A new year fosters hope and optimism. In 2009, all Pharma companies, Investors and Regulatory authorities will need wisdom and prudence to bring in cheer. With this backdrop, we have taken a fresh approach in the presentation of our annual Global Pharmaceutical and Biotechnology Outlook (TM) 2009. After defining the key determinants of growth within each sector, we recommend an Overweight position in Rising Stars (RS, unprofitable companies).
Our rationale for recommending that investors be Overweight in the RS sector (as per Recommended Portfolio in Executive Summary Outlook ‘09) is based on a holistic and comprehensive analysis of the BioPharma industry in the US, Europe, Japan, and Emerging Markets over the last decade, coupled with revenue projections for this universe through 2016. Almost all Global pharma companies will have to address the rapid top-line decline driven by patent expiries (without much in their pipeline to make up for this erosion), increasing therapeutic substitution and voluntary or Government-ordered price cuts. Perhaps for the first time ever, consumers in the US (and likely elsewhere), are avoiding filling prescriptions due to the current economic turmoil, and questioning the safe haven status of the BioPharma sector (despite modest outperformance in recent weeks). We discuss these trends in our report on the Global US and EU sub-sector.
Global pharma should have externalized its R&D efforts aggressively from 2005, when its R&D outlook started deteriorating. However, the current stock market crisis offers an opportunity to acquire promising pipelines of RS companies, now trading at attractive valuations.
RS company managements focus mostly on innovations that can bring about novel products and are usually funded by angel investors, Venture Capitalists (VC), Private Equity investors, and the public following an IPO. The investors are using a broad brush for all innovators, applying a historical barometer and law-of-average method to evaluate these firms. It has become imperative for a RS to seek better avenues for their funding from sources which “values its efforts,” Global Pharma or Mature Biotech companies fully understand the value of innovation, and hence are the most “suitable partners.”The liquidity crunch on the street does not justify discounting value of innovations as many late stage products are necessary to fulfill the pressing needs of doctors and patients.
A symbiotic partnership model is emerging as many of the large companies find the “string of pearls” approach an efficient way to rebuild a balanced pipeline by joining hands with a number of RS companies. Those RS companies with a late stage product and sound proof of concept have an upper hand in bargaining, as good products are even more scarce than cash. Cash-rich, pipeline-poor Japanese companies have confirmed this trend, as illustrated by the substantial premiums paid by Takeda, Eisai and Shionogi recently.
The current economic environment once again forces us to remember the two key points while investing in the RS sector:
1. Major corrections in valuation have proven to be an excellent entry point.
2. Among the hundreds of “Fallen Angels” lie a handful of promising RS companies.
Prudence justifies that long-term investors focus on certain criteria that surface a select group of companies with a POC (proof-of-concept) at hand or just around the corner. In our Macro thesis report in RS, we have selected 41 RS companies and train our focus on the 14 Opportunities. Macro matrices based on the following parameters frame the debate for these companies.
1. Ability to develop a drug for an Unmet Need – ie: Vaccines, Genetic diseases , etc.
2. A First in Class or Best in Class compound.
3. Partnership with a large company for at least one of its compounds that validates the promise, while reducing risk.
4. Cash for at least 18 months to sustain burn/investments in PhII and PhIII clinical development of own pipeline.
5. Innovative and Proprietary Cutting Edge Technology and/or discovery platform.
6. Track record to bring a compound from the Bench to Proof of Concept stage and (in a handful of circumstances) to the market place.
Based on this we expect our Rising Star top picks, BioMS, Intercell, Intermune, LifeCycle Pharma, Myriad Genetics, and NicOx are to become tomorrow’s “Shining Stars” or Mature Biotechs.