The Life Sciences Report: Michael, you are a sellside analyst, but you take a buyside approach to your due diligence process. You have referenced Richard Bernstein's 2005 book, Navigate the Noise: Investing in the New Age of Media and Hype, which among other things recommends that sellside analysts shut themselves off from the herd to discover mispriced equities. How do you think the sellside got its herd mentality in the first place?
Michael Higgins: The "herd mentality" has been around longer than the market, and smart investors are always trying to take advantage of it. Most analysts look at stocks from the bottom up, and aren't following the European Central Bank, events in Ukraine, U-6 unemployment rates, etc. I try to follow macro trends within our industry—things like the Supreme Court leaning into circuit courts and appeals courts, or generic firms' success in getting the U.S. Food and Drug Administration (FDA) to put teeth into branded companies that don't provide samples of their risk evaluation and mitigation strategy (REMS) drugs, etc. This is being addressed in a bill called the FAST Generics Act.
TLSR: You apply the top-down, macro approach with a bottom-up approach, looking at fundamentals of individual equities. How is the top-down plus bottom-up strategy accomplished in the real world of portfolio management?
MH: Top-down approaches aren't owned only by strategists. Analysts, in fact, need to identify themes to understand the forest they are working in. The fact is, 80% of a portfolio's performance can be tied to timing the industries owned, not the stocks. But asset managers need details within the space, and good sellside analysts should be providing a zillion-plus-two details. Let the portfolio managers quibble about what facts are most relevant and adjust their positions accordingly. In our world, a small-cap healthcare portfolio manager knows how an analyst behaves and how the Street reacts. That reaction can be one of the factors affecting the manager's trading decisions.
TLSR: Herd mentality has given rise to some bad habits. Why—or maybe I should ask how—do some significant growth drivers get overlooked by analysts and investors?
MH: Assuming the tenure of a senior analyst is sufficient to allow some time to notice and/or search for investable trends, then that analyst should be able to make those macro calls. But it's also likely that the analyst is under some form of pressure to publish on a company in a space that he or she is not really familiar with, or that evokes some knee-jerk memory or reaction from asset managers. A fundamental call may be misplaced or missed altogether.
"The analyst can push his or her agenda within the firm, or be left with working on an assembly line shoving out research that he or she didn't fuel."
I am very open with all the stakeholders I am in touch with. I am adamant that an analyst has to do his or her own work in a particular space, such as a medical condition, or an overlooked patent rule, or a product's commercial stage. The analyst can push his or her agenda within the firm, or be left with working on an assembly line shoving out research that he or she didn't fuel.
Everyone I talk to agrees with this combined top-down and bottom-up approach, but I typically don't see it practiced when I look at what a specific analyst covers.
TLSR: Michael, performing good, original work on equities means you sometimes have to go out on a limb. Given a choice, would you rather go with the herd at times?
MH: I've been on both sides with the same stock, and that's the worst: You loved it when no one liked it and liked it when everyone loved it. After MannKind Corp.'s (MNKD:NASDAQ) Afrezza ([insulin human] inhalation powder) got approved this August, I got an email from a sales guy I used to work with years ago congratulating me on my call at $2/share. I didn't cover MannKind when he emailed me, and I don't cover it now. I replied, "Thanks." In his response he questioned whether or not I was right to make the call at all, considering how the call made me look until the FDA made its decision. When I originally looked at the company, I called up every MannKind bull I could find to gain some insights, because in 2011 I knew how divisive the stock was, and I heard more passion than fact. It must be my Midwestern outlook, but I'll make that call every time.
TLSR: What does it take to pick good stocks?
MH: Perspective might be something you earn from experience, but real-world results require the right perspective. It's mostly about acting with the right level of conviction. That's one of the requirements for finding misplaced or mispriced securities.
TLSR: The FDA approved 41 new molecular entities in 2014. Are we truly in a new and accelerated era for drug approvals? Are time frames for drug development actually being collapsed, or are there just more development projects in the pipeline?
MH: The FDA did a nice job recapping 2014's results recently. In fact, the agency's report did a good job of showing that there have been more approvals outside of the traditional 10-month reviews than ever before. There are accelerated reviews, breakthrough and orphan drug designations, the Generating Antibiotics Incentives Now (GAIN) Act, etc. Fifteen years ago, major pharmas' response to the inevitable problem of being myopically focused on blockbusters for the biggest health conditions was to partner with another major pharma, or to tweak the molecular design of a leading drug in a category. Their prolonged "be big or go home" strategy has contributed to the investable climate we have today. We have a lot of smaller players that can be tightly focused on a few assets, which is what investors appreciate and will fund. But there's a long list to describe the bullish frenzy we've witnessed. And most are valid!
TLSR: Have drug developers and investors caught on to what works with the FDA?
MH: Pharma management, partners and investors have focused on development of approvable drugs and drugs that are much more marketable than those instigated and developed in the 1990s. I expect these trends will continue beyond the 2016 election.
TLSR: You referenced orphan drugs. That's a very important avenue for investors right now. Will outlier orphan-drug pricing power continue?
MH: We have to watch out for the greedy upside of pricing power because it comes with an inevitable slaughter. And unfortunately, I don't see the mechanism in place for individual companies to exercise the restraint that ultimately benefits the whole. But orphan drugs are still such a small portion of pharmacy benefit managers' (PBM) business that they won't encounter any major headwinds for companies and investors, at least for the time being.
"The 'herd mentality' has been around longer than the market, and smart investors are always trying to take advantage of it."
Looking ahead, the President's 2016 budget projects a 30% rise in Medicare Part D drug benefits, from $63.3 billion ($63.3B) this year to $82.5B in 2016, partly due to the rising cost of specialty drugs. I think that, regardless of the outcome of the budget battle, there's sufficient appetite for reimbursement in the near term, at least from the government's perspective. UnlessExpress Scripts Inc. (ESRX:NASDAQ) or others do more than grab headlines, I don't see PBMs taking the punchbowl away anytime soon. For the last three years I've cautioned those developing preclinical assets from modeling continual price appreciation. I would expect they could continue to enjoy the regulatory tailwinds, despite FDA commissioner Margaret Hamburg's departure.
TLSR: Do you currently have an investment theme or theory? Are there particular disease indications or technologies that you feel strongly about?
MH: I prefer to play in the same sand box. I find that portfolio managers pay more attention to analysts that "own" a particular space, and I've been following the opioid addiction market since 2006. Last September, I had the rare opportunity to have my research on the demographics and prevalence of opioid addiction published as a poster at PAINWeek 2014 in Las Vegas. To me, the real benefit of that has been how it's opened doors for me with addiction key opinion leaders (KOLs). I'm not just another Wall Streeter looking for free info and their free time. I offer the poster, which gives me more time with the guys out there who really know what's going on.
In 2006 I recommended Alkermes plc (ALKS:NASDAQ), and I found underappreciated opportunities in pipeline candidates from BioDelivery Sciences International Inc. (BDSI:NASDAQ) and Orexo AB (ORX:STO) in 2010. To step back, in 2002 Suboxone (buprenorphine + naloxone; Reckitt Benckiser Pharmaceuticals Inc. [RBGPY:OTCPK]) was approved as an orphan drug, but a decade later the number of addicts grew greater than twentyfold, with over a million addicts on buprenorphine annually. I don't recommend Orexo or BioDelivery Sciences today.
"Acting with the right level of conviction is one of the requirements for finding misplaced or mispriced securities."
It's taken me some time to see it, but I've come to appreciate that the biggest growth segment in this market today is in the number of mature, "stable" opioid addicts. If you know one opioid addict, you know one opioid addict—you don't know them all. I don't think investors understand the zillion faces of opioid addiction. While there aren't official statistics for this "stable" group, they encompass any addict that has become "relatively" clean, has surpassed those initial few embattled years of sobriety, and is now truly focused on sobriety. For those living with this type of chronic condition, I believe Titan Pharmaceuticals Inc.'s (TTNP:OTC) six-month implant of Probuphine (buprenorphine hydrochloride implant) will be the leading non-oral choice.
TLSR: With the implant, Titan is bypassing or circumventing the problem of noncompliance, right?
MH: That's right. You can scan the brains of opioid addicts and see their addictions. Except for Alkermes, the active ingredient in these companies' addiction products is buprenorphine. It's a partial opioid agonist that provides pain relief without the euphoria of full agonists like heroin, oxycodone (OxyContin), hydromorphone (Dilaudid) and others. Currently, addicts are supposed to take a sublingual pill of buprenorphine every day. It's a daily test that at least 60% of addicts fail. I believe Titan's Probuphine, a series of four rods of 80 mg of buprenorphine that's linearly released, is ideal for the addict who wants to take a pill every day but is physically addicted to opioids.
TLSR: Titan's shares have been relatively weak over the last two years. What is the issue here?
MH: Probuphine is Titan's only clinical asset, and in April 2013 the company received a complete response letter (CRL) from the FDA. The stock will sit in the penalty box until investors fully appreciate why Titan got the CRL, and what kind of revenue opportunity sits in front of them. The company is now running a fifth Phase 3 trial, called PRO-814, to address the CRL. We're looking for positive Phase 3 results in roughly three months in what we're calling a "patient-ranging" study versus a typical dose-ranging study. Randomized patients are taking half the dose of Suboxone they were in the first four Phase 3s, while Probuphine's dosing remains the same.
TLSR: How will this study answer the FDA's concerns?
MH: Despite the majority of the March 2013 advisory committee (AdCom) voting to recommend approval based on Probuphine's efficacy profile, safety profile, REMS and overall effectiveness—four separate votes—the agency's CRL asked Titan to show the effect of Probuphine when buprenorphine levels more closely approximate the blood plasma levels of Suboxone. The agency looked past the clinical outcomes that the AdCom looked at, and instead focused on the plasma buprenorphine levels. It was an issue during the AdCom, but I was shocked to see the CRL.
"We have a lot of smaller players that can be tightly focused on a few assets, which is what investors appreciate and will fund."
The design of the ongoing Phase 3 is the same as the prior two Phase 3s, except that the enrolling opioid addicts are stable on half the dose of Suboxone. The primary endpoint continues to be a comparison of urine scores that are negative for opioids. There's no reason to believe Probuphine will be less effective than Suboxone in patients that are stable on a lower Probuphine dose. It's unlikely that Probuphine will deliver too much buprenorphine because it's a partial opioid agonist, so its euphoric effects are muted. This is an opioid treating opioid addicts, and doctors want to lower the dose to wean their patients off buprenorphine. But most studies show that takes a long, slow taper. A lower dose would work better as a tapering method. But the risk that too much buprenorphine in these addicts will mean Probuphine is less effective than Suboxone is, we believe, very low.
TLSR: Having an implant would rule out the possibility of a child getting hold of flavored sublingual films and tablets. Very young children have ended up in the emergency department or intensive care unit for eating these products. Should the FDA consider this? Could this be a value driver?
MH: You've done your homework! The amount of new information coming out on this topic is incredible. KOLs are increasingly aware of this issue. It's an increasingly bad problem. In my recent notes on Titan, I've quoted several papers that discuss this topic. Addicts share with addicts! Sometimes to "take the edge off." Sometimes to entice others to start abusing opioids. More often they lean on Suboxone during the week so they can work, then go off for a few days and get high on the weekends. But the hardcore addicts aren't that strategic. They use "Subs" when the money runs out.
TLSR: Please share another idea or theme.
MH: Another theme is to invest in a drug and/or company that can benefit from one or more of the nontraditional regulatory pathways. While these aren't blockbuster markets, the regulatory burdens have reduced clinical expense and risk. Most companies in this space have a limited number of assets, making the research into them more appealing to investors.
Over the past five years, I've recommended investors own Mast Therapeutics Inc. (MSTX:NYSE MKT:), which has a sickle cell therapy called vepoloxamer (purified poloxamer 188; MST-188) in a Phase 3 trial called EPIC with 388 patients. This trial is expected to wrap up around year-end. It will have taken three years to enroll, which is longer than I initially anticipated. The leading competitor is GlycoMimetics Inc. (GLYC:NASDAQ), which has a Phase 3-ready asset, rivipansel (GM-1070). The GlycoMimetics Phase 3 trial was supposed to start last fall, but partner Pfizer Inc. (PFE:NYSE) has held up the start due to unspecified manufacturing problems.
Vepoloxamer is a poloxamer, a tri-block copolymer that contains a unique weighting and combination of polymers. It's unique in that it's a purified version of a poloxamer that attaches to hydrophobic (water-repelling) portions of cells and molecules, and has lipophilic (fat-loving) properties. Vepoloxamer binds to the surfaces of ruptured red blood cells. Think of it as a bird landing on the water, where the wings reconnect the ruptured membrane of the sickled red blood cell as the body sits in the opening of the cell.
"We have to watch out for the greedy upside of pricing power because it comes with an inevitable slaughter."
The hallmark symptom of sickle cell patients is the excruciating pain they experience during vaso-occlusive crises (VOCs), which occur roughly twice a year for roughly 100,000 Americans, primarily of African descent. During these VOCs, the normally round red cells have become sickle-shaped and clog blood vessels. But what drives the decreased flow is the adhesions, which this poloxamer inhibits. Only one drug is approved to prevent VOCs from occurring in the first place. That drug, hydroxyurea, has no impact on a VOC after it starts.
TLSR: Vepoloxamer is in a Phase 2 study for acute limb ischemia. The company's molecular adhesion and sealant technology (MAST) platform could be handy for treating other conditions, not just sickle cell, couldn't it?
MH: Yes. Vepoloxamer is an infused medicine that is being tested in acute indications where red blood cells are rupturing, and there's significant data and rationale for the use of vepoloxamer in other ischemic conditions. We hold vepoloxamer's utility in those conditions as upside. We expect data from that Phase 2 trial in acute limb ischemia in early 2017. We expect data from a Phase 2 study in acute decompensated heart failure by the end of this year.
There is also corresponding upside in ischemic stroke, and in 2015 we will see the start of a Phase 2 trial in shock that will be run by the U.S. Department of Defense (DOD), to resuscitate a patient following major trauma or hemorrhagic shock.
Given investors' weight of the Phase 3 in sickle cell, we are also leaving as upside the Phase 2 results of a drug acquired a year ago, AIR001 (nebulized sodium nitrite inhalation solution) to treat pulmonary hypertension associated with left heart disease. The company has just begun two Phase 2 studies in this indication.
TLSR: Will Mast have to go back to the market for capital next year?
MH: Mast is funded through data, but it may need to raise capital in 2016 if the company decides to hire a sales force. Or, the company could strike a marketing agreement with a Phase 3-positive drug, and that should yield a relatively high royalty rate plus milestones. With no known drug-drug interactions, we believe vepoloxamer will become the gold standard in treating VOCs, and become the most commonly partnered drug for others in the pipeline to be tested with.
TSLR: Do you have one more idea to share?
MH: Yes. I'm always looking for a platform asset or disease pathway that is both validated and unique. That drove my interest in BioDelivery Sciences and Orexo a few years ago. In looking for these prospects, I've been circling around the drug discovery industry for a number of years, and have found a company in Germany that is not only leveraging its unique abilities to develop platforms, targets and novel agents, but is also profitably transitioning from a services company to a generator of partnered pipeline assets. This is a corner that a lot of biotech generators just couldn't turn. . .like PDL BioPharma Inc. (PDLI:NASDAQ) and its Queen patents.
Evotec AG (EVTCY:OTCPK) has approximately 650 employees, mostly in Europe, with most revenues coming from the U.S., and a pipeline that's been growing exponentially over the past three years. So far there's been limited U.S. investor ownership, but we expect roughly a third will be U.S. investors within the next three years as the pipeline matures.
TLSR: I'm looking at the company's pipeline and partnerships, which include Roche Holding AG (RHHBY:OTCQX), Johnson & Johnson (JNJ:NYSE), Boehringer Ingelheim (private) and Bayer AG (BAYRY:OTCMKTS; BAYN:XETRA). I count six drugs in Phase 1 and 2, and more than double that in the preclinical and discovery stages. The company is profitable, and yet the market cap is only about $500 million ($500M). What's the problem here?
MH: Evotec's top-line growth could be larger, if not for the company keeping rights to programs that it is building with its own hands. Evotec has had to give up revenues for the pipeline value they're building. During this time the stock has mostly ebbed sideways, as investors place most of their attention on the quarterly numbers.
We find a lot of reason for optimism. This isn't a small team working on one platform or pathway. The company generates platforms and pathways as its core expertise. While there's been a spike in the number and value of Evotec's partnered programs, most exciting to us is that this has occurred while profits and cash flow have been stable. In other words, the pipeline value continues to grow, and the company continues to be increasingly undervalued by the Street. In the past two years, Evotec's top line has kept pace with the 5–10% growth in the worldwide drug discovery business. But understand that to grow its pipeline, Evotec has had to "take the edge off" revenues it would otherwise receive in lieu of rights on the assets it is developing with partners.
The leading partnered pipeline asset is a Phase 2b oral drug for Alzheimer's disease, EVT302, with results expected from Roche this summer. While the odds are long, this is one of Evotec's partnered Alzheimer's programs, which provides stable revenues in an industry comprised of relatively unstable companies.
TLSR: Michael, thank you.