Robert Lawton is managing partner of Catoosa Fund, a long/short hedge fund. He began his career in the industry more than 20 years ago at Alex. Brown & Sons.
If you could only hold one stock position in your portfolio (long or short), what would it be?
Long, Geron Corp. (GERN).
Tell us more about the company behind the stock.
Geron is a small-cap (currently around $500 million) biotech with two primary focuses: oncology and Human Embryonic Stem Cell (HESC)-based therapies.
In oncology, Geron has a broad IP portfolio which include a large number of patents targeting what may prove to be a worthy area of pursuit in the fight against cancer: telomerase. Telomerase was discovered by two early Geron collaborators who were awarded the Nobel Prize for medicine in 2009 for their discovery. Geron currently holds over 300 domestic and international patents related to telomerase as a potential cancer target.
Geron's other, slightly less crowded, and certainly more controversial focus relates to Human Embryonic Stem Cells (HESCs) as a potential remedy for a myriad of maladies, from Alzheimer's to paralysis. They have first mover advantage in the field and the benefit of being unreliant on the federal government for research dollars toward their pursuit, thereby sidestepping to some degree the controversy surrounding federal funds supporting this research.
In 2010, the FDA allowed Geron to proceed with the first ever clinical trials of HESCs in humans. I can't possibly overemphasize the importance of this historic trial. The primary endpoint of the Phase I is safety, although the secondary endpoint will be to determine efficacy. If safety is demonstrated along with even a modicum of efficacy? In my view, it will be considered one of the biggest scientific breakthroughs in the history of medicine.
How does your choice reflect your fund's investment approach?
We are a long/short hedge fund focusing primarily on domestic equities in all range of capitalization and sectors. We try to isolate situations where there is likely to be a relatively near-term catalyst to propel the shares in either direction.
I prefer to invest on the long side in companies with strong balance sheets, first mover advantage and/or dominant positions among their peers, and management I'm comfortable with. In the case of Geron, it's a $5 stock with a strong cash position, no debt, and are in the midst of a very high-profile clinical testing phase.
How much is your selection based on Geron's industry, as opposed to a pure bottom-up pick?
The biotech field, as you probably know, is littered with the wreckage of considerably more failures than successes. For every Dendreon (DNDN) or HGSI there are infinitely more Medivations (MDVN) or deCODE genetics. The potential to cure illnesses or alleviate suffering, coupled with the resulting "blockbuster" revenue streams accompanying such a success, can be quite seductive.
What I like about Geron is they have a very broad and deep IP/patent portfolio, strong cash position and, as excruciatingly slow as it has been waiting for results, I believe they are in the home stretch, at least regarding the HESC component of their business. If successful? I think the long-term upside is incalculable.
How is Geron positioned with regard to competitors?
They are the 600-pound gorilla in the space, for now, conducting the first in-man, very high profile clinical trial. It's really somewhat of a binary event for the science, in my view. They will likely succeed or fail in a very big way, and advance or set back the science of HESCs forever.
The good news, from an investment standpoint, is that in the event the HESC side of their business fails spectacularly, they still have a formidable oncology department.
How does the stock's valuation compare to its competitors?
The market cap is around $500 million, nearly half of which is cash, with zero debt. Their burn rate is around $50 million a year, so they are pretty well funded for the near term, having recently completed a $100 million secondary.
The stock has largely been dead money for the past 12 months, with a tight trading range between roughly $4.50 & $6.50/share. I expect that range will end this year, somewhat dramatically.
In terms of other peers in the area, what do you think about competition from bigger companies like Cephalon (CEPH) - which like GERN does oncology work along with recent agreements to develop stem-cell therapeutics? Or smaller StemCells Inc. (STEM)? Is it about first-mover advantage in this area?
I think with regard to HESCs, they are peerless due to their IP and first-mover advantage in the field. Remember, they have been at this since the beginning and were early to finance and capture IP rights.
Regarding oncology... they are no match for deeper pocketed big pharma but, again, their telomerase focus, if successful, separates them from the pack, due to their broad patent portfolio associated with it.
Does your view differ from the consensus sentiment on GERN?
Geron has no shortage of critics, myself occasionally included among them. Investors and the few analysts who do cover the stock seem to be (understandably) frustrated.
The company recently completed a secondary priced well below the market at the time. I must confess I was gobsmacked by both the timing and pricing of the offering, but the old adage in the biotech space is "raise money when you can, not when you need to." Overall, I think most investors are frustrated with the arguably "glacial" pace of Geron's journey from lab to clinic to market.
Worth noting, however: It was only in 1998 that stem cells were first discovered. Today they are being tested in humans with "Patient A" receiving an injection in October. In the broader view of time, a few quarters or years is insignificant in light of the larger backdrop of history and what is at stake.
Simply put: Imagine if a previously hopelessly paralyzed individual has any mobility restored? In addition to providing hope to millions, I believe it will go a long way toward silencing the critics of this controversial endeavor. Regardless of where you sit on the political or ethical debate, it's hard to argue with someone confined to a wheelchair for life that HESCs which were previously destined for a dumpster shouldn't be used to restore their mobility because of the Bible.
Separately, regarding analyst coverage: Thanks to the Internet and the laws of the land, huge quantities of information are easily accessible to anyone who seeks it and are in no way proprietary to the landscape of Wall Street anymore. Point being? In my view, the vast majority of "Wall Street Analysts" are worthless at best and dangerous at worst. The stock is largely uncovered - for now - and that's fine by me. My experience has been that the analysts usually pile on well after the smart money has taken a position (or exited).
Does the company's management play a role in your selection?
Always. I'm comforted by the fact that the CEO of Geron, Dr. Thomas Okarma, holds both an M.D. & a Ph.D. from Stanford and is a graduate of the executive program of the Stanford Graduate School of Business. He appears to be a scientist first and a businessman second. I'm fine with that. Even the company's director of investor relations has a Ph.D. in the field.
What catalysts, near-term or long-term, could move the stock significantly?
As discussed, the first ever in-man HESC trial is likely to be a closely watched major catalyst for the shares. If there have been no major safety issues along with even a minor improvement? The stock should move both abruptly and significantly.
What could go wrong with your pick?
If safety issues arise leading to a halting of the trial? The stock will likely get clobbered, at least initially. If it shows negligible efficacy but is generally well tolerated? I think the stock gets clipped pretty hard there as well.
The same is true if their oncology pursuit fails miserably (safety issues) or simply shows no efficacy, but this is likely years away and they have a pretty deep bench in that regard.
Frankly, I think the company is likely be acquired long before any phase IIIs are completed. I consider the risk/reward at around $5/share to be roughly 2 points downside vs. 5 to 10 points upside. I'll take those odds any day of the week.
This patience issue seems to be a key one for Geron. It's come under fire in the past for heavily diluting shareholders on positive results; what's the risk that continues even in the case of a successful trial - since that would bear heavily on the stock price?
Dilution has been frustrating but I'm still in the "raise money when you can, not when you need to" camp. The bottom line is: If they produce substantive results in the clinics? The stock goes much higher and they are welcome to come back to us for further R&D funding (and therefore dilution).
Failing that? They better not come back, hat in hand, anytime soon or I'd view that as troubling.
Thanks, Robert, for sharing your choice with us.
Disclosure: Long GERN.
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