Sometime during the middle of the year, Genentech (DNA) shareholders are going to get $95 in cash for each share of Genentech stock they own. In total, nearly $47 billion in funds are expected to be returned to biotechnology investors.

We’ve come up with an effective “basket approach” to re-deploy those funds back into the biotech sector — in search of the next Genentech.

Antisense Makes a Lot of Sense

For a little over $13, investors can pick up one share of Isis Pharmaceuticals (ISIS). Isis is the market leader in antisense technology.

We’ve made it no secret in the past — we are big fans of antisense. We view the drug discovery engine fueled by Isis’ antisense technology very similar to the power of Genentech’s recombinant DNA and monoclonal antibody technology breakthroughs of the 1980’s. Antisense drugs are still in their infancy, but no company is better positioned to benefit from this exciting new approach to drug discovery than Isis Pharmaceuticals.

Isis boasts over a dozen clinical stage candidates in just about every major disease class. The leading candidate, mipomersen, a cholesterol-lowering agent, is currently in phase III trials, partnered with Genzyme (GENZ). Mipomersen has blockbuster potential in our view given key differentiating factors that could make the drug a superior option for high risk or statin intolerant patients with high cholesterol.

Other drugs at Isis or Isis partners include ISIS-113715 for diabetes, OGX-011 and LY2181308 for cancer, alicaforsen for Crohn’s disease and ulcerative colitis, TV-1102 for multiple sclerosis, and ISIS-353512 for coronary artery disease. Besides the best pipeline in small-to-mid-cap biotech, Isis also has over $500 million in cash on hand. If there ever was a “Baby Genentech,” Isis surely fits the bill.

Here Come the Stem Cells

Finding the next big thing is certainly something biotech investors are always in searching for. Above we discussed our enthusiasm for antisense technology as powerful drug discovery engine. Perhaps the only other discovery platform that provides as much enthusiasm as antisense is stem cells. The leading stem cell company is Osiris Therapeutics (OSIR).

Osiris is developing Prochymal, an adult stem cell product currently in 3 phase III trials for steroid refractory graft-vs-host disease (GvHD), acute GvHD and Crohn’s disease. Prochymal is also in a slew of earlier-stage clinical programs for diabetes, myocardial infarction, chronic obstructive pulmonary disease and acute radiation syndrome. It’s a potential wonder-drug built on a the premise that viable adult mesenchymal stem cells (MSCs) can engraft and selectively differentiate, based on the tissue environment, to such lineages as muscle, bone, cartilage, marrow stroma, tendon and fat.

Research shows that MSCs offer anti-inflammatory, anti-fibrotic and regenerative properties that make this platform an exciting disease modulator treatment engine for discovering new drugs. Investors can pick up one share of Osiris for just over $17 per share.

The One-Drug Home Run

Not every biotechnology company needs to have a potentially revolutionary new drug discovery platform in order to out-perform the market. In the case of Vertex Pharmaceuticals (VRTX), all you need is one drug — one very big drug. Vertex, along with development partner Johnson & Johnson (JNJ), is developing telaprevir in phase III trials for hepatitis-C (HCV) infection.

Telaprevir has shown the best data we’ve seen so far to combat HCV. It’s a leap-forward product, and should be a blockbuster almost immediately after approval in 2011. The drug should help drive Vertex to profitability, as well as help fund the company’s research efforts, which include earlier-stage candidate for HCV and cystic fibrosis. And, like the above three, Vertex is well capitalized, with over $800 million in cash on hand. One share of Vertex will cost you $28.

Acorda Therapeutics (ACOR) is developing Fampridine-SR, a potassium channel blocker that prevents nerve impulse leakage over demyelinated regions of axons. Acorda is developing the drug as a therapy to improve walking and motor function in patients with multiple sclerosis (MS) or spinal cord injury. It’s an area of significant unmet medical need — and if approved, Fampridine-SR would own the market.

Rumors were circulating in February that Biogen Idec (BIIB), the worldwide leader in MS, was interested in acquiring Acorda. We see several other names, including Pfizer (PFE) and Sanofi-Aventis (SNY), that would also be excellent potential suitors for Acorda. But in the meantime, assuming the FDA approves Fampridine-SR in 2010, which is something we are confident in, we see Acorda reaching profitability in 2011. As a result, the stock is attractively valued at just over $24 for one share.

With the remaining $13 left over, we recommend investors buy 2 smaller biotechnology stocks on the brink of profitability. Both Pozen (POZN) and Cypress Biosciences (CYPB) each have one drug approved that is sold by a commercialization partner.

Pozen’s Treximet, a new combination NSAID+triptan migraine drug, received approval last year and is being sold by GlaxoSmithKline (GSK). Cypress’s Savella, a new dual-reuptake inhibitor for fibromyalgia syndrome, received approval earlier in the year and will hit the market through partner Forest Labs (FRX) this summer. Both products offer a significantly better treatment option for patients suffering from migraine headaches or fibromyalgia, and both should post sales around $500 million in the U.S. by 2013.

Both companies will receive double-digit royalty on sales of their respective product, and that means that both companies will be highly profitable by 2012 as a result.

Profitable biotech companies are hard to come by. Investors can pick up one share of Pozen for just over $5 and one share of Cypress Bio for just over $7 to round out their new basket approach to replacing Genentech as the staple biotech representative holding in their portfolio.

Read the full analyst report on “ISIS”
Read the full analyst report on “OSIR”
Read the full analyst report on “VRTX”
Read the full analyst report on “ACOR”
Read the full analyst report on “POZN”
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