The Life Sciences Report: Dhesh, you attended the JPMorgan Healthcare Conference and the Biotech Showcase 2014 in San Francisco in mid-January. What takeaway advice do you have for investors looking into the life sciences sector?
Dhesh Govender: This was the 12th JPMorgan Healthcare Conference that I have been privileged to attend. Attendance was up significantly from previous years. Pharma investors were flocking around the reps of early-stage companies, discussing new product launches and partnership possibilities. Conference chatter revolved mostly around mergers and acquisitions (M&A). The takeaway message is that the valuations of early-stage biotech companies are poised to increase significantly, in tandem with a widely expected surge in M&A activity during 2014.
TLSR: Are the great returns that we saw in 2013 going to continue?
DG: In the early-stage small-cap space, there is significant upside to be realized. However, the upside for many large-cap biopharmas will be capped, especially for firms with product launches. We shall closely monitor the new product trajectories, but companies that enjoyed prelaunch valuation bump-ups will be looking to grow their markets. These firms will continue to concentrate on developing preclinical, phase 1-type assets, as well as on building revolutionary tools to help with clinical trials and patient assessment. On the diagnostic side, for example, companies will employ innovative theranostic (integrated therapeutic and diagnostic) methods to identify the right patients for a drug. I anticipate a small-cap rally to occur early on in the year, with activity leveling off in Q3/14. Then small caps will rally again in Q4/14.
TLSR: In San Francisco, you predicted that 18–20 major life science deals are coming down the pike. What is the catalyst for the life sciences rush?
DG: The books are closed for 2013 and investors have to deploy fresh capital. I know of several large funds that are launching as we speak, and these funds are dedicating more than $500 million ($500M) to the life sciences. Interest in the biotech sector is currently similar to that given to information sector technologies in 2001–2002, when there was an absolute flurry of amazing deals. Last year alone, more than $10 billion ($10B) was raised for life science companies. I expect that number to be surpassed in 2014. The challenge for investors, naturally, is to find well-managed companies with great technology coupled to valuations poised for maximum return.
TLSR: At the San Francisco showcase, presenters talked about different kinds of therapy areas and new technologies, including regenerative medicine. What technologies drew your attention as an investor?
DG: New technologies in the oncology and neurology spaces are especially ready to generate premium pricing power in the marketplace. One reason for the expected windfall is that the regulatory agencies are increasingly amenable to authorizing shorter time horizons for oncologic and neurologic product approvals.
"The valuations of early-stage biotech companies are poised to increase significantly, in tandem with a widely expected surge in M&A activity during 2014."
The barometer is the U.S. Food and Drug Administration (FDA), as well as federal funding for the National Institutes of Health and National Cancer Institute. Even though funding levels have diminished, changes in how the FDA regulates the approval of new drugs are giving these biotech spaces a boost. With its new leadership going great guns, the FDA is now very amenable to working with the needs of new technology companies. We expect that to continue.
In fact, the oncology and neurology sectors contain a goodly number of undervalued companies with upcoming catalysts that have not yet appeared on the status quo radars. I expect to see an influx of initial public offerings for new companies in regenerative medicine and with cell-based therapies for oncology, neurology, and immunology. These in-the-wings product ripenings bode well for good hunting by big pharma.
TLSR: Can you talk about any of the companies you are following in these arenas?
DG: In 2013, Novartis AG (NVS:NYSE) made a very lucrative deal with the University of Pennsylvania to support Carl Junes' work on CD19 for chronic lymphocytic leukemia (CLL). That is a template for the future. Bristol-Myers Squibb Co. (BMY:NYSE) and Merck & Co. Inc. (MRK:NYSE) are taking advantage of the excellent data presented on their PD-1 and PD-L1 antibodies at the American Society for Clinical Oncology in June. Investors in the checkpoint inhibition space will be very well positioned for developments during 2014, I must say.
TLSR: During 2014, will the trend for small life science companies be about solidifying partnerships with big pharma or about positioning for acquisitions?
DG: The opportunities for smaller companies to partner and to make deals is ripe, because big pharma has to enter early to realize substantial value. Smart companies were represented by top management at the Biotech Showcase in San Francisco. Investors want to talk directly to the CEOs and scientists at early-stage companies. I had dinner with a Roche Holding AG (RHHBY:OTCQX) executive during the conference. Roche sent about 150 of its upper-level people to the conference to look at smaller companies and their innovative technologies, and to talk turkey.
TLSR: Is there competition between the juniors for access to the deep pockets of big pharma? What strategies are used to garner such attention?
DG: Data is the currency for early-stage companies. They can demonstrate value as a partner for a large pharma if they have certain proprietary tools and, more important, if they have a target or a product candidate that fits nicely into the large biopharma's existing pipeline—or that can flow in combination with an already approved drug. For example, new vaccines that can be combined with current therapy are hot.
"Last year alone, more than $10B was raised for life science companies. I expect that number to be surpassed in 2014."
Remember too that pharma is a global marketplace. U.S.-domiciled firms with attractive intellectual properties are focusing on the global market, and non-U.S. firms are looking toward the U.S. markets.
TLSR: Let's talk about the pace of innovation, particularly in genomic sequencing, which is accelerating. Is that going to bring down the cost of development for smaller biotech companies and open up access to banking and investment capital?
DG: Innovation in the cost of genomic sequencing is leveling the playing field. For example, the cost of running a trial using the whole genome sequencing services offered by Illumina Inc. (ILMN:NASDAQ) is now less than $1,000. That means smaller biotechs can compete with large pharma in product development and testing. Traditionally, sequencing costs were tens of thousands of dollars per test.
We all know Moore's law, from the technology sector. That trend will continue; paying even less than $1,000 for genomic sequencing is a sweet spot that can be touched. Lowering these costs means more people will be able to pay for access to these new technologies. That will force large pharma to increasingly collaborate with smaller firms at the edge of innovation.
TLSR: Can you provide specific examples of companies poised to take advantage of M&A, partnerships, or new innovations? Are you adjusting your portfolio to take advantage of these trends?
DG: Without getting into trouble with the compliance department at my firm, Cedar Lane Enterprises, I can suggest that checkpoint inhibition is a very hot topic in mergers and acquisitions. We are a hedge fund, and we are constantly looking at strategies and catalysts on the derivative side, as well as the long-short side, to maximize returns. Traditionally, we have observed that pending deals that have not been done by the end of the year are usually done toward the beginning of the new year. We expect a lot more news flow in this sector in terms of M&A, and we will position our portfolio to take advantage of that, especially on the derivative side, during April, May and, possibly, June.
TLSR: Are there any companies with interesting technologies or catalysts that you'd like to talk about?
DG: Sorrento Therapeutics Inc. (SRNE:NASDAQ) has an antibody drug conjugate platform that is blossoming into a full-fledged pipeline project. The driver of Sorrento's lead program is a nanoformulated paclitaxel (Taxol). The company will commence its pivotal first patient trials with this therapy in the U.S. any day now.
With a $213M market cap and a potential launch in two years, Sorrento is tremendously undervalued. Sorrento was started up by the team that launched and developed Abraxane, also a nanoformulated paclitaxel, which was acquired by Celgene Corp. (CELG:NASDAQ). At the JPMorgan conference we heard from Celgene's CEO; Abraxane guided $2B in peak sales in 2013 and should add another $1B in sales this year. Success breeds success!
TLSR: Thanks for your time, Dhesh.
Dhesh S.K. Govender is a portfolio manager for healthcare and life sciences with the Cedar Lane Fund, a division of New York-based Cedar Lane Enterprises.
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1) Tracy Salcedo-Chourré conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an employee. She or her family own shares of the following companies mentioned in this interview: None.
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