Small-Cap Biotechs With Blockbuster Potential: Hugh Cleland

Includes: ACST, NEPT
by: Life Sciences Report

Canadian portfolio manager Hugh Cleland of BluMont Capital has chosen an interesting niche. He invests in stocks too small for mutual funds and major institutions, which allows him to get in on the ground floor and capture huge gains when the companies begin to mature. He actively participates in each company's destiny, much like a venture capitalist. In this interview with The Life Sciences Report, Cleland discusses his core holdings.

The Life Sciences Report: You manage two funds at BluMont-the BluMont Northern Rivers Innovation RSP Fund and the BluMont Innovation PE Strategy [BIPES] Fund I. Describe these funds and their differences from a very high-up perspective.

Hugh Cleland: Both funds focus on the tech and healthcare sectors and invest in publicly traded small and micro-cap companies, with a few private investments sprinkled in. The Innovation PE Strategy Fund takes a private equity approach to investing, meaning it is a six-year fund with no redemptions. In the latter half of the fund's life, we distribute the proceeds of sales to our investors. But as far as our private equity approach, we are more hands-on, helping companies in a variety of ways, including working with existing management to ensure appropriate skill sets are represented on boards and in management, and helping to raise money and develop analyst coverage. I even sit on a few boards.

TLSR: The BIPES fund sounds more like venture capital [VC], no?

HC: It is a bit of a misnomer to call it private equity. It's really VC- late-stage VC, to be more precise.

TLSR: There are times in the life cycles of some public companies when you can actually buy them for less than you could have put them together as private equity. Is that the idea here?

HC: Absolutely. I often find that valuations in the publicly traded sub-$100 million [$100M] market cap world are lower than for comparable companies in the private world.

TLSR: How has your fund performance been last year and year-to-date?

HC: The BIPES Fund is up about 20% since inception, which was Jan. 31, 2011. We were doing much better than that at one point-up 50%-but then Neptune Technologies & Bioressources' (NASDAQ:NEPT) production plant in Sherbrooke, Quebec, Canada, blew up on Nov. 8, 2012. Neptune was, and continues to be, one of my largest positions.

In addition, we've experienced a serious headwind with the unwinding of the resource bubble. The TSX Venture Exchange, where most of my companies are listed, is down almost 60% in the same two-and-a-half year period that the BIPES Fund has been in existence. The market environment has been one heck of a headwind for the stocks of companies in the fund.

TLSR: You don't own resources, do you?

HC: I do not, but many investors who own speculative small-cap tech and healthcare companies in Canada have been overweight in the resource area for the last 5-10 years. As they have been watching their resource stocks fall by 50-90%, they seem to have been panicking-- understandably so-- and often getting out of all their small-cap investments, including healthcare and technology investments.

TLSR: Go ahead with Neptune. Is it still a core position for you?

HC: Yes, it is. The company was on a very dramatic upward growth trajectory until last November, when the explosion occurred. It had just raised $35M to fund a significant plant expansion before that tragic event.

The company has now come forward with plans to get production going again. It is taking a different tack, with partnerships, joint ventures and outsourcing deals becoming an important part of its strategy. The company addressed the new strategy in its last conference call, and gave guidance that by Q1/14, it would have internal production capacity of about 150,000 kilograms [150kg] per year of its Neptune Krill Oil [NKO] product. The company has been talking to three different potential outsourcing partners and expects to make a decision on those by August. By the end of September, I believe that we'll have visibility on how Neptune can have NKO production capacity in the 600K-1M kg/year range, but I don't think the market has put that together yet. The market will be looking at this company in a much different way soon.

TLSR: I understand the company has received its first insurance payment from the accident. But if you look at the news flow from Neptune, it's impossible not to see how many class-action lawsuits have been filed against it. This is a small company with a $182M market cap. How does it withstand such a legal assault?

HC: That was one of the pieces of very good news that came out in the company conference call on May 23. All of the suits have been dismissed. It's over. There is no more risk from the lawsuits.

TLSR: Hugh, I know many people are familiar with krill oil, but explain to me briefly why it is better than fish oil as a cardiovascular agent.

HC: Krill is a small crustacean, not a fish. The phospholipid omega-3 oil derived from krill is increasingly being cited by many experts-both in the world of "pop health" and in the world of serious scientific work-as being superior to other sources of omega-3, including fish oil. Krill oil has four primary ingredients-eicosapentaenoic acid [EPA], docosahexaenoic acid [DHA], astaxanthin and phospholipids-compared to fish oil's EPA and DHA. It appears that, similar to fish oil, krill oil has a very important lowering effect on triglycerides, but in contrast to fish oil, it also seems to lower low-density lipoprotein [LDL] and raise high-density lipoprotein [HDL]. It is believed that the fact that the EPA and DHA in krill oil are chemically bonded to phospholipids is one of the primary reasons for the positive LDL and HDL effects. The astaxanthin is also bonded to the phospholipids. The fact that the EPA, DHA and astaxanthin in krill oil are all bonded to phospholipids makes them more bioavailable as they are metabolized in the body.

Acasti Pharma Inc. (NASDAQ:ACST), Neptune's pharmaceutical subsidiary, is one of my four largest holdings as well. We've been waiting for phase 2, open-label trial [NCT01516151] results for its drug candidate CaPre [a purified extract from krill oil]. The company announced a few weeks ago that it finished enrolling the trial, and we expect to see results this summer. I expect the stock will have a nice run-up into those results. My expectation is that the results will demonstrate that Acasti has, at the very least, a best-in-class "fish oil drug" and may, in fact, be in possession of a blockbuster. I'm awaiting those results with some excitement and optimism. The market caps of both Neptune and Acasti are currently a fraction of where they will be if the trial results are good, and it's been encouraging to see Acasti recently set new all-time highs on the TSX.V in Canada [it also trades on NASDAQ under the symbol ACST].

TLSR: You said the phase 2 trial with CaPre is open label. How do you get definitive, share-moving data from an open-label trial?

HC: There are actually two phase 2 trials underway right now, and the placebo-controlled double-blind phase 2 trial [NCT01455844] results are expected in Q1/14. But the open-label results are coming up shortly-likely in July.

It's Dr. Harlan Waksal's opinion that the open-label results will be significant enough to move the needle and will be sufficient to initiate discussions with big pharma on either partnering or a sale. Waksal was a co-founder of $7 billion [$7B] takeout ImClone Systems Inc., and today he is executive vice president for business and scientific affairs at Acasti. He also sits on the Neptune board.

I think part of the reason Dr. Waksal believes in the product is that there is a deep body of knowledge around omega-3s. The existence of this body of knowledge should mean that, if the open-label data are good enough, potential partners and investors won't need to see the double-blind data before getting excited. Also, both of Acasti's phase 2 trials have an unusually large number of patients [274 in the open-label trial and 429 in the placebo-controlled trial], which means there should be a higher degree of confidence than in most phase 2 trials. The bottom line is that if the data are as good as I am expecting, the open-label study itself-- in the context of the huge body of clinical data around fish oil-- should be enough to catapult this stock to a whole new level.

TLSR: How much of Acasti does Neptune own?

HC: More than 60%.

TLSR: Even though Neptune owns more than 60% of Acasti, these stocks have not traded in sync. Over the last 12 months, Neptune is down 17%, while Acasti is up 37%. From my cursory view, it appears that Acasti does give some support to Neptune, which could have been hurt a lot more with these events.

HC: It's the sum-of-the-parts underlying support to Neptune from Acasti. There were a few months after the explosion where investors could essentially get everything in Neptune-even part of Acasti-for free, meaning that for a short while Neptune's market cap was lower than the value of its percentage ownership in Acasti. Some investors panicked out after the explosion. But for some sophisticated investors, it presented a great opportunity, and the stock is now up nicely from its December-January lows. Perceptive Advisors LLC, a very respected biotech investment group in New York City, is a 9.9% owner of Neptune. Perceptive Advisors has continued to be a key part of the shareholder base, and I think its circle has been among the buyers of the stock since the plant exploded. Perceptive Advisors clearly see the potential for dramatic gains in Neptune's share price over the coming months and years.

The companies I have talked about are what I consider core positions, with Neptune and Acasti each comprising more than 10% in the portfolios I manage.

TLSR: I look forward to speaking with you again in the future, Hugh.

HC: Thanks so much, George. It's always a pleasure.

This interview was conducted by George S. Mack of The Life Sciences Report.

Hugh C. Cleland is an executive vice-president and portfolio manager at BluMont Capital Corp., based in Toronto, Canada. BluMont Capital acquired Northern Rivers Capital Management, which was co-founded by Cleland in May 2001, in January 2010. Cleland currently manages two funds for BluMont: the BluMont Northern Rivers Innovation RSP Fund and the BluMont Innovation PE Strategy Fund I, which takes a private equity approach to the management of publicly traded small- and micro-cap technology and healthcare stocks. Cleland worked at Interward Capital Corp. from 1998 to 2001, originally as an analyst and later as associate portfolio manager specializing in technology equities. In 1997-1998 he was research associate to the senior telecom services analyst at Midland Walwyn Inc. Cleland earned a bachelor's degree with honors [1997] from Harvard University, and earned his CFA designation in 2001.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional Disclosure:
1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an independent contractor. He 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 its services or as sponsorship payment.
3) Hugh Cleland: I personally and/or my family own shares of the following companies mentioned in this interview: Neptune Technologies & Bioressources, Acasti Pharma Inc. I personally am and/or my family is paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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