Legendary investor George Soros is a “big picture” guy. He likes to spot major themes and then find the savviest direct ways to benefit. This approach has served him well: he’s worth an estimated $14.2 billion and, according to Forbes, was the 35th richest person in the world in 2010. A pair of biotech investments highlights his desire to profit from the steady decline of Big Pharma stocks, so I decided to analyze these two investments and to see how you can profit alongside him.

As I’ve noted previously, many major drug companies are set to lose exclusive rights to some of their most profitable drugs. From the industry’s misfortune, real winners will emerge: companies with newer promising drugs and companies that steadily profit from making drugs once they lose patent protection. Soros has big stakes in both areas, with his $130 million stake in Teva Pharmaceuticals (Nasdaq: TEVA) and a $75 million investment in Dendreon (Nasdaq: DNDN).  Both stocks are off of their recent highs, giving you a chance to invest like Soros, without paying full price.

Teva Pharmaceuticals
Israel-based Teva has become the giant of the generic drug industry, holding an industry-leading 18% market share. The company specializes in securing exclusive manufacturing rights to drugs that have just gone off-patent, a short six-month window when generic prices are still relatively high before loads of competition pile in.

It’s a remarkably steady business: sales have grown at least 16% every year in the past decade, except for 2005, when sales only grew 9%. Analysts expect sales to grow 15% to 20% again in 2011, though you should expect sales growth closer to 10% in subsequent years. It gets harder to move the needle when annual sales exceed $20 billion.

About a decade ago, Teva decided to expand its repertoire by developing its own proprietary drugs. The big R&D effort had many misses, but one major success was Copaxone, which is used to treat symptoms of multiple sclerosis. The drug has single-handedly generated hundreds of millions in profits for Teva. Concerns that Teva may lose its exclusive rights to Copaxone are a major reason why shares have steadily drifted 20% lower since last spring (at a time when many other stocks have posted powerful rallies).

Yet concerns about generic competition for Copaxone now look overstated. In a roundabout way, the Food & Drug Administration said as much. Teva wanted approval for Copaxone mixed with less sugar water. The FDA responded on Dec. 23 with a request for a brand new set of clinical trials. Analysts at Needham think this means that generic rivals, all of whom will be coming up with their own formulations for the drug, would also need to conduct clinical trials to get approval. That could “significantly delay (or derail) any pending follow-on versions,” wrote Needham’s analysts in a recent report.

So why does Soros like this stock? He’s likely enamored with Teva’s low valuation: shares trade for just 10 times projected 2011 profits, not much higher than the multiple assigned to big drug stocks, even though Teva has clearly superior growth prospects. To be sure, the days of a 15 or even 20 times forward multiple are gone, but there’s no reason shares of Teva can’t trade up to 12 to 13 times projected 2012 earnings per share (EPS) of $5.80. That means shares should trade up to $65 or even $75 in the coming year, a gain of 27% to 47% from the recent $51 share price.

Dendreon
Soros doesn’t see Teva as a potential biotech home run. That view is placed on Dendreon, which has had a wild ride in the past few years. Shares surged from less than $3 in early 2009 to more than $55 last May as the company’s prostate cancer drug, PROVENGE, looked like it had achieved blockbuster status. Yet not everybody is a fan of the stock, which is why shares are back below $40. Short sellers note that PROVENGE has proven to be only moderately helpful, perhaps making it harder to justify a price tag that can approach $100,000 over the full course of treatment.

PROVENGE’s fate lies with Center for Medicare and Medicaid Services (CMS), which will determine next month whether the drug will be covered. Note that prostate cancer mainly strikes elderly males, making Medicare the biggest likely insurer to reimburse of the drug. The majority of industry watchers believe it will receive full CMS reimbursement status, though only for prostate cancer, and a clear statement against use for off-label applications. Private insurers have largely agreed to cover PROVENGE.

How big will PROVENGE become? Dendreon is boosting its manufacturing capacity tenfold and the company thinks that with higher capacity in place, it can sell $400 million worth of PROVENGE this year. That seems awfully optimistic. But the long-term $1 billion annual target may be feasible: about 200,000 men are diagnosed with prostate cancer in the United States every year, along with a similar number in Europe.

Looking beyond the domestic opportunity for PROVENGE, Dendreon is expected to start pursuing foreign sales (European approval will be sought in early 2012), and it is also developing a further roster of drugs, led by Neuvenge, which helps to stimulate an immune response against tumors.

Despite the bright outlook, more than 15 million shares of Dendreon are held by short-sellers. Why so bearish? First, they wonder if PROVENGE can really build a head of steam with such an expensive drug when many prostate cancer sufferers end up dying of something else anyway. If further cost-containment pressures come to healthcare, then drugs like PROVENGE would be especially vulnerable. Second, the shorts doubt the company can ramp up output anywhere nearly as quickly as it hopes, and they predict analysts’ sales forecasts for the next few years will need to come down. Lastly, some of that short interest may simply be due to an unusual caveat in a recent convertible stock offering that has the buyers of the deal shorting stock as a hedge.

Action to Take –> Shares of Dendreon have slumped to $35, though some analysts think they could rebound to $50 or even $60 once Dendreon’s picture clarifies. I’m no biotech expert, but George Soros employs plenty of them. And his team strongly believes in Dendreon’s prospects — and that kind of vetting counts for a lot. Meanwhile, Teva clearly looks like a low-risk way to play the ongoing generic drug revolution. Between Teva and Dendreon, investors will likely do well riding Soros’ coattails.