Word on the Street:The Buy-Side View for 2013

The BIO CEO Investor Conference never disappoints. It remains where companies, investors and industry executives can look for a partnership, raise capital, network or simply gain some useful, fresh insight from industry experts. Companies always want to get inside the heads of buy side players, and Monday’s opening Plenary Session, Word on the Street–Buy Side View for 2013, was informative and made me ponder the very future of the industry.

The session was sponsored by ISI and moderated by ISI Senior Managing Director Mark Schoenbaum. He posed some interesting and thoughtful questions to panelists Geoff HsU (partner, OrbiMed), Oleg Nodelman (Founder and Managing Director, ECoR1 Capital) and Nathan Sadeghi-Nejad (partner, Palkon Capital Management).

The questions seemed fairly basic, however the fresh and insightful responses kept the 3600 square foot room packed from beginning to end. Here are a few and some of the responses.

1. The biotech industry was up 45% in 2012. Why?

2. Next, “with new drug approvals increasing, is the FDA becoming easier to deal with or is the quality of applications getting better?”

3. What happens when a biotech stock is overvalued?

4. Has the quality of sell side research changed in the last ten years?

5. How has small cap company management changed over the years?

Addressing the growth in the biotech industry, Geoff Hsu, who considers himself somewhat of a contrarian, noted, “The industry was simply due for a re-rating, especially with the FDA approving 40 new drugs in 2012.”  Oleg Nodelman added that the sentiment was so negative in 2011 and early 2012 that there was no place to go but up.

Addressing the issue of dealing with the FDA, Nodelman said, “The numbers look better but if the FDA were consistently approving poor drugs it would not be sustainable.” Hsu noted that the FDA climate is ‘friendlier’ these days. Consider that in 2012, Arena Pharmaceuticals had the first (of two) obesity drugs approved in the last 13 years (Belviq), when for years the public and investors did not believe this would happen again after Fen-Phen was pulled from the market.

When asked what happens when a biotech stock is overvalued, Sadeghi-Nejad remarked that valuation is more of an art than a science. While this was somewhat of a vague response, he noted that he looks at discounted cash flows, future product P/E, etc.

Nodelman responded, “Models aren’t useful with what I look at. I consider the core value of the company and products. In 2008, everyone was on suicide watch. Therefore relatively 2012 and 2013 thus far seem much better. People also rely on most recent data, naturally. Lastly he noted that the company must be aligned with investors, that you don’t want to see, for example, the CEO selling shares.

Hsu commented that he looks at patent life, peak sales, and milestones. Valuation, he believes, is relevant mostly in the case of extreme undervaluation or extreme overvaluation. Anything in between depends on catalysts. He noted that determining intermediate stock swings is key, which has become much more difficult in the last six years. Hsu boldly says that with enough hard work he can pretty much predict clinical trial results. He admits that this takes a lot of time but he focuses on binary events, reads all literature and utilizes the services of both internal and outsourced biostatisticians.

Regarding the quality of research, Nodelman commented that many more people began looking at the space beginning in 1997. And he noted a concern about an inherent conflict because bank analysts are not going to say anything detrimental about a client company. Noldelman admitted he does not generally rely on buy/sell recommendations.

Hsu acknowledged that his rather logical strategy is to look at what the analysts own, not what they recommend.

The final question was challenging, asking the panelists to point at any changes in the quality of small cap company management. Hsu believes it is better recently because today’s managers typically are more senior and have more experience.

Nodelman noted that some of the best biotech companies were started many years ago by people in their 20’s, but that this is noticeably not the case anymore. In the past, these teams were dedicated to building great companies. In today’s climate, management generally has only an exit on their brain. Building a great company with the ultimate goal of an exit is, says Nodelman, counterintuitive.

Nathan Sadeghi-Nejad concluded by saying that while the teams may be a little better today, there are no real young exciting management teams like those put together by Richard Pops, CEO (now Chairman and CEO) of Alkermes in 1991. Sadeghi-Nejad noted that Pops  brought Alkermes from privately held with 25 employees to an international, publicly traded company with 1200 employees. Pops also serves on the board at BIO.

It was a fascinating experience to spend time getting into the minds of some of the brightest in the industry in this first plenary session where we learned that all of us can always learn something new.

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