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Michael Berry Applies His 10 Discovery Investing Factors to Biotech

Source: George S. Mack of The Life Sciences Report  (11/20/12)

Michael Berry Discovering how and why a famed natural resource investor would begin to apply himself vigorously to biotechnology stocks is fascinating. Take Michael Berry, founder and managing director of Discovery Investing, for example. Berry doesn't shy away from high-risk biotech plays because he loves the feel of hitting a grand slam right out of the park, even if that doesn't happen often. Berry brings his expertise toThe Life Sciences Report in this interview, sharing his best ideas and describing how he applies his Ten Discovery Investing Factors to some very sophisticated biotech companies.

The Life Sciences Report: We know you as a natural resource investor, but you've actually been involved in biotech for 10 or 11 years. Back in May, you wrote a note saying you would concentrate more on life sciences. Why?

Michael Berry: The issue is mainly one of asset allocation. It is true that for the last decade we've been focused on natural resource investments, but we think there's a slowdown coming in that arena for the interim. We've kept our fingers in life sciences, but the resource sector has been so hot for so long that it almost took over. I'd say we have been about 65% resource-oriented, with about 20% of our investments in life sciences and the rest in infrastructure and high tech. The key is that our discovery model, the factor structure, applies to all of these different areas because they are based on basic discoveries and the resultant valuations.

TLSR: Anyone who knows you is aware of your Ten Discovery Investing Factors. Would there be any notable differences in how they are applied to biotech versus natural resources?

MB: I apply the same model—the same 10 factors—to high tech, to infrastructure, to resources, to biotech or any company in the life sciences. At the very top level, there are no differences in how we score companies.

A little over a year ago a group of senior investment thinkers took those 10 factors, which I had defined in 2000, and applied them to resource investing and life sciences. In other words, we built a tree of questions incorporating each of the 10 factors for each sector, recognizing that we were looking at different issues in a cancer-discovery project versus a copper mine. Copper is grade, tonnage and that type of thing. A cancer discovery deals with clinical trials, genetics, small molecules and biologics. There are differences in the way we score a cancer company versus a copper company, but in general, a world-class discovery in either field yields great wealth.

"There are differences in the way we score a cancer company versus a copper company, but in general, a world-class discovery in either field yields great wealth."

Investing in life sciences has a very strong quality-of-life aspect to it—a very strong social investing perspective. People have not caught on to this benefit of Discovery Investing (DI) yet. That is a big difference between life sciences and resource investing. Many people consider resource investing to be a negative—an environmental problem and so on. If a company is looking for a cure for amyotrophic lateral sclerosis (ALS), multiple sclerosis, infectious diseases and cancer, it would be considered a socially productive investment. However, you cannot build green energy infrastructure without cheap copper. That's where the socially responsible aspect of DI comes in.

Also, because the life sciences arena is an incredibly expensive endeavor, I look for management teams that can deal with dilution effectively, whether that's done with joint venturing or multiple products. The monetization strategy is different in the life sciences arena. How do we get to the endpoint where a little company can pay off its investors? That's quite different from what we see in the resource sector.

TLSR: You have some really small-cap biotech stocks in your portfolio. Are you concerned that their technologies, values or growth potential will be overlooked because of share liquidity and share marketability issues? How do you deal with that as an investor?

MB: I was a fund manager at Heartland Advisors Inc., and I learned value investing from some of the giants in the field. David Dreman was one, and Bill Nasgovitz of Heartland another.

I learned micro-cap investing from Bill. In the late 1990s I got caught in a downturn in the value cycle. Everybody says there are four different ways to classify stocks—they are either value stocks or growth stocks, or they are small-, mid- or large-cap stocks. But I realized there was a whole discovery sector in the world that didn't fit into those classifications. These stocks are very small and very illiquid, and investors take on a huge amount of risk because nobody covers them. But the reward potential is great. It's like baseball, where a .300 hitter may win you the league championship. If you have a world-class discovery in life sciences, you don't need a lot more than that one discovery. Take ImClone Systems Inc., for example. One out of 10 is equivalent to a .400 batting average in baseball.

"The socially acceptable investing aspect also makes life science investing extraordinarily worthwhile for people in their 50s, 60s and 70s."

To answer your question: We effectively manage our risks to take profits when we see run-ups, and not sell the entire position. If the 10 discovery factors are used correctly, and a large "crowd" scores the company, most of these stocks do have run-ups. We attempt to help increase liquidity in the stock by writing about it, but it does take a special kind of investor to accept Discovery risk. Those of us who are baby boomers—and there are quite a few of us out there—have had our wealth portfolios cut by 30%, plus or minus a little, across the board. We are looking for investment media for a small percentage of our wealth, say 5–10%. Discovery in life sciences is it. The socially acceptable investing aspect also makes life science investing extraordinarily worthwhile for people in their 50s, 60s and 70s. It allows Grandpa to do something worthwhile for the grandchildren, who may face increased risks of diabetes, cancer and other immune-related diseases.

TLSR: Good news or progress in a company's pipeline can actually go unnoticed in these micro-cap companies. People aren't just selling on the good news, but they're ignoring good news entirely and using any excuse to sell these kinds of stocks.

MB: We've seen that across the board in the micro caps. Liquidity is very tough, and this issue has become very severe in the past three or four years. It is difficult to raise money at this stage of the game. But the problem is unique in that I think it's a result of the 2008 credit crisis, which has not yet been resolved. From that perspective, I see a one-off here. You're absolutely right that it doesn't matter what a company says: I can think of a dozen companies that have had clinical successes in trials, and the market yawns. The market is afraid right now, but I think as we turn into winter we will start to see some reaction.

TLSR: Could you tell me your best ideas?

MB: OPKO Health Inc. (OPK:NYSE) is a company that Dr. Phillip Frost has put together over time. It's what I call a generator company. Frost is chairman of Teva Pharmaceutical Industries Ltd. (TEVA:NASDAQ), and owns 47% of OPKO. He is a very significant individual in the life sciences world. I don't own OPKO at this stage of the game, but at some point I may choose to.

It boggles the mind the number of different projects that OPKO has under way, and it also has many good—and interesting—products. My guess is that over time the company will spin some of these products off into separate companies, or it will joint venture them, or it will sell them to big pharma. Frost has already sold two companies with sales of around $1 billion ($1B) each. I'm guessing that is how he plans to monetize products at OPKO as well. The key thing about the company is that it has been derisked, and it's also quite liquid.

TLSR: Back in May, the American Academy of Family Physicians recommended against performing routine prostate specific antigen (PSA) tests on asymptomatic men of any age. That position is in line with the U.S. Preventive Services Task Force. There is a chance that reimbursement standards could be tightened. To that point, OPKO's PSA is a point-of-care test, and I wonder if the company could be advantaged by providing point-of-care turnaround so that clinicians do not have to use a reference lab?

MB: That is a point Frost has made with me a number of times. OPKO knows this industry pretty well, and yes, I think it could be advantaged. The PSA test that OPKO has is, in fact, point of care, which means a reduction in cost, and that's what everybody wants in the life sciences game. The last time we met with Frost, the first thing he wanted to talk about was the PSA issue. It is on his mind, for sure.

TLSR: OPKO recently acquired Prost-Data, doing business as OURLab. It's a boutique pathology laboratory specializing in oncology diagnostics serving urologists. It was a $40 million ($40M) acquisition. What is your impression of this addition?

MB: I am very positive on it. It adds horizontal integration for OPKO's point-of-care diagnostic systems and is another outlet for the company's 4Kscore prostate diagnostic system, a next-generation PSA test. The company is also developing a point-of-care version of 4Kscore. This is a major push forward, in the sense that it is diagnostic, quick, cheap and, hopefully, soon available. It will add significant value to the company.

TLSR: Is there another company you want to mention?

MB: I am really interested in ChromaDex Inc. (CDXC:OTCBB), and I would mention that Phillip Frost has a position in it. I like it because it's a phytochemical and biologics company. I think it can sidestep a lot of U.S. Food and Drug Administration (FDA) hurdles—not all of them by the way, but a lot of them. This is a tremendous market, with some billion-dollar submarkets. The company has some revenues currently, and Fidelity Management and Research Co. is invested in it. Phytochemicals and biologics are a nice combination when looking at the traditional FDA-controlled world.

TLSR: There is a wave of interest now in nutraceuticals all over the world, not just in the U.S. There is also a lot of retail investor interest in these types of companies and their products. Do you see ChromaDex as a beneficiary of these two factors?

MB: Yes. The marketing channels in nutraceuticals are completely different from the standard. Turn on the TV early in the morning and you will see many ads for different nutraceutical products. In addition, ChromaDex has set the standard for testing of nutraceuticals and phytochemicals in the industry. I think the company has a bright future. This is one of those stocks in which an investor knows what his or her downside is—it's $0.65, where the stock has made a good base for about a year now. It is a fairly cheap stock, and there could be two to three times upside in this company. Management seems on track. It has had pretty good exposure on 60 Minutes and other television series. It is an interesting discovery company.

TLSR: What is your next idea?

MB: It's Senesco Technologies Inc. (SNT:NYSE). The discovery here was made at the University of Waterloo, in Ontario, Canada, which was my alma mater. Naturally, I gravitated to it immediately. It's a genetic therapy, and the eukaryotic translation initiation Factor 5A gene, eIF5A, is an old one. It is highly conserved by evolution, existing in both plants and animals, and it encodes the eIF5A protein (Factor 5A) that controls apoptosis, or cell death.

Developing the therapy, which is focused on multiple myeloma and other B-cell cancers, has been a long haul. The company is currently in the clinic and on its second cohort of tests on multiple myeloma (MM). Based on the first cohort results, we are encouraged that the company may have a safe and significant treatment.

"I look for management teams that can deal with dilution effectively, whether that's done with joint venturing or multiple products."

The stock hasn't had much love. It's at about $0.15 today; the company has a market valuation of only about $20M. Senesco had new management come in a few years ago, including ImClone Systems Inc. co-founder Harlan Waksal, who loved the play and took over as chairman, then hired a new chief executive. The company is targeting eIF5A with the RNA interference (RNAi) drug SNS01-T (nanoparticles consisting of small interfering RNA). It is in a phase 1b/2a clinical trial. So far, it has had good results. Multiple myeloma doesn't have many good therapies, as I'm sure you know.

TLSR: Revlimid (lenalidomide; Celgene Corp. [CELG:NASDAQ]) is the only one I can think of right now.

MB: That's correct. SNS01-T has actually stabilized two of the three patients in the first dosing. These were refractory patients who had failed other MM therapies. The dosage will increase with the second cohort. There are four groups to go through. The Mayo Clinic is doing the testing, along with the University of Arkansas for Medical Sciences in Little Rock, and the Mary Babb Randolph Cancer Center at West Virginia University. The therapy appears safe. It appears to be hitting its target from the markers they are measuring in multiple myeloma patients, and that is a big positive.

The company also teamed up with Celgene and did preclinical tests using a combination of Revlimid plus SNS01-T, which had an 86% success rate in mice. Five of the six mice showed no cancer, no tumors, after 10 weeks. Again, this was preclinical, but it is very positive. The therapy is beginning to look like it may work. Plus, Celgene is around Senesco now.

Obviously, the share price is too low at this stage of the game. But the company was granted orphan drug status on two other blood cancers. It is going to be able to roll out this therapy, targeting other cancers as it goes down the road. The company also fixed its capital structure recently. It had a lot of preferred shares, but now it won't have a lot of overhang.

I'm pretty excited about this one. I own a lot of Senesco, and I have never sold any. I know the management team very well. Kip (Christopher) Forbes, of the Forbes family, is probably the biggest shareholder now. Senesco is a good name, and it's a cheap stock that should be rewarded.

TLSR: Not only is it a cheap stock, but it also received a delisting notice from the New York Stock Exchange Market (NYSE.MKT).

MB: The company was going to try to raise a significant amount of money to avoid the delisting. My preference would be to let the delisting go forward. What does it matter whether you're on NYSE.MKT or not? The company doesn't have a lot of institutional holding, but it is in clinical trials with its main drug and it has had some success. I'd go for the goal line now, and I would not dilute the company down.

"Phytochemicals and biologics are a nice combination when looking at the traditional FDA-controlled world."

If SNS01-T appears to have some efficacy with its Factor 5A drug, even in the most minimal dose, which is cohort 1, then the price will take care of itself. Obviously, there is the issue of having enough money to continue forward, and the company is talking to a number of large pharmas. We shall see where it comes out. At this stage of the game, I'd move forward and get the 1b/2a trials done. I'm a very large shareholder, and I have a lot of people in this stock, but I'm not interested really in seeing the company raise $7–10M at $0.15 at this stage.

TLSR: Is it possible that the company could actually get through phase 2 trials and then through proof of concept? Can it raise the capital to do that?

MB: Yes, I think it can. If you look at the people behind it, like Harlan Waksal and Kip Forbes, I don't think it will have any problem raising the money. But I do worry about the dilution. Senesco is going to have to have a program whereby it can get the share price up and then get out in front of investors, both retail and institutional, to talk about the company.

TLSR: What's your next idea?

MB: Neuralstem Inc. (CUR:NYSE.MKT) has had quite a bit of success. I've been with this company for six or seven years. It has a bank of stem cells that it created from a single source. It has teamed up with foremost stem cell researcher Dr. Eva Feldman, a neurologist from the University of Michigan Medical School. The company has been transplanting stem cells to deal with a number of conditions—from ischemic paraplegia to chronic stroke to spinal cord injuries, like those we see in football and other sports. More recently, the company has had pretty good success in the clinic at Emory University on ALS (Lou Gehrig's disease).

TLSR: Neuralstem is up 53% over the last three months.

MB: It has made significant strides forward over the past few months.

TLSR: This stock has had a very rough time during its life cycle as a public company.

MB: Yes, it has, and so has Senesco, which has not turned around yet. I am a discovery investor, and discoveries have been made in and for both of these companies. But until they are properly explained to the market and realized by the market, the prices aren't going to move.

TLSR: It does seem that micro caps do not communicate well with the markets at times.

MB: It is the sector's biggest failure, because in discovery, whether you are talking about natural resources, biotech or high tech, they all have the same model. Most management teams focus on discovery. They are geologists, biologists, chemists or whatever, and they don't have the skill to attract people who can sell the significance of their discoveries to the marketplace.

TLSR: Mike, I've enjoyed speaking with you very much.

MB: I enjoyed it too. Anytime. Thank you.

From 1982–1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published a book, Managing Investments: A Case Approach. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.

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DISCLOSURE:
1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: Neuralstem Inc., OPKO Health Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Michael Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Neuralstem Inc., Senesco Technologies Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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