By the Sick Economist
Violence is in the air these days. Whether it’s fretting about an imminent invasion of the Ukraine, or the Chinese Communist Party’s constant threats against Taiwan, or America’s endless role as the “world police,” talk of violence is all you hear in the media.
Anyone who has substantial investments in the biotech sector certainly feels like a victim of financial violence. XBI, an exchange traded fund that serves as a proxy for the more cutting edge names in biotech, has lost nearly 50% of its value in just one year. Within that index, many publicly traded companies have seen their share prices plummet by 60%, 70%, or more. We haven’t seen this kind of swift and total collapse of a sector since the tech collapse of 2001. Many less experienced investors are shell shocked.
“Shell Shock.” Most readers will have an idea what that term means, but may not fully understand its origin. Shell shock was a term used for soldiers from the World War I era who went off to war and were never quite right again, even if they were lucky enough to survive (And many didn’t. Some estimate that as many as 40,000,000 people died as a direct result of World War I).
Not only were individual soldiers unprepared for the living hell they were wandering into, but the world, in general, had no idea about the level of destruction that was about to be unleashed. 19th century armies showed up to a 20th century war riding horses and carrying revolver pistols. They were met with steel tanks and hot lead dispensed from the muzzles of rapid fire machine guns. Many European generals thought the entire conflict would be over in less than a year. 5 years of hellish trench warfare later, the slaughter ended, due mainly to exhaustion.
Today’s biotech investor is not much different from that innocent and naïve young man who signed up to fight in 1914. The biotech sector had been so hot for so many years, that many casual investors forgot what a risky play a profitless biotech start up can be. Additionally, many investment banks and deal sponsors forgot how irresponsible it can be to encourage very young companies to go public. In the last two years, dozens of companies went public with no life sustaining cash flow; many don’t even have revenue!
As the era of “easy money” comes to an end, and the Fed is forced to raise interest rates, we face a world transformed just as surely as the hapless generals who wanted to make sure that their horse cavalry were ready to fight in 1914. They had no idea what they were in for.
But we do have the benefit of historical hindsight. Financial history suggests that today’s biotech shareholders are in for long and grinding trench warfare. Any hope of a quick bounce back for XBI stocks that have lost 50 or 60% of their value is unrealistic. Some stocks will survive at a low level, some will be absorbed by healthier competitors, and many will perish on the battlefield that is the Nasdaq stock market. A few companies will dig in, fight this battle inch by inch, and eventually emerge victorious. It’s the difference between pets.com, which got pushed down in ‘01 and stayed down, and a little struggling business called “Amazon” which lost 90% of its stock market value in 2001 and today, is, well, Amazon the company that ate the world.
Financial trench warfare is painful, slow, and often frustrating. However, mostly, it’s a game of long term strategy. Here are three investing strategies that you can use to prevail in the biotech trenches….
1. Get Companies for Free
Nothing is quite free in life. But you might be surprised what you can grab for virtually free during the fog of war. When I say, “get companies for free” what I mean is: buy a company when its shares are trading for less than the cash it has on hand. For example, let’s say that Biotech Corp used to have a total market capitalization of $600 million, and the company had $300 million in cash on its books. Now, due to the crash and the overwhelming negative sentiment about all things biotech, the very same company is trading for just $300 million. But it still has $300 million in cash on its books. That essentially means that all of the company’s science, all of its patents, all of its molecules, are valued at $0. When you buy shares, you are obtaining a pool of cash, and the rest is basically free!
If this sounds like a freak occurrence that shouldn’t be happening, that’s because it is. This is a very abnormal distortion that only happens during moments of panic in the financial world. According to a twitter post by Travis Whitfill, MPH, there are currently more than 129 publicly listed biotech companies in this precarious situation. (twitter, 2/17/22, 3:40PM). That constitutes a full 19% of publicly listed biotech stocks!
Wow! Great news. Open season on bargain shopping, right? Maybe, maybe not. If you are an experienced bargain bin shopper in real life, you will know that many items are selling at junk prices because they are junk products. Junk is junk at any price.
If a company is selling at less than its cash on hand, how could things possibly get worse? Much like Dante’s Inferno, many of these struggling companies just keep descending to new, worse, levels of hell.
First, many have science that just won’t work out. When the investment bankers came up with the great idea of every biotech, at every stage, going public, they forgot that only 10% of medicines in phase I testing ever make it to commercialization. So, even if you have $300 million on hand, your company’s prospects can still be grim if the underlying science never quite works out.
Second, even if your science is heading in the right direction, you can still easily burn through millions upon millions before enough progress is made. One of the guiding principles that led start-up c-suites to go public at any stage was the delusion that easy cash would just keep flowing forever. Year after year, young biotechs had no problem at all raising millions of dollars with just a few promising test tubes to entice new investors.
But the investor is a fickle creature. Many are not overly committed to biotech, and now that the sector has lost its “cool” factor, they may just as well go chase the next shiny object that comes across their polished oak desk. In the chaos and bloodshed of a post crash biotech community, many biotechs will run through their cash without enough scientific progress to attract new funds.
Keeping all that in mind, there are still likely a few diamonds among the coals. Remember, if you chose to invest in Pets.com when it crashed, you got nothing, but if you chose Amazon.com after it lost 90% of its value, today you could be reading this post from your mansion in Palm Beach.
Three stocks that could fall more into the Amazon category and less in the Pets.com category are: $BLUE, $DYN and $SYROS. All three boast solid management teams with deep ties in the scientific and Wall Street community. All three are focusing on legitimate research in genetic driven diseases with huge unmet needs. And all three are very well funded for now.
This isn’t a strategy for the faint of heart, but no one wins a war through caution.
2. Go Full Vulture
Vultures get a bad rap because they live by feeding on the dead. It’s not pretty to watch, but it turns out to be an outstanding survival strategy. Some scientists believe that the vulture has survived this way, virtually unchanged by evolution, for millions of years. Vultures prosper by feeding on the dead and dying, and so can you.
Now of course, the whole business is unsavory. So this is not a strategy for those with weak stomachs. But at this stage of the post crash world, there are a lot of companies writhing around in pain, mortally wounded, but not quite dead yet. Smart vultures will circle in now, before the other scavengers realize there is an opportunity coming.
Remember from our earlier discussion, a lot of junk companies are just that, junk. They are of little value, dead or alive. You are looking for companies that have demonstrated promising science in markets with big unmet needs. They maybe just aren’t big and strong enough to survive alone in this brutal new age. Just because they have some good clinical results doesn’t mean they have enough funding on hand to make it all the way to commercialization and positive cash flow. Also, smaller companies have had a very hard time getting attention and service from the FDA. Their drug applications tend to languish for months or years, while larger biopharma concerns have the connections and lobbyists to make sure that applications are reviewed swiftly.
A lot of smallish biotechs will not make it as independent firms. Rather, they will be bought cheaply by larger biopharmas, who have the deep pockets necessary to survive in today’s harsher business environment. Your goal is to find promising companies that won’t make it on their own, and buy them cheap before they are consumed by larger biopharma companies seeking fresh meat.
What would such a company look like? They should have positive data from phase I or phase II testing. The data should be clear and unambiguous in terms of verifying the basic scientific thesis of the research. Furthermore, the research should be oriented towards a large unmet need in the medical community. In today’s barren landscape, “also ran” and “me too” companies will be left to rot. Biopharma acquirers are looking to buy unique technology that is mostly proven, but just needs better funding and a stronger corporate parent.
Three companies that could fall into this category are: $ADMA, $MESO and $SYBX. All three companies have produced substantial positive data that prove that they are onto something. All three have made substantial investments to establish a manufacturing infrastructure that has intrinsic value to somebody. But all three are “sub-scale” meaning that they are trying to cross an ocean in a dingy boat, when what is needed is a battleship.
Typically in post crash environments, these kinds of companies don’t go bankrupt. Rather they are eaten alive by strong biotech organisms, and their technology becomes integrated into the acquirer’s programs. Your goal would be to buy the shares for a song before an acquirer realizes there is value to be had. Not an easy business, but potentially rewarding for an investor with the right temperament.
3. Look for Allies
One way to think of large scale war is as an industrial competition. History has proven vividly that all humans of all races, nationalities and creeds are capable of intense, sustained barbarism. So violence and aggression alone don’t win large scale conflicts. Industrial resources do. The side that can muster the largest amounts of man and material for the longest sustained period will win.
World War I was so dreadful for so long, because it was essentially an industrial stalemate. Both sides were global leaders in innovation and manufacturing. Both sides had access to massive quantities of young men to feed into the meat grinder of war.
The only thing that eventually broke the stalemate was the entry of the United States into the war on the side of Britain and France. Due to a series of diplomatic and military blunders by the German high command, the USA entered the war with the full industrial might of an angry continent behind them. Ultimately, France and Britain won World War I because they obtained the right ally.
You can use the same technique to win the biotech war. As we discussed earlier, the only realistic prognosis for the biotech business environment for the next few years is: grim. Where multi million dollar funding rounds used to flow like the rising tide, now there will only be a trickle of funding for the most obviously deserving start ups. Where stock investors and biotech analysts used to give new ventures the benefit of the doubt, now we will be deeply entrenched in a “show me” phase for the sector.
In this new, rugged environment, it will be very helpful to have big friends. And a lot of the most promising biotech startups do. If you look for small companies with big partners, you can invest with a certain amount of security.
What are the benefits that partnerships bring to smaller outfits in this business environment? First, having big friends makes it much less likely that your small concern will go bankrupt. Many biotech firms that are valued at just $500 million or so, are partnered with Big Pharma companies that sport market capitalizations of $20 billion or more. What amounts to a tiny amount of financial support from the partner can equal a lifeline for a floundering start up company.
Second, the fact that certain companies already have signed and active partnerships with larger corporations lends a certain validation to their research programs. It means that these research programs have been thoroughly vetted by teams of PhDs and MDs. In an environment where quality suddenly matters, this validation helps build confidence for an investor.
Lastly, having a big partner brings “the finish line” closer for small biotechs. As discussed earlier, in recent years, smaller biotechs have found it tougher and tougher to get anything passed by the FDA in a timely manner. Time is money. In an environment where funding is scarce, a small biotech running on fumes can easily go bankrupt in the middle of attempting to navigate the mind boggling bureaucracy of the FDA. In most biotech partnerships, all of this is taken care of by the larger partner. The start up biotech only has to produce good data. That’s it. Once the drug meets certain scientific milestones, the biopharma giant with the deep pockets can flex its muscles and make sure the cash starts flowing.
Three examples of smallish biotechs with big partners are $FATE, $TSVT, and $CGEN. These companies have active alliances with biopharma stalwarts such as Johnson & Johnson, Bristol Myers Squibb, and AstraZeneca. All three are related to cancer, a growing market that still presents many unmet medical needs. Even when these tough little biotechs think they are on their last legs, they can count on their big ally to help win the war. This might be a good tactic for you if you want to be “the last man standing” on the other side of this spasm of biotech destruction.
Everyone gets into something over their head every once in a while. Unfortunately, it’s very likely that millions of amateur biotech investors are now staring at their deeply red portfolios in shock and disbelief. As a veteran of many financial battles myself, I hate to tell you – we are in for a long, tough fight. But it’s a war that can be won, and the spoils of war will be substantial for the victors. Sheer grit is important, but toughness alone won’t be enough. You need strategies. If you follow the three strategies outlined above, you just may survive long enough to fly the flag of victory.
Disclosure: The Sick Economist owns shares in: $BLUE, $SYROS , $ADMA, $MESO, $TSVT and $CEGEN