This article was written by Nicholas Mitsakos : Chairman and CEO at Arcadia Capital Group.
It’s Still Magic
Biotechnology has been beaten up a lot lately and has had a very volatile and unimpressive recent history. However, biotechnology is still one of the single greatest investment opportunities available, and new and exciting factors are developing and enhancing the attractiveness of the sector. Market-beating opportunities exist and continue to be created via scientific development, data collection and analysis, and a virtuous circle of innovation, quality management, and product development. Identifying a few essential components can lead to extraordinary investment opportunities.
The sector has thrived, for the most part, over the last 30 years, and that will continue, although some of the rules are changing. Navigating various opportunities, understanding risks and the size of potential addressable markets, along with pricing strength (mitigated by potential political actions and regulation), timing and competition can yield some of the best long-term investment opportunities available.
While there is great volatility, scientific, and business risk (along with political meddling), we are seeing breakthroughs across many therapeutic areas, in both treatment and our understanding of the biology of disease.
The X Factor
There are lots of reasons to focus on biotechnology investments. But real excitement is being generated by impressive innovation coming from entrepreneurs, operators, and managers with experience and skill from some of the most successful companies in the space, such as Genentech, Biogen, Amgen, and Gilead Sciences. These teams are “The X Factor” driving organizations, and they are typically the biggest predictor of success. Science and technology are a necessary, but not sufficient, part of the equation. Great people can do a lot with mediocre assets, just as poor managers can destroy the value of even the best science and technology. But, combine great people with great science and some of the best investments available are created.
Speculation, Fast Money, and a Rollercoaster
Biotech remains a market of speculators and event-driven strategies. Biotech investors tend to focus on the next data-driven catalyst, obscuring a company’s long-term growth potential. Valuations tend to be extrapolated from small or single data points – the success or failure of a phase in a clinical trial, regulatory reaction, or new policy impacting the company. A company’s value is sometimes reduced to a single shot on goal, whether successful or not, and this is typically misleading and erroneous – either too much or too little value is given to these singular events. It is shortsighted and fails to understand the true long-term value present in a company’s addressable market, quality science, and management team. A value-based and growth-like equity mentality, as we see in technology, is more appropriate and reveals the most attractive cases.
But, until that happens, the volatility in biotech stocks will continue. It is not uncommon on any given day for a company’s stock’s price to be adjusted up to 70% up or down based on a single data point. This volatility makes it hard for most investors to keep a long-term perspective and stay the course. Biotechnology is dominated by short-term traders and hot money. That impairs the sustainability of the sector as an attractive investment, but it should not intimidate careful long-term investors.
It’s the Science, Stupid – and the Regulators
Scientific breakthroughs translate to successful drug development, from monoclonal antibodies in the 1990s to immunotherapies today. Now, gene and cell therapies are creating significant breakthrough therapies. It is still early to determine the true economic dynamics of this new class of drugs, and it may be appropriate to be patient with many, but the trajectory is exciting and great opportunities are developing.
Regulators may have something to say about all this excitement. Political discussion and rancorous debate focus around healthcare policy. However, effective drug therapies can save many costs that would otherwise arise elsewhere (the cost of long-term care, invasive therapies, and other more substantial costs). There is a reasonable scenario that the economic opportunities for innovative drugs will remain, or perhaps even improve, for high-value therapies. Most regulatory price pressure will be exerted on low-value drugs. Biotech innovation will continue to be valued highly, even if politicians and regulators speak with a loud voice.
Disruptive innovation is creating significant value, but so are drugs that save costs. This is an untapped area where development will accelerate. Drug development needs to address costs and cost savings. An example is prescription digital therapeutics. These are FDA-approved prescription programs where chronic-use drugs have a 35% to 50% one-year compliance rate. Prescription digital therapeutics can improve compliance and save significant future health-care costs. Substantial healthcare costs are expended simply to treat noncompliance. This area is a significant opportunity.
How Early is Too Early?
It is difficult to differentiate among early-stage opportunities. Some early-stage companies (Phase I or Phase II) achieve an identifiable proof of concept, increased survival, efficacy, or other clinical benefit. Often, there are no competitors, and these can therefore be substantial investment opportunities. Sometimes, scientific innovation creates multiple companies addressing the same target market. While this can create pricing competition, these can still be meaningful opportunities. Identifying some dimension of proof of concept reduces risk, and typically means the difference between an unusually attractive long-term investment and an opportunity whose risk does not justify an investment.
The most exciting opportunities exist if innovation represents not just one drug, but a platform from which other products can be produced, and it is combined with an excellent management team – the X Factor.
Scientific Progress Makes All the Difference – and Always Will
Our ability to understand the biology driving individual diseases has advanced greatly over the last 30 years. An example is oncology. Instead of lumping patients into a large group based on where in the body a tumor shows up, we understand with much greater precision what’s really going on. Lung cancer, for instance, is probably 50 different diseases, and now more precise and effective therapies can be designed. We can understand the needs of individual patients with much greater clarity because, along with scientific advancement, better and more relevant data can be captured and analyzed, accelerating scientific development further. This virtuous loop is a game-changer, and attractive opportunities can be built at an accelerating rate as better data brings scientific advancement generating better data and better products.
All this enables an unprecedented understanding of whether or not a drug will work earlier on in the development cycle. This will become one of the most significant drivers of value creation because it leads to more effective allocation of capital, and the ability to pursue more targets. Overall, it enhances the sector and increases the number and scale of attractive opportunities. That builds equity value.
As an example, more effective therapies are being developed by focusing on the genetic drivers of disease. Better data aggregation and analysis is a critical component. There is a huge and largely untapped opportunity to invest in data extraction, whether through electronic medical records or genomic data from large sequencing programs and clinical genetic testing. Companies are starting to license, organize, and analyze patient and disease data across multiple disease categories.
This is leading to different approaches to previously perplexing diseases. For example, organizing and examining data might enable a breakthrough in treating Alzheimer’s disease, currently stubbornly intractable, by parsing data into many different disease categories, potentially creating more precision-based drug-development strategies. New data-driven and more precise therapeutic strategies may have a substantially higher likelihood of success.
Management and Science
Biotech stocks are extremely volatile and seem to go down substantially before investors have any hope of making money. Many fail anyway, making assessments of science and management, along with competition and potential markets, all the more critical – and challenging. Growth areas continue to develop, and organizations led effectively with strong science are more likely to do extremely well.
Great biotechnology businesses will continue to be created, and this sector still represents one of the single best investment opportunities available. Great science focused on large opportunities combined with strong management will be a winning investment strategy, if investors have long-term perspective and fortitude.