The Barbell Approach Builds Powerful Healthcare Stocks: StoneCastle's Bruce Campbell Print
By George S. Mack of The Life Sciences Report   
Thursday, 07 May 2015 15:20

Portfolio manager Bruce Campbell wants the best of both worlds in his Canadian healthcare investments.

He looks for companies that are strong and balanced, with muscular organic growth on one side and healthy acquisitions on the other. In this interview with The Life Sciences Report, the founder and president of Canada-based StoneCastle Investment Management spotlights six names that have proven themselves with good runs but have potential for much bigger gains.

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The Life Sciences Report: As StoneCastle's portfolio manager, my understanding is that you invest in healthcare companies that can help patients in the near-term, as opposed to those that are years away from monetizing a product. Is that close to your theme?

Bruce Campbell: Typically, we're looking for companies that have cash flow or earnings presently, or that have catalysts on the horizon that will enhance earnings and cash flows for their businesses. We don't typically invest in biotechs with binary events down the road, and if we do, they are certainly not going to have very big positions in our portfolio. The event might be further out than a quarter, but it's certainly in the immediate future. We do not invest in research-intensive companies doing drug development that won't get to market for a decade.

TLSR: At StoneCastle, your goals are capital preservation, powerful performance and risk management. In the one-year returns on some of your holdings, I can really see the powerful performance. But I note that you have some very small market-cap companies in your portfolio. How do those themes, particularly capital preservation and

risk management, fit with these small- and micro-cap names?

BC: We look at it a little bit differently than maybe a larger institutional investor might. We have the ability to be pretty nimble because of our size. We invest in smaller companies, and because of that we tend to have better access to management, and we get better, more current updates than we would from a large, multibillion-dollar healthcare company. We feel that really helps us protect our capital because we know what's going on and we can act very quickly. There are not situations where we're handcuffed and

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can't get out of a position. That's capital preservation.

"Nobilis Health Corp.'s marketing component drives more business to its centers and
has been very successful."

Second, looking for near-term catalysts and earnings growth, as opposed to events that are many years down the road, also helps with capital preservation and risk management because we are able to make course corrections very quickly if we see something that we don't like.

TLSR: Being able to make course corrections in a hurry implies that you invest in shares that are marketable. You have to have adequate trading volume in these names, even though they are small caps. Is that, in part, what you are looking for in a company?

BC: That's correct. First, we don't invest in any private companies in the healthcare sector. Second, when we do take positions in this sector, we are typically looking for a name we could move out of in one day's trading volume, at minimum, or less.

TLSR: Before you founded StoneCastle, you worked at major buyside firms in both the U.S. and Canada, where billions of dollars were under management. In that setting, you generally can't buy micro- and small-cap stocks. You clearly had to perform diligence on much larger names in the past. Comparing very large names to very small could be like comparing apples and oranges. What did you take from that type of major fund management experience that applies to this smaller-cap universe?

BC: With many companies we invest in, I don't think it is necessarily apples and oranges. It's a variety of apples that we're looking at.

"We want the safety of the manufacturing business as well as the straight-out, aim-for-the-fences biotech business."

Some of the smaller names have the same characteristics as larger companies. For instance, we look at companies that have revenue, cash flow and earnings. The big difference is the following, or institutional support, that the large-cap names have. In a lot of cases, we're looking at companies with lower multiples just because they are not well followed by analysts and investors. Generally speaking, if you were to look at a company's history, you would be looking for the same types of things. For instance, you'd be looking at how the company compares in growth rate to its peers. One major difference, of course, is that these smaller names have a lot more ability to grow—to double, to triple and more. But you get more volatility with smaller valuations. We've worked that into our process, and we're trying to maintain enough flexibility and freedom if that volatility does show up.

TLSR: You own medtech, drug development and healthcare delivery companies, the latter being clinical companies that could be described as physician practice management groups. From your point of view, what is the easiest of these three categories to analyze as an investor?

BC: I would say that healthcare delivery is probably the easiest, because it comes down to the numbers and the growth catalysts going forward. I would say drug development would be the most difficult, because you're trying to handicap the probability of that drug being successful. Then, if the drug moves successfully through the regulatory hurdles, you must also handicap its market share and its pricing in the market, and whether there is a royalty deal with a larger or smaller company.

TLSR: Let's talk about healthcare delivery for a moment. Some of your Canadian holdings operate in the U.S. Aren't margins poised to shrink in healthcare delivery? Medicare and Medicaid are tightening controls, and private payers are likely to follow that lead in holding down increases in reimbursement. How do you make money in this kind of environment?

BC: Obviously, that's an important thing to be cognizant of. It is going to be one of the longer-term themes in the space. We look at the potential for shrinking margins from a couple of perspectives. One is that the pie itself is growing. If you can get more pieces of that pie, even though the pieces might be smaller than they were five years ago, the pie itself is growing, and therefore you can keep your business growing. But we think that the trend over the next few years is going to be that margins are going to continue to shrink.

TLSR: Does a business model in direct healthcare to patients have to include acquisitions?

BC: We've been very focused on, and very attracted to, companies that have an acquisition strategy. That said, we like to see companies with acquisition strategies that also have some ability to grow organically. What we've found in the industry is that typically a straight acquisition story will be very much in vogue when acquisitions are coming fast and furious. But it becomes a balancing act on how to grow and integrate all of those businesses into a company. The market can start to sour a little if acquisitions don't go so well. When acquisitions start to slow down, the valuation that the market will pay for a company might disappear. That is why we're looking for companies with the ability to grow organically as well. I think there is a lot of opportunity in both of those areas going forward.

TLSR: Let's continue on the direct patient care theme. Could you mention a name in that category?

BC: Nobilis Health Corp. (HLTH:NYSE; NHC:TSX) is a company we own. It has gone out and acquired ambulatory centers from the physicians who originally started the practices, and has kept those doctors as partners. Nobilis does not own 100% of its facilities in most cases. It has also developed a marketing component to drive more business to the individual centers, and has been very successful with that. It has grown by acquisition, but it is also growing organically with its marketing expertise.

TLSR: It's hard to train physicians to be employees—especially entrepreneurs who have founded or originated a business. Do you see physician ownership as a major part of the strategy here?

BC: It is. What Nobilis' experience has shown is that a lot of founders are great physicians, but after their businesses have grown, they discover they are not necessarily great business people. Maybe that's a function of how much time they have to spend working on business versus patient care.

"Looking for near-term catalysts and earnings growth helps with capital preservation and risk management."

Typically, when Nobilis buys an ambulatory center, the business hasn't been very strong. It keeps the physicians as partners to incentivize them to stay at that center and not go out to compete against Nobilis. With its management skills, the company is able to manage the facility, and the doctors are able to practice medicine. That's the formula Nobilis has found works best, as opposed to just having physician employees.

TLSR: Do the centers keep their original names, their original identities?

BC: They have in some cases, and in others, they've changed the name. In some cases, they've brought the Nobilis name into the original name. What you'll end up seeing over time is that the company will eventually move to a branded Nobilis center once it becomes a recognized brand.

TLSR: Nobilis is a Canadian company that operates in the U.S. Is there any way to make money delivering healthcare in Canada?

BC: That is not in Nobilis' business model at this time. I think there is bigger opportunity for the company in the U.S. than there is in Canada. At this point in time, it is not looking too closely at Canada.

TLSR: You also follow medtech. Give me a name you like in that category.

BC: One of the companies that's growing from both an acquisition and an organic standpoint is Patient Home Monitoring Corp. (PHM:TSX.V). Its name reflects what the company is doing. It has a number of different monitoring systems that allow a patient to be tested for different conditions at home, and that information gets relayed to the patient's doctor automatically.

"Smaller names have more ability to grow—to double, to triple and more. But you get more volatility with smaller valuations."

This company has been very aggressive in making acquisitions in the last year, but it is also seeing great organic growth because it cross-sells to its customers. For example, Patient Home Monitoring might go out and buy a company that does Coumadin (warfarin) monitoring. It may find that a certain number of the patients it has just acquired also have diabetes, for which monitoring is very necessary and for which it already has a program. The company is able to cross-sell its services and increase its revenue on that basis, by providing more services to existing customers who have more than one disease indication that needs to be monitored.

The model is to acquire a patient via acquisitions, then to cross-sell a number of other indications that can be monitored from home, and also to acquire small, reasonably priced businesses and then roll them up into one nationwide business.

TLSR: This company's market cap has more than tripled over the past 12 months. By the way, I could say this about any number of the companies you own. Do you worry about some of these valuations, and about the profit taking that could occur?

BC: Certainly we do. But in managing the portfolio, we're continually monitoring our position size. In Patient Home Monitoring's case, for example, we originally bought the name when the stock was significantly lower than it is now. We have had to trim our position to keep its portfolio weighting in check. As you implied, that could be said for quite a few of the names in our portfolio. That's typically how we manage things.

TLSR: Will the smartphone, with specialized apps, enter into Patient Home Monitoring's business model?

BC: If it could, I think Patient Home Monitoring would really like that functionality, because its larger costs cover the monitoring devices it has to buy. If the company were able to pay a software developer to come up with some type of app that could be on a smartphone, it would significantly reduce its hardware costs.

TLSR: Let's go to another name.

BC: Again, we have the acquisition and organic growth theme with Concordia Healthcare Corp. (CXR:TSX). Concordia has gone out and acquired drugs that are off patent. It has also acquired companies at attractive valuations. And now Concordia is starting to see organic growth materialize, both from the companies and from some of the drugs as well. It has been able to increase pricing on some products, sustain the numbers of prescriptions being written for these drugs and, at the same time, increase its revenue and cash flow.

TLSR: Concordia's share price is up five times from 12 months ago, and it is now a mid-cap company with a market valuation of about CA$2.9 billion (CA$2.9B). What exactly has been the driver here? Was it just adding to its product line?

BC: I think that's it. Its valuation was significantly cheaper than that of its peers when it came out as an initial public offering a little over a year ago. Now Concordia is making significantly larger acquisitions. At every step, the market has questioned whether the company could accomplish these acquisitions, and so the valuation has come up every time the company has done what it said it would do. At the same time, the market questioned whether Concordia could put some of these price increases through, and it has. The number of prescriptions being written has been pretty stable, even with the price increases. So its cash flow has been stronger.

TLSR: You own other companies with more than a $1B market cap, but I'm looking down the list, and I see one with a market cap of about CA$18 million (CA$18M)—Revive Therapeutics Ltd. (RVV:TSX.V). Is it unusual for you to own companies that are so small?

BC: It is. And Revive doesn't really fit into the acquisition and organic growth profile that we have been talking about. This company is trying to get an existing drug rebranded for a different indication, and so this is more of a binary outcome than we typically like at StoneCastle. Revive is in our portfolio, but we have a very small position weighting.

TLSR: Even though it's a small position for you, you have obviously found something about it that you like. Tell me about it.

BC: Revive is trying to get its drug REV-002 (bucillamine) approved for gout in the U.S. It is a disease-modifying drug used for rheumatoid arthritis in Japan and South Korea. It has been shown to reduce inflammation, and it lowers the levels of uric acid in the system.

"We like to see companies with acquisition strategies that also have some ability to grow organically."

The efficacy of the drug shouldn't come into question in the 66-patient Phase 2a trial underway now. The primary endpoints will be a composite measure of adverse events that include physical exam, electrocardiograms, labs and vital sign measurements. Final data for this trial will be collected in midsummer, and that's the binary event. The company is either going to meet its endpoints, or it won't. Based on the data Revive has developed, and some of the information that it has from Japan, where the drug was licensed, REV-002 should be successful. Bucillamine looks very promising based on what we know from its use in Asia. Of course, we won't actually know whether it will meet those endpoints until the final data are released.

TLSR: At this low valuation, you must expect some real appreciation of this stock. What do you imagine it could be worth?

BC: Its $18M market cap should probably be fivefold that value. It should be more like a $100M. But Revive is not well known. We think that it could have a fairly significant move with positive results.

TLSR: Did you want to mention another company?

BC: One company that we're pretty excited about going forward is CRH Medical Corp. (CRH:TSX). Again, this is an acquisition story. The company has its own device for hemorrhoid surgery that is a little different from existing treatments. It announced at the end of 2014 that it was acquiring an anesthesiology services group, which performs anesthesia services specifically for gastroenterologists. By having access to so many GI doctors, it will also be able to market its hemorrhoid system, which will drive the organic growth that we've talked about today.

TLSR: This stock has had a pretty good run-up since mid-October. What was the driver?

BC: The anesthesiology services acquisition is fairly significant because the cross-selling could be significant. This business is very high margin, but it's also very fragmented. We think there is lots of room, from an acquisition standpoint, to continue to roll up anesthesiology groups. As CRH does that, it's also going to build the hemorrhoid business. This is a name that we are excited about.

TLSR: Could you mention another name?

BC: Another company that we find quite fascinating and that has done very well isProMetic Life Sciences (PLI:TSX). When we originally looked at ProMetic, we treated it as a manufacturing/commodity business. Its technology allows the removal of different proteins and components from blood, and no one else in the marketplace has the ability to get the same results that ProMetic does. A lot of drug companies in different levels of clinical trials are using ProMetic's product. Its business could grow exponentially as some of these drugs in development get approved. ProMetic could go from small clinical trials to being mass-marketed.

The company has also developed drug candidates for some orphan diseases. If it is successful with one of those, the company could be putting a drug into a fairly significant category, where we could see sales that would propel ProMetic much higher than where it is today.

This name has a base manufacturing business that I don't think you could describe as boring, although it's certainly not exciting when you talk about the biotech world. But it also has a biotech aspect. That's really what we want—the safety of the manufacturing business as well as the straight-out, aim-for-the-fences biotech business.

TLSR: Bruce, thank you.




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