The Life Sciences Report: You see micro-cap investing very much like venture capital (VC) investing. How so?
Joshua Levine: From time to time I talk about micro-cap investing as a form of venture investing for the public. We are not looking for a 25% gain. The micro-cap investor, like the venture investor, is looking for big multiple gains of three, five or 10 times over the life of the investment. There is a very big risk-reward factor for investors in micro caps, and the micro-cap investor should have the same long-term perspective that the venture capitalist has.
TLSR: Josh, you've recently written about and highlighted some differences between your investment philosophy, as you lay it out in the MicroCap Investor, and that of the Dow Jones' editorial staff and how they pick their Next Big Thing list for The Wall Street Journal. At the top of the Dow Jones guys' list are the track records of the VCs sitting on startup boards, as measured by merger-and-acquisitions activity and the total market value of initial public offerings. That sounds reasonable to me. But you differ with that. How?
JL: The Journal focuses on major investors who are involved in the formation of a company, and how these players have performed in the venture game in the past. For micro caps, I believe it takes a different perspective. Above all, it is management's track record and past experience that are crucial. The micro-cap management team is dealing with a different type of investor base and a different set of challenges and circumstances than the management team of a privately held, venture-backed company, with different mandates and obligations to meet in addition to growing the company.
TLSR: Does this mean that you won't invest in a company if its management doesn't have some sort of a track record that you can look at? Or, at minimum, do you insist on meeting management before you become an investor?
JL: With smaller micro caps it is very important for me to meet the management team, to spend time talking, asking questions and seeing how the team projects a strategy, a vision, and how that has been executed on. I also want to find out about the team's ability to adapt to inevitable changes. It's actually more a question of experience and character than track record.
TLSR: It's understandable that you want to invest in very small companies because that's where the big upside is, but the risk is also much greater in any way you want to measure it—maturity of the enterprise, maturity of its market, access to capital, the certain risk of dilution in a very small company, marketability of shares and, of course, volatility of the shares. Can you give me some ideas on how you mitigate the risk in a sub-$100 million ($100M) market-cap company?
JL: Again, it starts with basic due diligence on the management team, and its ability to adapt to change and learn from earlier mistakes. Another important item on my checklist is capital structure. If it is too complicated to understand, then it doesn't make sense to go beyond that. I want to know how the shares outstanding are distributed and the makeup of the different kinds of placements and warrants. Have the stock offerings been well managed and controlled? It should be relatively clean and simple. When it's not, that usually raises red flags. I think there are enough quality companies and management teams that investors should be able to filter out "funkier" companies very quickly.
TLSR: It strikes me that micro caps are particularly vulnerable to intellectual property (IP) challenges, if for no other reason than the fact that they don't have bulging balance sheets to pay IP lawyers to defend patent challenges. How do you diminish the risk of being caught in this kind of squeeze?
JL: I certainly don't have the capability to evaluate 30 or 40 patents in a company, but I try to get a handle on the IP issue by looking at the patents, talking to the people behind the company and trying to get a sense of it all. Companies love to throw their IP around and talk about it as a great asset—that their patents could be worth hundreds of millions of dollars by themselves. But 99% of the time, that's untrue. Most patents really have little or no value. Even with the ones that do, it's questionable what they mean to the company. In some cases, patents are obviously an important strategic tool and a form of defense against competitors, but small companies with limited capital resources can be vulnerable. In many industries, if a large competitor wants to appropriate a small company's technology in one way or another, it can take steps and the micro cap is probably vulnerable.
TLSR: Then, if a micro cap can't afford to defend its IP, even though it might be bulletproof, how do you mitigate that risk?
JL: An investor really can't. But, the positive side to this issue is that often the patents don't give away the goods. There's more to it than that. The most important part of IP is what's inside the heads of the people who work for the company and have a stake in it. The key people—the lead engineers and scientists—are an integral part of the IP. That often creates the defensive barrier against outside threats. In biotech, especially, you don't see the same kind of infringement issues you might see in some other areas of technology. The life sciences are very complex. If a larger company is interested in a smaller company's drug, it usually makes sense for the pharma to work with that company, either through a licensing agreement or a partnership of some sort.
TLSR: Josh, before we talk about your individual ideas, tell me how much of your current allocation is in biotechnology.
JL: Biotech stocks account for almost half of the current portfolio. It is my favorite area. There are a number of reasons for that. Several of the companies in the portfolio qualify as what I call game changers. They are stocks that I'm in for the long haul, and I see tremendous potential for them. These companies have created technology platforms that can enable multiple products, drugs or applications. In that sense they have some built-in hedge to risk because they are not dependent on a particular compound that might fail a clinical trial. The three companies I will talk about today have all of the characteristics that are favorable to micro-cap investing as I approach it.
TLSR: Go ahead first with your favorite idea.
JL: First is Oculus Innovative Sciences Inc. (OCLS:NASDAQ). The company has developed an outstanding medical product called Microcyn. It is an anti-infective agent that comes in a solution and hydrogel. It's pH neutral and is similar to the hypochlorous acid that is produced by neutrophils (a type of white blood cell), which respond to infection, kill bacteria and promote healing. White blood cells release this natural oxidant to fight invading pathogens. Microcyn works according to a carefully controlled chemistry that appears to mimic the body's natural mechanisms.
TLSR: How similar is it to sodium hypochlorite, which is bleach? Microcyn smells like bleach.
JL: Actually, the active ingredient is totally different. Some people in the "websphere" have said that it is just diluted bleach, but it couldn't be more different. The active ingredient in Microcyn, hypochlorous acid, is 70 times more efficacious than the active ingredient in bleach, sodium hypochlorite. Hypochlorous acid is a much stronger antimicrobial agent than sodium hypochlorite. You don't find bleach in the body. Also, from firsthand experience, I can tell you Microcyn is completely safe to drink or spray in the eyes or nasal cavity.
"The micro-cap investor should have the same long-term perspective that the venture capitalist has."
Currently, Microcyn is generally applied to wounds and promotes healing. As the company has moved along it has found hundreds of different uses, including dermatological, oral and surgical uses among a range of vertical markets. Microcyn is very effective because of its anti-infective properties—it kills virtually all bacteria, viruses and fungi—and it has been shown to reduce inflammation, promote oxygen flow and contribute to more rapid healing.
TLSR: I know that Microcyn has several U.S. Food and Drug Administration (FDA) clearances. Have all these clearances come through medical device-type development pathways?
JL: Yes. I think the company has about half a dozen clearances so far, and there are several more in the pipeline, but the company is also pursuing Microcyn as a drug. Initially, it created a formulation proposed for use as an irrigant in surgical situations, and this is very important because it represents the next big phase in the company's development. Right now, saline is the irrigant used most often in surgeries. Microcyn clearly has many advantages over saline because it is such a powerful anti-infective and because of its anti-inflammatory nature.
TLSR: It sounds like it could minimize the use of antibiotics in some patients. Is that how the company is thinking?
JL: Yes. And Microcyn shows no development of bacterial resistance, which is a huge problem in the antibiotic world. Early on Oculus put Microcyn to use on diabetic foot ulcers, which are wickedly terrible and often result in amputations. A number of people have done studies in this area, and Microcyn has had really tremendous results. Dr. Cheryl Bongiovanni, director of the Vascular Laboratories/Wound Clinics at Lake District Hospital in Lakeview, Oregon, a major wound care center, has used it for a number of years and has talked about it in videos and on conference calls. She has said that with the introduction of the Microcyn product, the use of oral antibiotics for wounds has dropped to zero. That is amazing. Her most memorable comment was that it wouldn't matter if Microcyn cost $1,000 per bottle because Microcyn saves so much money by simply shortening the course of treatment so dramatically.
TLSR: What's your next idea?
JL: The next is another platform company: Inovio Pharmaceuticals Inc. (INO:NYSE.MKT). Based on my research, I believe it's the only publicly traded pure play on a complete DNA vaccines platform. To make its vaccines more effective, the company has developed an electroporation technology that helps deliver certain drugs into cells. Cells are designed to keep things out, but with Inovio's technology electrical pulses are sent through the skin to open short-lived pores in cell membranes that permit entrance of the drug that was injected. This greatly improves drug delivery and performance.
The pipeline is impressive. The company covers cancers, both preventive and therapeutic, and infectious diseases such as human immunodeficiency virus (HIV), hepatitis C (HCV), human papillomavirus (HPV), and some other chronic infectious diseases.
TLSR: We've seen therapeutic immunization work in practice, but do you think that investors' perception is that electroporation technology is a gimmick? Does it look like a parlor trick to some investors?
JL: No, absolutely not. Early on there was some question about electroporation, but the technique has been around long enough and has been applied in enough cases to demonstrate that it is the real thing. Today, after all the studies Inovio has done, it has demonstrated very clearly that it gets very impressive T-cell responses. If not for electroporation, it wouldn't get these kinds of responses—and it is getting the responses across all its vaccines. From study to study, it never changes.
TLSR: As I look at the pipeline, with so many clinical studies going on in HPV, leukemia, prostate and lung cancer and with several phase 2 trials going on, I'm thinking that Inovio's $72.5M market cap looks very low. This company has serious activity going on in the clinic. Why is it at this level?
JL: I agree; the company is undervalued. One reason is because everything you just listed is in phase 1 or early to mid-phase 2. However, the biggest reason for this low valuation was that one large institutional shareholder, Special Situations Funds—the largest single holder back in early 2011—held over 21M shares but recently went down to less than 4M shares. It has been unloading its position for a very long time, and I suspect that by the beginning of 2013 it will be completely out of this stock. That accounts for the latest downtrend. Who knows the motivation for selling? But it accounts for a lot of the action.
"There are enough quality companies out there that investors should be able to filter out 'funkier' companies very quickly."
However, I should mention that this technology is still very new, and big pharma has been looking at it closely. Inovio has publicly stated that it is engaged with a lot of large companies now, and the company has certainly not been shy about revealing there is demonstrated interest from big industry players. It just can't project when and what is going to happen.
TLSR: Do you feel that a big pharma deal will validate this company's technology and bring the shares up over $100M, where institutions can begin to accumulate the shares?
JL: It would be a pivotal moment in the company's history, absolutely. It would ring the bell for the industry and send a signal to other potential partners. It would instantly give Inovio the kind of credibility it has lacked.
TLSR: The company has technology licensing deals, for instance with University of Southampton Leukaemia & Lymphoma Research Centre in the U.K. Are these going to be low, single-digit royalty kinds of deals?
JL: I suspect so. But the deals that Inovio made earlier on are along those lines because the company didn't have much leverage in those days. Basically, it had to take what it could get. A few of those deals were done before Inovio merged with VGX Pharmaceuticals, a small, private company solely developing DNA vaccines, back in 2009—which led to VGX co-founder Dr. David Weiner, a DNA vaccine pioneer, to come on as Inovio's scientific advisory board chairman. The structure of those deals and the way Inovio approached them is very different from what you will see in the future. Today the company either has full control or much more control of rights and clinical trials.
TLSR: Josh, what's your next idea?
JL: The third would be Neuralstem Inc. (CUR:NYSE.MKT). It also has a very compelling technology platform. The company is in the stem cells space, but unlike other stem cell companies it has a unique approach in a number of ways. Most importantly, Neuralstem has created an entire bank of proprietary neural stem cells by isolating stem cells from the brains and spinal cords of aborted fetuses. Based on its successful phase 1 trial for amyotrophic lateral sclerosis (ALS) the company's hope is that cells injected into the spinal cords of patients will provide support, perhaps by releasing growth factors, and prevent motor neurons from dying.
TLSR: These are adult stem cells of embryonic origin, but do they maintain their immune privilege as they do during a pregnancy? In other words, I'm wondering if these patients may have to go on immunosuppressants when they receive these cell transplants.
JL: It's a good question. In fact, with regard to Neuralstem's phase 1 trial for ALS, researchers discovered that patients could not tolerate immunosuppressants prescribed after surgery and most of them had to drop or reduce the dosage of at least one of the two anti-rejection medicines.
"The most important part of IP is what's inside the heads of the people who work for the company."
Interestingly, by using a process of "DNA fingerprinting," researchers found that among the five patients who had discontinued all suppression meds for 57 to 638 days prior to death, there was no correlation of DNA content to survival period without immune-suppression drugs. Neuralstem reports that these data suggest that long-term immunosuppression of patients is not required for long-term survival of its cells, which may lead to only transient use of these drugs in future ALS trials.
TLSR: One of the 15 ALS patients from this phase 1 trial has talked to media because he is doing quite well. Even though this trial is a safety-and-dose study, and not powered to determine efficacy, we may be seeing something interesting happen here.
JL: That is true. The patient has talked to the press; he is the only one who has. He's had quite stellar results. The therapy not only halted his ALS, but his symptoms seem to have reversed in a disease that does not reverse. Now, this is just one patient. There's no way to know what's going to happen beyond that. But this patient has really stunned researchers and others looking at the company's technology. It's certainly promising, and great for this patient and his family.
TLSR: I realize that Neuralstem didn't take this story to the media, but the company has put it on its website as part of the news flow. Do you think this could be attracting an unsophisticated retail investorship in the company?
JL: There's always the possibility, but I don't think we have seen that happening. And remember, the company is not out promoting this. In fact, I don't know if you saw CEO Richard Garr's Dec. 4 blog post, in which he addressed this. He stated that this is only a single patient in a longer-term phase 1 trial. He talked about the FDA protocols because of the novelty of Neuralstem's approach, noted that this is only interim data, and said that though something like this can happen, people shouldn't expect this to be the norm.
Garr also pointed out—and I think very importantly—that ALS is a one-direction disease. It is a downward spiral to a terrible death. The other point he made is that people shouldn't expect Neuralstem's therapy to be a cure. If it can halt ALS in its tracks or slow it down, it would be an enormous success.
TLSR: It was a pleasure, Josh. Thank you.
JL: My pleasure. Thank you.
Josh Levine has 25 years of senior-level experience analyzing trends in biological, energy and information technologies and investing in micro- and small-cap stocks. In 2002 he joined independent investment-research boutique ChangeWave Research, where he became editor of ChangeWave MicroCap Investor in 2004. That publication became Levine's MicroCap Investor in 2010. Levine is also senior analyst for ChangeWave Research, which manages a survey network of 25,000 members to track the rate of change in corporate and consumer demand trends, and provides the results through an institutional research subscription service. ChangeWave is a service of 451 Research, a leading global analyst and data company focused on the business of enterprise IT innovation.
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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: Oculus Innovative Sciences Inc. and Neuralstem Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Josh Levine: I personally and/or my family own shares of the following companies mentioned in this interview: None. 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.