Micro-cap biotechs must have creative, adaptive management first and foremost, says editor Josh Levine of Josh Levine's MicroCap Investor. A second key characteristic is a technology platform that can ultimately generate a suite of products. In this interview with The Life Sciences Report, Levine shares both his investment philosophy and his best three biotech ideas, all of which he expects will return huge multiples to investors.
The Life Sciences Report: You see micro-cap investing very much like venture capital [VC] investing. How so?
Joshua Levine: From time to time I talk about micro-cap investing as a form of venture investing for the public. We are not looking for a 25% gain. The micro-cap investor, like the venture investor, is looking for big multiple gains of three, five or 10 times over the life of the investment. There is a very big risk-reward factor for investors in micro caps, and the micro-cap investor should have the same long-term perspective that the venture capitalist has.
TLSR: Josh, you've recently written about and highlighted some differences between your investment philosophy, as you lay it out in the MicroCap Investor, and that of the Dow Jones' editorial staff and how they pick their Next Big Thing list for The Wall Street Journal. At the top of the Dow Jones guys' list are the track records of the VCs sitting on startup boards, as measured by merger-and-acquisitions activity and the total market value of initial public offerings. That sounds reasonable to me. But you differ with that. How?
JL: The Journal focuses on major investors who are involved in the formation of a company, and how these players have performed in the venture game in the past. For micro caps, I believe it takes a different perspective. Above all, it is management's track record and past experience that are crucial. The micro-cap management team is dealing with a different type of investor base and a different set of challenges and circumstances than the management team of a privately held, venture-backed company, with different mandates and obligations to meet in addition to growing the company.
TLSR: Does this mean that you won't invest in a company if its management doesn't have some sort of a track record that you can look at? Or, at minimum, do you insist on meeting management before you become an investor?
JL: With smaller micro caps it is very important for me to meet the management team, to spend time talking, asking questions and seeing how the team projects a strategy, a vision, and how that has been executed on. I also want to find out about the team's ability to adapt to inevitable changes. It's actually more a question of experience and character than track record.
TLSR: It's understandable that you want to invest in very small companies because that's where the big upside is, but the risk is also much greater in any way you want to measure it-maturity of the enterprise, maturity of its market, access to capital, the certain risk of dilution in a very small company, marketability of shares and, of course, volatility of the shares. Can you give me some ideas on how you mitigate the risk in a sub-$100 million [$100M] market-cap company?
JL: Again, it starts with basic due diligence on the management team, and its ability to adapt to change and learn from earlier mistakes. Another important item on my checklist is capital structure. If it is too complicated to understand, then it doesn't make sense to go beyond that. I want to know how the shares outstanding are distributed and the makeup of the different kinds of placements and warrants. Have the stock offerings been well managed and controlled? It should be relatively clean and simple. When it's not, that usually raises red flags. I think there are enough quality companies and management teams that investors should be able to filter out "funkier" companies very quickly.
TLSR: It strikes me that micro caps are particularly vulnerable to intellectual property [IP] challenges, if for no other reason than the fact that they don't have bulging balance sheets to pay IP lawyers to defend patent challenges. How do you diminish the risk of being caught in this kind of squeeze?
JL: I certainly don't have the capability to evaluate 30 or 40 patents in a company, but I try to get a handle on the IP issue by looking at the patents, talking to the people behind the company and trying to get a sense of it all. Companies love to throw their IP around and talk about it as a great asset-that their patents could be worth hundreds of millions of dollars by themselves. But 99% of the time, that's untrue. Most patents really have little or no value. Even with the ones that do, it's questionable what they mean to the company. In some cases, patents are obviously an important strategic tool and a form of defense against competitors, but small companies with limited capital resources can be vulnerable. In many industries, if a large competitor wants to appropriate a small company's technology in one way or another, it can take steps and the micro cap is probably vulnerable.
TLSR: Then, if a micro cap can't afford to defend its IP, even though it might be bulletproof, how do you mitigate that risk?
JL: An investor really can't. But, the positive side to this issue is that often the patents don't give away the goods. There's more to it than that. The most important part of IP is what's inside the heads of the people who work for the company and have a stake in it. The key people-the lead engineers and scientists-are an integral part of the IP. That often creates the defensive barrier against outside threats. In biotech, especially, you don't see the same kind of infringement issues you might see in some other areas of technology. The life sciences are very complex. If a larger company is interested in a smaller company's drug, it usually makes sense for the pharma to work with that company, either through a licensing agreement or a partnership of some sort.
TLSR: Josh, before we talk about your individual ideas, tell me how much of your current allocation is in biotechnology.
JL: Biotech stocks account for almost half of the current portfolio. It is my favorite area. There are a number of reasons for that. Several of the companies in the portfolio qualify as what I call game changers. They are stocks that I'm in for the long haul, and I see tremendous potential for them. These companies have created technology platforms that can enable multiple products, drugs or applications. In that sense they have some built-in hedge to risk because they are not dependent on a particular compound that might fail a clinical trial. The three companies I will talk about today have all of the characteristics that are favorable to micro-cap investing as I approach it.
TLSR: Go ahead with one of your favorite ideas.
JL: Inovio Pharmaceuticals Inc. (INO). Based on my research, I believe it's the only publicly traded pure play on a complete DNA vaccines platform. To make its vaccines more effective, the company has developed an electroporation technology that helps deliver certain drugs into cells. Cells are designed to keep things out, but with Inovio's technology electrical pulses are sent through the skin to open short-lived pores in cell membranes that permit entrance of the drug that was injected. This greatly improves drug delivery and performance.
The pipeline is impressive. The company covers cancers, both preventive and therapeutic, and infectious diseases such as human immunodeficiency virus [HIV], hepatitis C [HCV], human papillomavirus [HPV], and some other chronic infectious diseases.
TLSR: We've seen therapeutic immunization work in practice, but do you think that investors' perception is that electroporation technology is a gimmick? Does it look like a parlor trick to some investors?
JL: No, absolutely not. Early on there was some question about electroporation, but the technique has been around long enough and has been applied in enough cases to demonstrate that it is the real thing. Today, after all the studies Inovio has done, it has demonstrated very clearly that it gets very impressive T-cell responses. If not for electroporation, it wouldn't get these kinds of responses-and it is getting the responses across all its vaccines. From study to study, it never changes.
TLSR: As I look at the pipeline, with so many clinical studies going on in HPV, leukemia, prostate and lung cancer and with several phase 2 trials going on, I'm thinking that Inovio's $72.5M market cap looks very low. This company has serious activity going on in the clinic. Why is it at this level?
JL: I agree; the company is undervalued. One reason is because everything you just listed is in phase 1 or early to mid-phase 2. However, the biggest reason for this low valuation was that one large institutional shareholder, Special Situations Funds-the largest single holder back in early 2011-held over 21M shares but recently went down to less than 4M shares. It has been unloading its position for a very long time, and I suspect that by the beginning of 2013 it will be completely out of this stock. That accounts for the latest downtrend. Who knows the motivation for selling? But it accounts for a lot of the action.
However, I should mention that this technology is still very new, and big pharma has been looking at it closely. Inovio has publicly stated that it is engaged with a lot of large companies now, and the company has certainly not been shy about revealing there is demonstrated interest from big industry players. It just can't project when and what is going to happen.
TLSR: Do you feel that a big pharma deal will validate this company's technology and bring the shares up over $100M, where institutions can begin to accumulate the shares?
JL: It would be a pivotal moment in the company's history, absolutely. It would ring the bell for the industry and send a signal to other potential partners. It would instantly give Inovio the kind of credibility it has lacked.
TLSR: The company has technology licensing deals, for instance with University of Southampton Leukaemia & Lymphoma Research Centre in the U.K. Are these going to be low, single-digit royalty kinds of deals?
JL: I suspect so. But the deals that Inovio made earlier on are along those lines because the company didn't have much leverage in those days. Basically, it had to take what it could get. A few of those deals were done before Inovio merged with VGX Pharmaceuticals, a small, private company solely developing DNA vaccines, back in 2009-which led to VGX co-founder Dr. David Weiner, a DNA vaccine pioneer, to come on as Inovio's scientific advisory board chairman. The structure of those deals and the way Inovio approached them is very different from what you will see in the future. Today the company either has full control or much more control of rights and clinical trials.
TLSR: It was a pleasure, Josh. Thank you.
JL: My pleasure. Thank you.
This interview was conducted by George S. Mack of The Life Sciences Report and can be read in its entirety at http://www.thelifesciencesreport.com/pub/na/14900.
Josh Levine has 25 years of senior-level experience analyzing trends in biological, energy and information technologies and investing in micro- and small-cap stocks. In 2002 he joined independent investment-research boutique ChangeWave Research, where he became editor of ChangeWave MicroCap Investor in 2004. That publication became Levine's MicroCap Investor in 2010. Levine is also senior analyst for ChangeWave Research, which manages a survey network of 25,000 members to track the rate of change in corporate and consumer demand trends, and provides the results through an institutional research subscription service. ChangeWave is a service of 451 Research, a leading global analyst and data company focused on the business of enterprise IT innovation.
1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: None. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Josh Levine: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.