July 2011’s Penny Shares to Watch…

This month’s penny shares to watch:

• Why biotech will command the headlines this year...

Sareum Holdings (SAR), Valirx (VAL), Nextgen (NGG)

• Three small cap ‘internet cops’ waging war on cybercrime...

Coreroc (CORO), Datatec (DTC), Digital Barriers (DGB), NCC Group (NCC)

Looking to invest in penny shares? Keep reading to discover my ideas for the coming month...

Why biotech will command the headlines this year

(This article first appeared in Penny Sleuth in June 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

This year has seen the dramatic revival of a small sector that has long been written off by most investors.

Until now, biotech has been the stuff of nightmares. The medical terminology is baffling. The process of medical discovery is long and expensive. But above all the vast sums of money poured into biotech have paid glorious salaries for chemists and biologists – but precious little to outside investors.

But a sea change in the industry could change all that. For years big pharma has lead the way in bringing blockbuster drugs to market. But they can’t do it any longer. Racked by costs and under threat from generic drug developers, the big pharmaceuticals are stepping back from research.

And that opens the door for biotechs. Over the next few years I think it is likely to be biotech stocks that command the headlines in this industry. And the advances underway in biotech could prove hugely lucrative for penny investors…

Penny drugs stocks are doing all the work

It is always wrong to write off the prospects of any industry. Ten years ago the mining industry was a forgotten backwater. Now investors cannot get enough of it.

The reasons that there are so many resource exploration companies are that anybody who can raise the money and acquire an exploration license can get into the business; and because the big miners are happy to let the small pioneers do the hard, risky work of looking for new sources of supply. If the little guys are successful they can expect to sell out to an industry major keen to bolster its own reserves.

The pharmaceutical industry now works in much the same way. It needs to find new drugs. Without drugs to sell it will not have a business. And yet big pharma is doing less and less to find those drugs. Faced by pressure on prices and competition from low cost generic versions of its own drugs, it is increasingly relying on the small players to do the research.

Today big pharma spends about 16% of its revenues on research and development – but only 4% of this is on research while the other 12% is spent on the very long and very expensive process of taking promising new drugs through the various stages of testing and approval.

A seismic shakeup in the drug industry

Big pharma’s retreat from research is shaking the industry. When I met the boss of one biotech business last week he told me that he could recruit as many biologists and chemists as he could possibly need from the ranks of those leaving big pharma. But he also told me of the difficulty of persuading big pharma to sign licensing and development deals.

And these deals are the lifeblood of biotech. Biotech companies live a hand to mouth existence, surviving on grants from governments and medical charities and finance supplied by industry partners. Biotech executives spend much of their time trying to convince big pharma to back their research efforts with hard cash. The biotech’s dream is to see its new compound taken right through the development stage and to the market, in return for multiple milestone payments and ultimately a royalty on all sales.

But the upheaval of the traditional industry structure is causing problems. In recent times the research departments of pharmaceutical majors have been in thrall to the marketing departments. The latter have demanded big blockbuster drugs that can sell widely and, even if they do no good to a large proportion of patients, will do no actual harm.

But a major shift in drug development is under way. Advances in medical knowledge, notably through genetic research, are helping us to understand the root cause of disease and why some people will respond to treatment while others do not. The upshot is that this will require a shift from the ‘one size fits all’ approach to therapy, and demand a wider range of innovative drugs that can target only those patients with sell defined conditions.

There are spectacular prospects in biotech

This should play into the hands of biotech researchers able to invent these new drugs. Executives at pharmaceutical majors, who have previously been able to lay the blame for product deficiencies at the door of their colleagues in the research laboratories, are now being asked to back third party research projects with large sums of money knowing that the risks of total failure and loss are all too real.

Not only do these decision makers have little experience with which to judge the merits of biotech research programs but, at a time when their employers are under financial pressure and are shedding staff, they are understandably reluctant to put their necks on the block.

Despite this impasse the balance of power seems to be shifting towards biotech. Big pharma is increasingly reliant upon buying into third party drug projects and that means putting real money behind biotech ventures. This year has seen some spectacular share price gains from biotech minnows such as Sareum Holdings (SAR), Valirx (VAL) and Nextgen (NGG) and a lot more could follow in the months ahead. I’ll keep you updated on the best prospects as we go.

Three small cap ‘internet cops’ waging war on cybercrime

 (This article first appeared in Penny Sleuth in June 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

“It’s not a brave new world, it’s a bad new world.”

Sony boss, Howard Stringer, was fuming.

His company has just been hit again by a vicious cyber attack. Still reeling from an assault on its PlayStation and Qricity online gaming and video networks in April, Stringer now has to deal with a security breach at SonyPictures.com.

This is more than just an embarrassment to Sony. It’s costing the Japanese giant plenty. Stringer had to shell out £100m to fix the first problem alone. And that doesn’t get anywhere close to the damage to Sony’s reputation, which is inestimable.

“Across the world”, it says, “we send 294 billion emails and five billion SMS messages each day. Over 93% of UK businesses and 73% of UK households have internet access.

“Our society is almost entirely dependent upon the continued availability, accuracy and confidentiality of its Information and Communications Technology. We need it for our economic health, for the domestic machinery of government, for national defense and for our day-to-day social and cultural existence.”

This dependence has left us vulnerable and Detica reckons that cybercrime is costing the UK £27bn per annum. The biggest loser is UK business and the main problems are the theft of intellectual property (IP) and industrial espionage. “The types of IP most likely to be stolen are ideas, designs, methodologies and trade secrets which exist in tangible form and add considerable value to a competitor. No business sector is likely to be entirely immune.

“Without urgent measures to prevent the haemorrhaging of valuable intellectual property, the cost of cyber crime is likely to increase even further.”

Three UK small caps fighting the battle against cybercrime

It is against this background that AIM-listed Coreroc (CORO), headed by the same team responsible for the successful ICT provider Datatec (DTC), has bought Massachusetts-based Top Layer.

Top Layer specialises in safeguarding networks especially against ‘denial of service’ attacks. These are criminal attempts to make a computer unavailable to its intended users. And it also has a product that allows enterprises and government agencies to aggregate and distribute network traffic more efficiently.

Last week I met Corero’s chief operating officer executive, Andrew Miller. He told me that Top Layer has superior technology that has not been effectively marketed. And he reckons that by opening up sales channels and pushing the products outside the USA, Top Layer could double its $10m annual sales, taking it to profitability.

But Corero isn’t stopping there. Top Layer is expected to be followed by other acquisitions and Miller wants to take advantage of one key trend. It’s this…

At present the majority of security spending is on firewalls which intercept packets of data that have come from a dodgy source. Increasingly though, there is a trend towards ‘deep packet inspection’ which, at ultra high speed, looks at the content of each data packet.

Leading security vendors such as Cisco, Checkpoint, McAfee and Fortinet are combining deep packet inspection capability into ‘next generation firewalls’. Miller believes that traditional firewall providers will struggle to compete… and this will lead to industry consolidation.

Other stock market plays in this area are Digital Barriers (DGB) and NCC Group (NCC). But it’s Corero that I’ll be watching. I’m really interested in how it will develop. It has a respected management team, who have committed £4.5m of their own cash into the venture. They’re going to work hard to get this business working well. And there’s no doubt that it is operating in a growth industry: fighting cybercrime.

Sadly cybercrime is on the rise. But for investors in these internet cops, crime might just pay.

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Good investing,

Tom Bulford Editor, Red Hot Penny Shares

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(This article first appeared in Penny Sleuth in June 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)