Having just left an institutional setting, I am now very excited to put together my own portfolio of biotechnology stocks. My goal is to take a similar approach as that of Baker Brothers when it comes to portfolio construction.
I plan to invest in companies that are true innovators in their respective therapeutic areas
In the US, one would generally say that smid cap biotech universe would be biotech companies under $10bn of market capitalization. However, the catch is that many companies in there may be zombies who have had their best days gone by after 2015 – their business model was focused on reformulating drugs (putting two cheap generics together and saying it is a whole new drug and raise price like a new drug). Obviously, that model is completely outdated except in very small cases, but unfortunately that business model is now outdated and has very low growth prospect in mid-to-long term.
While the catalyst of the sell-off of those companies’ stocks (ALKS, MNK, HZNP, etc. – although HZNP has successfully transitioned away, but still sold off HARD during 2015/2016) was Hilary Clinton’s tweeter account, the underlying fundamentals have been trending this way in that the US healthcare expenditure as % of US GDP has increased SO MUCH (I think close to 15% now?) that unless the data for the drug is really good (i.e. best-in-class or first-in-class), healthcare insurance companies will keep pushing back hard on doctors – asking them to redirect patients to get cheaper alternatives or document the need for the drug (like medical history) – and many times, doctors can give up.
Given the market development, global pharmas have been solely focused on developing and acquiring the true “first-in-class” or “best-in-class” drug – therefore we are seeing some serious prices that are getting paid for small number of assets that have such promising prospects.
For instance, Gilead recently acquired Immunomedics and they did not hesitate to emphasize that Immunomedics’ flagship product Trodelvy is the “first-in-class” product.
Breakthrough “first-in-class” drugs have the advantage of enjoying very rapid penetration into market – which is something that is unique to pharmaceutical industry.
A breakthrough, innovative, first-in-class drug like Trodelvy essentially SELLS ITSELF – its studies have been featured on the most prestigious medical journals already and have been presented at the most prestigious medical congress. Therefore, even before the drug becomes commercially available with FDA / EMA approval, the doctors are already very familiar with the data – they likely have already asked their friends who have participated in the trials to get in-person experience or how to manage side effect profile for their patients. They sometimes just ask their sales representatives on when the drug would be available and put in order as soon as the drug is launched. Doctors are looking out for their patients and they really want to bring hope to their patients.
Gilead has been on acquisition spree recently – they have been wanting to reduce revenue exposure to HCV and HIV franchise – both are experiencing diminishing growth prospects or even showing revenue decline.
SO – what am I focusing on – ONCOLOGY / INFLAMMATION&IMMUNOLOGY / RARE DISEASE and WHY?
3Q20 pharma earnings really speak to the global trend in pharmaceutical industry. They are focused on
1) products without significant pricing pressure,
2) products with high volume growth prospects (enough to offset potential net price decline), and
3) products that will benefit of aging population or significantly prolonged life space of patients through therapeutic intervention.
For this reason, large cap pharmas are squarely focused on oncology, I&I, and rare diseases – as shown in reent transactions.
Oncology
Oncology products have the holy grail characteristics that has all three –
1) pricing pressure is minimal (Seagen’s new products carry very high price tag) given the urgent medical need,
2) biomarker-driven therapies are expanding TAM of existing targeted therapies as some targets are expressed across multiple tumor types,
3) longer surviving patients translates to greater revenue per patient – which gives enormous operating leverage.
Immunomedics/Gilead: Gilead paid $21bn for Immunomedics – an innovative oncology company with ADC platform.
Seagen / Merck: Merck-Seagen announced $4.5bn partnership that includes HER2 TKI (tukysa) and ladiratuzumab vedotin (LV), which is getting investigated for TNBC. As part of the deal, Merck bought $1bn of equity of Seagen for $200/share.
Inflammation/Immunology/Autoimmune (I&I)
I&I is facing some level of pricing pressure – however, the volume is growing rapidly – aging population has increasing autoimmune problems and therefore the patients that need the autoimmune down-regulation are expanding rapidly. With Humira going biosimilar in the US in 2023, large caps are fighting to take throne from Humira. Abbvie seems to be leading in this case with Skyrizi and Rinvoq.
Principia/Sanofi: Sanofi paid $3.7bn for Principia – a company with BTK inhibitor platform that is getting leveraged for multiple sclerosis treatment.
Momenta/JNJ: JNJ acquired Momenta for $6.5bn – JNJ brought anti-FcRN franchise in-house and anti-FcRn is expected to the next therapeutic class for treating autoimmune disease.
Rare disease
Rare disease patients often suffer from deficiencies of critical proteins driven by mutation. Rare disease pricing is protected by regulation to provide incentive for drug development. The volume growth for these therapies is two-fold – 1) genomics is identifying more patients earlier, and 2) patients are living longer and healthier – often these drugs are priced and administered on per kg or per lb basis – so each patient grows and gets heavier and therefore drug volume from each patient naturally increases exponentially over time and this is compounded by annual price increases.
Roche acquired Spark, Pfizer acquired Bamboo therapeutics, Novartis announced a large licensing deal with SGMO, Novartis acquired AveXis, etc. There have been a lot of large cap interest in rare diseases – which is a departure from their historic focus (large volume, pill drug, etc.).
In conclusion
Those three areas have been hot for a while now, but I continue to feel that the trend that supported those three therapeutic areas is secular and still remains early stage. With value getting concentrated on a few select best-in-class or first-in-class products, it only makes sense to focus on the most innovative ones – cheap, middle of the pack products don’t really have a place in today’s winner-take-all market in biotech.
Thanks for reading and please leave any comments or questions below!
