Insider Wisdom And The New Medicine

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Includes: AFFX, ALXN, BMRN, GEVA, HRTX, JUNO, LJPC, MRTX, PRPO, SGEN
by: Bruce Pile

Summary

There is a revolution going on in medicine creating a historic investment opportunity.

The revolution is from chemical to genetic medicine.

Insider wisdom is a lower risk way to participate.

You can't really understand the new medicine until you come to an appreciation of what's behind it. That would be the little project that, in 1990, the Department of Energy, The National Institutes of Health, and some international organizations began - The Human Genome Project. It was to be a 15 year globally coordinated effort. Why all the fuss about genes ? It all began in 1865 when Gregor Mendel discovered genetics and published the results of his garden experiments showing that, for instance, if you crossed yellow peas with green peas, all the offspring were yellow (because yellow is the "dominate gene" as we say today) and when these offspring reproduced, the offspring were 3/4 yellow and 1/4 green. Mendel's laws began to be fleshed out in humans in the '50s with study of the double helix DNA molecule. We all have about two meters of it in every one of our cells. The disease implications of all this were clear by the mid '80s. That's why the government powers that be saw fit to create the Human Genome Project that would map and sequence the human genome completely so that we could begin practicing a new kind of medicine.

And they did it. It was pretty much completed around 2003, two years ahead of the 15 year schedule and under budget. It was worth every penny of the roughly $3 billion the US government spent on it (in 1991 money). By the tabulations of FasterCures every $1 spent on the Project has triggered $178 in US economic activity. "An investment in knowledge always pays the best interest" they quote from Ben Franklin. They conclude that "As the largest, single undertaking in the history of life sciences, the Human Genome Project has paid back extraordinary dividends on the U.S. government's investment." That total investment of $3 billion has produced, in 2012 alone, genomic endeavors resulting in $31 billion in US GDP, $19 billion in personal income, at a cost of about $2 a year for each US resident. Now that's a stimulus package.

The Project was pronounced done in 2003, and genomic medicine was eagerly anticipated. But practical, disease killing applications have not exactly been sprinkled on us like magical fairy dust. There is a kind of Moore's Law at work in getting genomic medicine into our every day life.

biostars

The SOLiD Platform is one of several next generation DNA sequencing technologies that came to be commercially available around 2006, rapidly dropping the time and cost of mapping any of our genomic compositions to something akin to getting a tooth pulled, but less painful. The Human Genome Project mapped the typical body using tissue contributions from several volunteers, but it is over 99% the same for all of us. It's in the other 1% or so where inclination to certain health problems and personalized therapy are discovered. This can be monumental in treating things like cancer. But even for healthy people, the advance in genomic mapping has us asking, as a recent article in US News did, "Should You Get Your Genome Mapped ?"

Genomic medicine is crossing an important threshold as noted in an article "Casey Analyst Forecasts Explosive Biotech Growth" (from late 2012):

"We all remember the sequencing of the human genome as a scientific milestone...it was followed by much media fanfare about the dawn of genetic medicine. Every untreatable disease was going to be cured. Every person was going to receive medicine tailored to his or her unique makeup.

Yet, more than a decade later, that promise remains almost entirely unfulfilled. It's not that the science has stood still. Quite the opposite: It has been moving forward at blazing speed... It was a monumental advancement, but not practical for everyday use."

Well, it's getting very practical now, and is at least partly to blame for some of the craziness in the biotech stocks. At ETFdb you will find a summary of the biotech ETFs, and, if you weren't aware, they have all been going into mega-bull mode the last 2 or 3 years. It sort of reminds me of the Moore's Law '80s and '90s phenomena of the communications bull market, only this time it's with genetic medicine. Ken Kurson, editor of the New York Observer, has an article in the May Esquire with the title "Killer Pharma". In it he bemoans the "retrograde amnesia" of today's investors in some penniless tech names, seemingly unable to recall 1999. He does, however, see an investable revolution going on in medicine. Amnesia yes, "But there is still some value to be had from disruption: biotech. The way human beings are medicated is undergoing a change that closely resembles what the internet did do classified ads."

For a hundred years the approach in medicine has been to introduce chemicals concocted for a mass audience into your particular body to stop some bad thing it is doing. Because we're all different, that typically is done at the expense of upsetting the body's intricate chemical balances in everything else, producing a new supply of problems. Have you ever been annoyed and aghast while trying to relax with some escapism TV viewing when, every third commercial, some drug impossible to pronounce is hawked with a pleasant voice droning on and on about every disgusting side effect it has ever produced in anyone? I would rather hear them read the phone book to me. Why don't they just slap a generic warning on every bottle saying "This stuff will mess you up" and not bother our TV viewing experience? We have taken the shotgun approach of making a chemical fix a disorder in a lab dish or rat, then prescribing that poison to millions of people, then living with and paying for all the problems all that unnatural poison creates. The old school drug industry doesn't mind, and it's a whole new wing of the legal profession. You don't take two aspirin and call me in the morning anymore, you call 1-800-BAD DRUG. A hundred years from now all this will seem like applying leeches to us.

Genomic medicine has a basically different approach in that it seeks to fix problems by having our body just do what it was designed to do - genetically. It uses the body's own processes to fix problems. "Immunotherapy" is all the rage now in biotech and it uses the body's own immune system to search and destroy disease. In "Killer Pharma", Kurson expressed his opinion regarding the genomic revolution that "the most promising wing of this paradigm shift is cancer immunotherapy". It is an uncomfortable but medical fact that we all get cancer every day, as well as the flu and every bug wanting to kill us. Each day our bodies make about 50 million new cells and around 1 million of those have errors in them. The immune system goes about its business of finding these trouble cells and neutralizing them so we don't get sick. And it does this better than our chemical concoctions. When you think about it, a genetically correct body would never get most of our debilitating disorders. It is only when genes are damaged or not working right that we are programmed to
problems. As they say in this science, we will stop endlessly treating symptoms, and simply fix the programs.

Does Kurson venture a stock pick in his article? Yes, two actually. He likes Juno Therapeutics (NASDAQ:JUNO) just three months a public company with a procedure to take T-cells out of a patient, grow them and program them to attack cancer cells, then put them back into the patient. The early trials look "amazing". He complains that JUNO has as multibillion dollar market cap but is still at least two years away from a product, and compares this to WhatsApp, which has to do with messaging on smartphones, before they were snapped up by Facebook for a silly $22 billion. But Kurson thinks there is no comparison when you compare the overall value to planet earth for each of these value stretched companies - curing cancer versus better messaging drivel between teenagers.

The other stock Kurson likes is Alexion Pharmaceuticals (NASDAQ:ALXN). They have a rare disease drug approved back in 2007, "but now it's all over genetic medicine" and he feels its large $37 billion market cap is the result of the market's anticipation of genomic medicine for the more prevalent disorders. Alexion made news back on May 6 when they bought Syngeva (NASDAQ:GEVA) for $8.4 billion, paying over twice the previous close for GEVA stock.

I was pleased to see that fat premium paid because I had GEVA in my fund at the time. I had not bought it because I am a medical genius, but because of the insider activity I had observed in it. That raises a big question for us non-doctor types in dealing with these new medicine stocks that don't trade on the things we like to analyze - revenue strength and valuation, cash flow multiples, and all the things having to do with present money. By the time these companies have all that, they have either been snapped up by the savvy M and A crowd or they have had tremendous run-ups that have passed you by.

You can read up on all this via articles like the excellent one mentioned above. Ken Kurson, who co-authored The Faber Report along with David Faber, can give you a lot of good information, but he doesn't have a Phd in any medical field, and I don't want to make him my stock picker. Casey Research, also mentioned above, is taking the approach of "concentrating heavily on mature technologies that are on the cusp of the market. It is a dream market for stock pickers right now." This is safer than a shotgun approach certainly, but also suffers from the too-late-for-a-killing problem as well as sudden therapy failures that can crop up and decimate even a mature stock. So how does one try to capitalize on what may turn out to be one of the great market opportunities ever ?

Probably the best way is to analyze, not the stock, but the insiders buying the stock. There are, of course, the officers of the company; and a sudden rash of buying or selling by them is often a good tell. But I'd like to focus on another type of buyer - the cross company career buyer. These are the very few who are often highly educated in the medical field and also are 10% owners and/or sit on the boards of several companies, and do massive buying in those several companies. They also like to run biotech hedge funds and, because they know not only medicine, but the business of medicine, they tend to have dazzling track records of performance. There funds are not for everyone as the downdrafts are huge, but the buying these very smart people are doing should command your attention for whatever portfolio % you wish to assign to this dangerous area.

Kevin Tang is one of those people. He founded Tang Capital Management in 2002 and compiled a 26% rate of return vs 5% for the Dow through mid 2010 - back before biotech was cool. But his fund is at the extreme high end of the risk scale with current holdings of just 6 common stocks, only 4 with any weighting - Heron Therapeutics (NASDAQ:HRTX), La Jolla Pharmaceuticals (NASDAQ:LJPC), BioMarin Pharmaceuticals (NASDAQ:BMRN), and Mirati Therapeutics (NASDAQ:MRTX). Talk about your riverboat gambling. If you own his fund, you have to hope this guy knows when to hold 'em.

My personal favorite for medical insiders to watch is the Fabulous Baker Brothers. Felix Baker owns a Phd in Immunology and is the most massive inside buyer I know of. Julian Baker holds an A.B. Magna Cum Laude from Harvard (social studies) and this blend of intelligence founded Baker Brothers Investments in 2000, which offers their hedge fund, Baker Brothers Advisors, among a family of funds for institutional investing. Together, they are on the boards of a long list of medical companies.

The Bakers' fund also tends to run just a handful of heavyweighted positions although they spread the money out over near a hundred names. What strikes me about the names they buy heavily is the high buyout rate. They look for the same things merger and acquisition people do apparently. For example, the fund's eight heavy positions at the end of 2013 were : ACAD, SLXP, XOMA, GHDX, SGEN, PCYC, INCY, and GEVA. Of those eight, three have been bought out at fat premiums in just a little over a year. That's a 375 batting average for takeout homeruns in just around a year. There are three Baker entities to watch, Felix personal buys, Julian personal buys, and the fund's heavyweights. Felix seems to do more personal buying than Julian, but when the two of them both buy something as well as make it a heavyweight in the fund, it grabs my attention. As of the end of March filing period as tabulated by J3 Information Services, the fund's holdings show the fund with 118 positions but just 7 heavyweights: PCYC (24.66%), INCY (14.50%), GEVA (12.12%), SGEN (10.88%), ACAD (7.11%), BMRN (5.58%), and GHDX (4.45%). That's about 80% of the fund. Two of those seven are now buyouts (286 batting average) so you're left with INCY, SGEN, ACAD, BMRN, and GHDX as the available heavyweights.

I find it instructional to look at the yearly progression of buying by the Bakers as they seem to not only know what to buy but when to buy it. I have detailed this in my blog article of April 10, 2014 on GHDX "Genomic Health And The New Medicine". From those charts, you can see that in those few cases when yearly buying goes over around $20 million, very big climbs tend to start within a couple years or so. That's what induced me to buy GEVA: (click on image to enlarge)

The buying intensified greatly after 2012, more than I've seen for any other stock but one. That one would be Seattle Genetics (NASDAQ:SGEN). In the "Killer Pharma" piece mentioned above, one of the author's two picks was Alexion Pharmaceuticals and they were the buyer of GEVA at a massive premium. GEVA's partner at the top of the Baker fund (along with INCY) is SGEN, and they are the leader in the author's "most promising wing of this paradigm shift, cancer immunotherapy". I don't know if Kurson is a Baker fan, but they seem to think alike.

In the interview with Casey Research referenced above, they were asked about breakthroughs in this concept of using the body's immune system to deliver engineered cancer killers. Two were discussed :

"The first is the recently approved use of antibody-drug conjugates (ADCs). Seattle Genetics (SGEN:NASDAQ) is the leader in this space, and its ADCs are created by bonding traditional chemo with antibodies selected from our own bodies that target very specific cancer cells. Chemotherapy, which is known as the "poison" in the oncological lingua franca "slash, burn, and poison," does precisely that to the entire body, causing horrific side effects in many patients. By piggybacking on the body's own mechanism for targeted immune response, chemotherapy can be rendered basically inert except when it comes in contact with cancer cells. This means more chemo can be delivered safely, working wonders on metastatic cancers and other difficult-to-target, small, multiple-growth cancers."

From the SGEN site, we see that genomic science is facilitating all this as they

"... have also formed a strategic collaboration with Oxford BioTherapeutics to jointly discover novel ADCs for cancer. Under the collaboration, OBT will generate panels of monoclonal antibodies against novel tumor-specific antigens identified using its proprietary Oxford Genome Anatomy Project database."

Seattle Genetics was one of those small drug companies willing to swim in red ink while exploring the scientific intrigue that big pharma doesn't have the budget for. But a stunning development in 2010 may be putting SGEN on the road to riches. If they could really use a genetically correct immune response to fight just cancer cells, it could drastically change the battlefield. Our bodies naturally attack foreign cancer cells with antibodies, and since the mapping of the human genome has opened the gate to "engineered antibodies" things have gotten interesting. From an Xconomy article in 2011 "Seattle Genetics, On The Verge Of Going Commercial, Seeks To Keep Its Scientific Soul" :

"A little science background is required to see why this matters. Other biotech companies have had a lot of success with targeted therapies over the past decade, making genetically engineered antibodies that specifically zero in on markers on tumor cells, while mostly sparing healthy cells-unlike typical chemotherapy. Seattle Genetics has gone a step further, by turning genetically engineered antibodies into what amounts to a "smart bomb" against cancer. The company's technology links the targeting antibody to a potent toxin, which gets unleashed on the tumor."

This idea of putting a cancer poison warhead on a genetically crafted antibody missile has been around for awhile. As the article explains:

"Most of these efforts to soup-up antibodies have failed over the years, but Seattle Genetics proved it had solved the puzzle last year in a pair of clinical trials. They showed that the new Seattle Genetics drug, brentuximab vedotin (Adcetris) could partially or completely shrink tumors in 75 percent of Hodgkin's patients who had relapsed after getting prior therapies, and that it did the same for 86 percent of people with anaplastic large cell lymphoma. About 30 percent tumor response rates would have been considered good enough to seek FDA approval. The results sent Seattle Genetics stock soaring, and forced the company to quickly put together its commercial game plan."

So this 2011 piece claimed that Seattle Genetics "proved it had solved the puzzle last year" which was 2010, which interestingly enough was the year the Bakers began their massive buying of the stock in earnest: (click on image to enlarge)

You have to wonder what's up with that. This is the most intensive insider buying I have seen from the Bakers. The $365 million shown for the latest full year includes $112 million so far this year including a $40 million purchase dated May 21. All of these purchases from 2012 on were personal buys by Felix, not fund buying. That's pushing a half billion dollars in personal buying in a little over two years.

Looking at figures like these may prompt one to sell the kids and bet the farm on whatever people like Tang and Baker are buying heavily. It's especially tempting when you see more than one heavy hitter buying the same stock as, for example, both Tang and the Bakers buying Mirati Therapeutics . Mirati currently ranks as #14 of the 118 Baker fund positions, but it's a small company and, with personal holdings, they have around 40% of the whole company.

If you are the type that can't stand buying something with an outrageous revenue multiple and a therapy that is many stock gyrations away from use, no matter who else is buying, then you may want to look at some of the pick and shovel genetic plays. These are the less exciting but safer gun runners in the battles who supply things like genetic assays and testing, development and manufacture of genetic analysis equipment, and so on. Two examples are Transgenomic (NASDAQ:TBIO) and Affymetrix (NASDAQ:AFFX). Transgenomic has current revenue at a very cheap 0.8 price/sales, but very sad results of negative $10 million TTM EBITDA on $27 million revenue (and this is a chronic 5 year trend getting worse) while Affymetrix offers revenue at a 2.5 multiple and cash flow from operations and EBITDA cash flow at around a 22 multiple. Of course the big killings to be had will come from the therapy developers themselves that attract the right insiders.

But there is peril in going after a hot picker because they are all human and the market humbles us all sooner or later. Biotech is also heating up in a market that hasn't hit a big speed bump in awhile, and although the charts I show here don't even have an '08 in them, a bull has gripped them since then over the last 3 years, and in the next speed bump, biotech will get bumped the hardest. As in the '90s with the revolutionary internet, genetic medicine is here to stay, but most of the stocks will go away. The key insiders will likely be our best guess for the stocks that will be the mega winners.

Disclosure: The author is long SGEN,HRTX,ACAD,MRTX.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.