Biotech Investing
Investment approaches that work in a challenging industry
By: Greg Obenshain, Daniel Rasmussen, and Anton Wintner, M.D.
Pharmacyclics was on the verge of failure. The company had IPO’d as a biotech darling in the late 1990s, peaking at $12 per share. In a pivotal Phase 3 trial, the company’s lead drug candidate, Xcytrin, failed to gain FDA approval. Despite a positive clinical trend, and what many experts at the time considered meaningful therapeutic activity, the trial had not reached statistical significance of its primary endpoint. Now, in the dark days of the financial crisis, Pharmacyclics stock traded close to $1 per share, with the NASDAQ threatening to delist the company.
Desperate and with few other options, Pharmacyclics doubled down on Imbruvica, a BTK inhibitor that had shown two partial responses in chronic lymphocytic leukemia. The move represented a dramatic departure from its previous lines of research and was considered a long shot.
The bet, however, would pay off. From the depths of crisis, Pharmacyclics would recover from the brink of delisting to a stock price of just under $15 in 2011 when Johnson & Johnson agreed to partner with Pharmacyclics on Imbruvica in a deal valued at $975 million. The drug went on to become one of the most promising new treatments for chronic lymphocytic leukemia, with Pharmacyclics stock hitting $261.25 in 2015 after AbbVie purchased the company for $21 billion.
This story of Pharmacyclics, recounted in For Blood and Money: Billionaires, Biotech, and the Quest for a Blockbuster Drug, is the prototypical biotech investment story. Biotechs face the constant specter of a failed trial, the despair of a struggling research agenda, the doubts that can send share prices spiraling to the verge of delisting. And they hope for and often achieve the clinical breakthroughs, pursuit by big pharma, and headline acquisitions that ultimately lead to outsized returns.
Biotechs are perhaps the most promising and most heartbreaking companies in the small-cap investment universe. They enter public equity markets for the purest of reasons: to raise capital at the scale necessary to fund the enormous expenses necessary to deliver life-changing drugs. When they succeed, they can achieve huge valuations in a short period of time. But they fail at a rate that is much higher than in other industries.
In the last 30 years, of the just over 1,000 biotechs that have reached at least $200 million of market cap, a whopping 67% have lost money. Of these, roughly 50% were acquired at negative total returns, 10% delisted and the remaining 40% are still public with a significant proportion trading below their cash balance representing “zombie biotechs”; failed programs where cash remains stranded instead of being returned to shareholders. Of the 33% that were successful, 55% were acquired and the remaining 45% are still public.
We have been working for over a year on a white paper in which we chart a path for how to navigate this sector. We cover the strangeness of the sector, the recent tribulations that have led to massive underperformance of the broader market, the important role played by specialist biotech funds, the factors that drive performance, how to manage risk, and, ultimately, a strategy for how to invest quantitatively in the biotech sector.
The paper, which you can download below, is the culmination of over a year of work. We’ve built our own database of biotech specialist holdings and company insider disclosures. We’ve studied SEC filings, acquisitions and company-level financials. We’ve created a point-in-time dataset of more than 130,000 clinical trials with meta data allowing us to quantitively compare individual trials and company-level research programs. And we’ve built signals based on these data sets that help point the way to a strategy for investing in the sector.
The biotech sector is difficult terrain to traverse. But consensus pessimism is what creates the ideal conditions to invest. The right data gives us the coordinates we need to cross the waste land. With a disciplined long-short strategy, we believe we can capitalize on the conjunction of change and science that defines biotech investing.