Tepnel Diagnostics, which specialises in medical and food diagnostics. The first product likely to reach the market detects antibiotic residues in the food chain. For example, a cow is treated with antibiotics, which in turn may contaminate the milk the cow produces or affect its meat. Human beings who drink the milk or eat the meat might over a period develop resistance to the antibiotic, reducing the drug's efficiency when it comes to be used. A growing number of European directives now require member countries to test food for antibiotic residues.

In medical diagnostics, Tepnel appears to have made a breakthrough in the field of DNA probe technology. Its system can detect a targeted disease from blood or other body fluids and ensures no false results. Tepnel believes it has the technology to develop tests for a very wide range of applications including HIV and other viral infections, genetic abnormalities such as anaemia and cystic fibrosis and medically important bacteria like staphylococcus.

Tepnel therefore has two very attractive products relatively near to full UK approval and subsequent marketing. The management seems to be very competent commercially as well as technically.

At the present price of 245p, with a net asset value of only 23p, Tepnel capitalises at pounds 55m. Henry Cooke, Lumsden estimates pre-tax profits of pounds 5m for the year ending September 1995, which with a 25 per cent tax charge would put the company on a modest p/e ratio of about 15. Further growth could then be very dramatic.

Bio-tech shares are very risky, so instead of investing in only one it is a better policy to invest in several to have a spread. I recommend Tepnel for a place in any British bio-tech portfolio.

Mr Slater is an active investor who may hold any shares he recommends in this column. Shares can go down as well as up. Mr Slater has agreed not to deal in a share within six weeks before and after any mention in this column.