By The Sick Economist
“Now is the Winter of our Discontent”
–Richard III, by William Shakespeare.
With the biotech sector being crushed in 2021, investors continuing to drown in red ink in early 2022, and millions of global investors fleeing from risky equities in general, how do we know which biotech names will survive for the long haul?
Pain is a biotech portfolio that only goes down. In 2021, the SPDR S&P Biotech ETF, commonly known as $XBI, plunged 20.5%. As of mid January 2022, the benchmark biotech index has tumbled another 10%. Within this index, many of the more cutting edge companies have tumbled even further.
What happened? As recently as 2020, the biotech sector was the darling of Wall Street. As the world confronted the worst pandemic in the last century, the public looked to the biotech industry to innovate our way out of trouble. And they did, producing a variety of Covid vaccines and treatments in record time. There is no doubt that the world in 2022 is in a much better place due to the robust innovation of the biotech sector.
So why are we seeing red across the board? The phenomena has much less to do with the specifics of the biotech sector, and much more to do with a general “flight to quality.” As the Federal Reserve has strongly signaled the beginning of a new interest rate regime, where fighting inflation is the priority, global investors have been abandoning risky, early stage, non profitable companies en masse. Just as Cathie Wood’s Ark Investments, a bellwether fund for innovative “new economy” companies, has been punished relentlessly, so has biotech.
Over the last few years, Wall Street has encouraged biotech companies to go public at earlier and earlier stages. Traditionally, new biotech concerns only became public companies when they had solid data from human testing in at least phase I or phase II trials. In the last year, dozens of embryonic biotech entities have IPO’d without any “clinical stage” data. This means that these companies have literally raised hundreds of millions of public money based only on tests done on rats, or even just simulations run on a computer. These kinds of companies would be many years away from offering a viable, revenue producing product. With the sudden change in the global business climate, investors have suddenly become skittish about making such giant “risk on” plays.
Any experienced investor knows there is opportunity in chaos. If the entire sector is crashing, some quality, sustainable companies are bound to be forgotten amongst the tumult. What are qualities that the astute equity shopper should be looking for?
First, we should be looking for well funded entities that are not going to run out of cash during the upcoming funding winter. Why would so many very early stage companies have gone public, when they won’t realistically have a product to sell for years? Because over the last five years, raising money for risky ventures has been like taking candy from a baby. With the Fed pumping out endless oceans of money and the rich constantly getting richer, the assumption was that young biotechs could always go back to the funding well. It now appears as if that well will be capped. So if you didn’t get enough water to last while you could, get ready to die of thirst.
Second, to earn the title of a publicly traded “company” rather than simply existing as a publicly traded “entity,” your target company would need to be reasonably close to commercial viability. This means they should have sold data in hand from at least a few stage one trials, with at least one agent in or around stage two testing. This kind of target company could realistically produce revenue in 12 to 36 months. The hundreds of prematurely IPO’d early stage biotechs may well just fade away if the market continues its downward trend over the next two years.
This would seem like a simple screening criteria. After all, to be considered, a biotech company would only need to meet those two criteria. But when you do your research, you will be shocked how few companies really do meet those standards!
Below find three companies that will probably survive the coming “biotech winter.”
1) Sage Therapeutics ($SAGE)
Sage may be less than a year away from launching a novel medicine into a market with massive unmet needs: major clinical depression. Anyone who has struggled through the depression of a loved one can tell you that modern medicine is only beginning to understand how to treat this devastating diseases. Most medicines on the market today take a month or more to work, if they work at all. Sage’s new medicine, Zuranalone, has been proven to work in days.
In addition to a real possibility for actual hard revenue in the not distant future. Sage has a number of other things going for it. The company has a diversified pipeline in the neuro/psychiatric field, with several molecules in ongoing testing to address diseases that have few effective remedies at the moment. They have a rock solid $1.8 billion in cash on their books, as well as a partnership with Biogen ($BIIB), a much larger pharma concern with deep pockets that could help their smaller partner weather any storm. And they have an energetic new CEO in the form of Barry Greene, who has demonstrated acumen in the past new product launches.
The only question that has dogged Sage for years is: exactly how big of a market will Zuranalone enjoy? Wall Street has been very interested in Sage when they thought the novel medicine could become the “go to” treatment for depression, and less interested when it sometimes appeared that Zuranalone could be confined to a more niche role in psychiatry. Either way, the medicine would represent a bold step forward in the treatment of depression, and this company appears to be in good condition to persevere while other biotechs are dying left and right.
2) Achilles Therapeutics ($ACHL)
Achilles is a small company with big potential, that has positioned itself in such a way that it will be able to see its research to fruition. There are a few clear reasons why their current posture looks durable.
First, Achilles is working in the right market, at the right time. Achilles is developing cancer treatments within the immunotherapy space. They are targeting lung cancer and melanoma, which are some of the deadliest diseases out there. The media is filled with miraculous tales of breakthrough immunotherapies causing these cancers to disappear like night ghouls exposed to sunlight. When current cancer immunotherapies work, they really work. But even mega blockbuster therapies like Keytruda work less than 50% of the time. Why would these treatments work so well in some people, but not at all in others?
Achilles believes the answer lies in personalized medicine. Each human being has a vastly complex, unique genome, and Achilles aims to unlock the individual answers that hide in all of our underlying source codes. Achilles currently has two separate phase I/phase II studies running to test these theories. This would mean that they could have viable products in two to three years. The company’s cash reserves are well stocked to make it to the end of 2023, by which time, they may not find it to be so hard to raise more cash to advance novel oncology approaches that have shown positive results.
Of course, that is always a big IF. The reason why lung cancer and melanoma continue to kill millions of people is because these diseases are very tough opponents. That very difficulty is another advantage for Achilles. If they can demonstrate any positive results at all, they are unlikely to ever go broke. There are many pretenders to the throne, but few can demonstrate real progress against cancer. Those that can, get financial support pretty quickly.
3) Zentalis Pharmaceuticals ($ZNTL)
Zentalis is also going after solid tumors, and there are several aspects of this young company that make it primed for successful commercialization in the not too distant future.
First, the company has no less than five different phase II trials going on for two different agents. That represents a lot of “shots on goal.” The more times you kick the ball towards the goal, the better likelihood of score.
Second, at least one of the company’s novel molecules already has a proven market. Molecule ZN-c5 is aiming to be the first oral SERD drug on the market. The existing dominant SERD is a drug known as fulvestrant, and has been administered to millions of breast cancer patients over the last twenty years. It is a very established drug in a huge market. But the current preparation of the medicine must be administered in painful and inconvenient injections. Zentalis’s new solution is a very similar medicine, but in a pill. The obvious commercial promise of this new formulation has lead Zentalis to score research collaborations with heavy hitters such as Pfizer ($PFE) and Eli Lilly ($LLY).
So, Zentalis could realistically launch some very lucrative cancer agents within two years. And the business is very well funded to reach that point, whatever the stock market does over the next few years. Recently the company reported that it had $366 million in cash on it’s books, which it believes should fund all operations through the end of 2023.
Lastly, Zentalis has experienced leadership in the form of Dr. Anthony Sun. Dr Sun holds both an MD, and a MBA from the Wharton School of Business. Most importantly, he spent most of his career on Wall Street before leading Zentalis. Anyone with a clinical background can lead a baby biotech when times are good and the dollars flow like wine. But when the market is crashing, and the funding spigot is suddenly turned off, it’s good to have a Wall Street veteran steering the ship. Dr. Sun knows a thing or two about funding biotech companies, meaning that Zentalis is unlikely to fail due to lack of resources.
When will the pain end?
Unless you know someone with a crystal ball, it would be hard to predict. But anyone who has been through the manic cycles of Wall Street can tell you that risky, underfunded, unprofitable biotech stocks could have a long way to fall from here. There is no natural bottom for an entity that raised hundreds of millions of dollars with nothing more than a petri dish and a dream. Do your own research, and stick with companies that were built to last.
Disclosure: The Sick Economist owns shares in $SAGE and $ZNTL