Learning From The Best - How Joseph Edelman (Perceptive Advisors) Invests

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Includes: ASND, FOLD, GBT, NBIX, RTRX, SUPN, VRTX, VSAR-OLD
by: ONeil Trader
Summary

Perceptive Advisors' Joseph Edelman is one of the most successful hedge fund managers out there and probably the most successful biotech hedge fund manager.

There are three levels of value creation in biotech.

I examine three successful investments Perceptive made over the last few years.

My investment style is similar to Edelman's.

I add my own example and two potential long-term winners.

This is intended to be an educative article, where I examine three successful investments made by Perceptive Advisors (at least successful to date), one of the biotech-focused hedge funds I value the most and look with interest what they are doing each quarter when they file their 13Fs with the SEC and if/when they file 13Gs or other ownership-related filings. The goal of this article is to show how value creation happens in the biotech industry and what is essentially my long-term goal – to find and own winners in the long run and to get rid of the losers and companies that are not living up to expectations. At the end of the article, I outline my personal example and stocks I think could become big winners in the next 3-5 years.

Three levels of value creation in biotech

I believe there are three essential levels of value creation when biotech/pharma stocks are concerned:

1. Development-stage value creation – a company drives its pipeline candidate or candidates through the clinic and creates shareholder value by successfully going through several stages of development (preclinical, early, mid- and late-stage). Some companies get acquired between the stages of development or at the end of the development cycle of a product - right after phase 3 results or after the product's approval. Those that don't transition to the second level.

2. Commercial stage value creation – a company has a product or products approved and creates value by driving sales of this product or products and earnings growth. Although I must mention there aren’t many pharma companies that are commercial stage-only. Almost every company has at least some R&D activities.

3. Commercial and development stage value creation – a company has an approved product or products and also has a pipeline and drives long-term shareholder value by driving sales of approved products and moving product candidates through the clinic. There are also companies that partner its approved asset (before or after it is approved) to a third party and uses the milestone payments and royalties to fund the rest of the pipeline.

The commercial + development stage is my favorite area and this is where I have most of my capital invested. And since commercial stage-only companies are scarce (and really not the ones I prefer), I am going to focus on levels 1 and 3.

Perceptive's successful investments

Going back to Perceptive Advisors - the hedge fund is run by Joseph Edelman, a former sell-side biotech analyst with an outstanding track record of investing in biotechnology stocks. He started his own firm in 1999, called Perceptive Advisors, and has generated an average annual return of 30%, net of fees over the last 18 years.

In this article, I cover three investments Perceptive made over the last few years, and all three are of my personal interest as they are part of the Growth Stock Forum’s Long-Term Growth Portfolio and my personal portfolio – GBT, NBIX, and FOLD. Luck would have it that these three stocks are currently Perceptive's three largest positions.

I selected to cover these three stocks because GBT is a development stage biotech (first level) while NBIX and FOLD are commercial + development stage companies (third level). However, by looking where Perceptive bought them, all three were development stage biotechs at first, though the fund continued to accumulate even when NBIX and FOLD turned into commercial companies.

Global Blood Therapeutics (GBT)

Perceptive purchased 0.9 million shares in Q3 2015 not long after GBT went public (I think they participated in the IPO, I’m not sure since it was a 13F filed at the end of the quarter rather than a 13G, which is filed soon after the purchase is made). GBT went public at $20 per share and surged to trade above $50 soon after the IPO. As the share price plunged in late 2015 and during 2016 and recovered subsequently, Perceptive continued to accumulate each quarter and got to 3.1 million shares by the end of 2016. And 2017 was no different – Perceptive was a buyer in each of the four quarters as well and ended 2017 with 4.9 million shares. It’s hard to estimate what their average purchase price is, but I think the best case is the mid-20s, but probably around $30.

Source: Stockcharts.com, WhaleWisdom

GBT made a lot of progress (for the most part) during the period of Perceptive’s accumulation, including positive preliminary phase 1/2 data of voxelotor in SCD, advancing it to a phase 3 trial, failing to deliver enough benefit in IPF and giving up on this indication, presenting additional positive phase 2 data including adolescents and data from its PRO (patient reported outcome) instrument and data from its compassionate use program. GBT also raised cash by doing three offerings since the IPO and was the subject of M&A rumors back in early 2017 (Novo Nordisk was rumored as a potential suitor). The value creation chain (so far) is quite clear here and related to voxelotor’s advancement through the clinic. Ideally, I want the company to have a pipeline, and not a single drug like GBT here, but more often than not, we persuade ourselves we are in it for the whole pipeline while we are really interested in that single asset. And CEO Love stated the company’s intention to expand the pipeline in 2018 through in-licensing of development-stage assets, so we may get a pipeline here after all.

Where does GBT go from here and what does Edelman expect? I believe the stock could and should go significantly higher from here or get acquired following voxelotor’s phase 3 results. Edelman himself gave us a clue what he expects in the long run. Below is the excerpt from Edelman's Barron’s interview (it’s behind a paywall now) in February 2017 (edited for market cap changes, emphasis added):

Global Blood’s market cap is $860 million (it’s $2.5 billion now). We’ve compared it to Vertex Pharmaceuticals (VRTX) which has two approved drugs for cystic fibrosis and is a $22 billion company ($40 billion now). You can say realistically that one day this will be a $3 billion drug. And you could ultimately have a $10 billion market cap. Last year, the stock was down 55%, even though the drug generated positive data and got closer to Phase 3.

In a more recent interview, Edelman said the following about GBT (emphasis added):

Currently, Edelman's highest risk-reward position is Global Blood Therapeutics. The California company is developing a drug for sickle-cell anemia. The potential reward is huge because the standard of care in sickle-cell disease, which often includes blood transfusions, doesn't work well and has numerous adverse side effects. Edelman thinks it's potentially a $5 billion global market. Downside: It's unclear whether Global Blood's approach will actually work.

So, Edelman thinks GBT could go to roughly $200 per share from here. I think it’s possible, but not before we see strong commercial uptake from voxelotor. My long-term goal here is certainly not to sell the stock when it doubles (I could have already done that when the stock traded near $60 per share). I want more out of investments like GBT, and, apparently, so does Edelman.

I went over GBT first because it’s the youngest position and has created the least value for Perceptive Advisors of the three positions. The other two will show how much a biotech stock can really advance (and decline!) in 3-4 years and 6-7 years, respectively.

Amicus Therapeutics (FOLD)

Amicus is a long-time and high conviction holding for Perceptive Advisors. They purchased 1 million shares in Q1 2014 when the stock was trading in the $2-3 range. Amicus was trading as high as $7 per share in 2012 but lost much of its value after GlaxoSmithKline pulled out of its Fabry disease partnership due to mixed phase 3 results. In the meantime, Amicus acquired Callidus which brought in the now very valuable Pompe disease program. But as a result of this acquisition, Amicus delayed its own Pompe disease program by a year, which contributed to the share price decline.

Perceptive stepped in as it obviously saw an attractive opportunity and added 7.3 million shares to its stake by the end of May 2014 (for a total of 8.3 million) when the stock was still trading in the $2-3 range. The stake rose to 12.3 million shares by the end of Q2 2014 and to 14.4 million shares by the end of 2014. The average purchase price for the first 12.3 million shares is most likely not above $3 per share while Perceptive paid $5-7 per share for the other 2 million. What was a $40-50 million investment soon ballooned to almost $300 million by mid-2015, when the biotech industry peaked and went into a brutal bear market from which it has yet to fully recover. Perceptive’s stake peaked at 15.2 million shares in mid-2016 and the fund then sold 2 million shares in Q3 and Q4 2016. The stock traded in a wide range in Q3 and Q4 ($5-10 per share) but Perceptive certainly made money on those 2 million shares. The decision to reduce the stake was probably driven by Galafold’s setback in the U.S. or by adverse market conditions.

However, Perceptive quickly changed course in December 2016 and started accumulating again as the stock dropped below $5 per share. The stake quickly rose to 15.8 million by the end of 2016 and to 17.9 million during 2017. And finally, Perceptive participated in the secondary offering earlier this year, paying $15.50 for 2.1 million shares and bringing its stake to 20.1 million shares. I believe Perceptive is sitting on at least a 200% gain and up to a 300% gain based on the timing of purchases as of this writing while the initial position is up more than 500%.

Source: Stockcharts.com, WhaleWisdom

This example shows that significant value isn’t created in a month, quarter, or even a year (sometimes it is if we get lucky), it’s a multi-year process and the situation didn’t look that great back in December 2016 as a 400-500% gain from the August 2015 highs almost evaporated. But Perceptive stayed the course and its stake is bigger than ever as I write this.

Can Amicus deliver significant gains from current levels? I believe it can, and apparently, so does Edelman. Depending on how things go from here – Galafold’s uptake, AT-GAA’s regulatory status and the company expanding its pipeline through M&A (in-licensing) later this year, I think Amicus can be a $30-40 stock in two years and that it could exceed $50 per share in 3-4 years. To get to $40-50, it would need to get Galafold sales to at least $300-400 million (and preferably closer to $500 million) and to get accelerated approval for AT-GAA in Pompe disease and for AT-GAA to see good uptake once it hits the market. Pipeline expansion and clinical validation of additional candidates could add to upside potential. If Vertex can be a $40 billion market cap company with $2-2.5 billion in orphan product sales, I believe Amicus can be at least a $10-15 billion market cap company with $1 billion to $1.5 billion in orphan product sales.

Neurocrine Biosciences (NBIX)

Perceptive is a Neurocrine investor for almost 8 years. I don’t have the exact share count for the initial position, but the fund held 3.3 million shares at the end of 2011. The share price was in the $5-10 range during that period. If we take $7 as the average price, Perceptive’s initial position is already up more than 1,000%. Not bad for a holding period of approximately 7 years – Neurocrine’s share price CAGR over the last 7 years was in excess of 40%.

Perceptive added 0.9 million shares to its stake during 2012 (stock traded in a $7-10 range), sold 0.3 million shares in 2013 ($9-17), sold 0.4 million shares in 2014 ($13-23) and sold 1 million shares in 2015 ($20-58) to reduce its stake to 2.5 million shares. Perceptive started to accumulate shares again in 2016, adding 0.3 million shares in 1H 2016 and selling the acquired shares in Q3 2016 (stake went back to 2.5 million shares) and then added 0.9 million shares in Q4 2016 and bought 1.8 million shares in 2017 to bring its stake to 5.1 million shares, a new record. Perceptive sold 0.4 million shares in Q1 which brought the stake back to 4.7 million shares, but that’s probably a size issue – the position is becoming too big for the fund and it likely had to reduce. NBIX is still Perceptive’s largest position despite the sale of 0.4 million shares.

Source: Stockcharts.com, WhaleWisdom

What’s worth noting here is that Perceptive paid far more for the additional shares it accumulated than it received when it sold those 1.7 million shares in the wide $9-58 price range. He addressed this (not his sales and purchases of NBIX shares, but the principle) in the Forbes interview (emphasis added):

Edelman doesn't believe in buying low and selling high either. "Only buy if the analysis indicates the stock is worth more and sell if it's worth less," he says. "This may involve buying something back at a higher price than where you sold it if new analysis or information says it should go higher." In the case of Neurocrine, Edelman bought in at $5 and continued to buy it as high as $80. The stock recently traded for $84.

I fully agree with every word in this paragraph.

And what happened at Neurocrine over the last 7-8 years? The company signed a lucrative partnership with Abbot Labs (now AbbVie) for elagolix and AbbVie took over its development and drove it to the finish line in endometriosis (PDUFA date in Q3 2018) and close to the finish line in uterine fibroids (reported positive phase 3 results in Q1 2018). It also pushed Ingrezza through the clinic in tardive dyskinesia, got it approved and executed a very strong launch and continued Ingrezza’s development in pediatric Tourette syndrome. The success in the clinic was the growth driver for Neurocrine through early 2017 and a combination of commercial and clinical success should be the driver of its next phase of growth.

As far as I’m concerned, Neurocrine still has plenty of room to grow in the following years. I expect Ingrezza to continue its strong uptake in the TD market, for elagolix to receive approval in endometriosis and in uterine fibroids, and for Neurocrine to get a meaningful piece of net sales from AbbVie. Ingrezza also has potential in Tourette syndrome and potentially other indications and other candidates are advancing or should enter the clinic. I already wrote about the stock’s potential in the following years in previous articles and if everything goes as planned, I would expect Neurocrine to reach a $15 billion market cap (to almost double from current levels) in the next 12-24 months and to at least reach a $20-25 market cap in the next 3-4 years. Additional upside is possible assuming contribution of other pipeline assets/indications (Ingrezza in pediatric Tourette’s, and maybe in other indications, NBI-74788 in classic CAH, opicapone, other pipeline candidates that may enter the clinic between now and 2021 and the company adding clinical/commercial assets through M&A).

Interim conclusion

A successful hedge fund like Perceptive Advisors:

  • Will buy a stock and hold it for years.
  • Will accumulate a position on the way up, if fundamentals warrant it.
  • Will sell part of its stake on the way up and buy those shares back at higher levels than it sold them for, and even more shares than it sold at those lower levels. Fundamentals and fundamental changes matter, not where the stock traded, where you bought the stock or where you sold the stock.
  • While not described so far in the article, Perceptive will sell a stock even at a significant loss and do so relentlessly. Even a fund like Perceptive has its fair share of losses. The most recent example I caught in the filings is Versartis (VSAR-OLD). The fund accumulated and held shares since 2014 and based on the filing history, I believe the average price was above $20 per share. Versartis' growth hormone candidate failed in the clinic and the stock lost 90% of its value, and so did Perceptive's position. Edelman wasted no time and started to dispose of the position and did so over the last six months.

I can relate to all of these points and try to do the same.

My own example

I have a very similar investing approach to Joseph Edelman. I too try to find winners and shoot for significant gains over a period of a few years. Supernus (SUPN) is my own example. I first purchased the stock in the high single digits (around $9 per share) and the stock was added to the Long-Term Growth Portfolio at its inception around $15 per share. The stock is up approximately 500% since my first purchase and 270% since it was added to the Long-Term Growth Portfolio. And I think it still has a lot of room to grow in the following years based on the growth of its commercial portfolio, label expansion opportunities for Oxtellar (monotherapy for epilepsy and treatment of bipolar disorder), phase 3 results of SPN-810 and SPN-812 in late 2018 and early 2019 and their eventual commercial success, as well as the company doing M&A to expand its marketed product portfolio or its pipeline. I believe Supernus has every trait of a potential long-term winner in the industry.

Source: Stockcharts.com

Other potential long-term winners

I continue to think that the above-mentioned names still have significant long-term growth potential - that's a big part of why I decided to include them. I will share two names I think are in the early stages of value creation, and both names are also part of Perceptive's portfolio. I share views on seven additional stocks that I believe similar long-term growth potential in an extended version of this article available only to Growth Stock Forum subscribers.

Ascendis Pharma (ASND). This is one of my favorite development-stage biotech companies and I really like the TransCon platform. Ascendis has three active clinical programs and all three candidates are potential blockbusters (or at least $500 million a year products) and the TransCon technology has potential applications in a lot of additional areas. We should see more clinical programs enter the clinic and create value in the following years and perhaps we will see partners Roche/Genentech and/or Sanofi finally push their candidates into the clinic. I believe Ascendis could become one of the most valuable rare disease companies in the world in the following years. For example, Ecor1's Oleg Nodelman (another biotech hedge fund manager) came out recently and said the stock could be worth $289 per share. I certainly think this price level is attainable in the next 3-5 years. Perceptive initiated a decent position - 982K shares (a 1.80% position) in the first quarter, so, I am really happy that Edelman recognized the company's potential and that he "joined me" here.

Retrophin (RTRX) has the traits of all stocks mentioned here, and an additional one that is, for now, only available to Neurocrine and Supernus. These companies, in addition to their commercial assets and their pipelines, have the option to do M&A and expand their respective commercial portfolios or pipelines. And Retrophin is doing that and should continue to do it. I don't see Retrophin's marketed product portfolio as a significant value creator for shareholders, but it is a funding vehicle for the pipeline. Sparsentan could become the company's most valuable asset given its potential in diseases like FSGS (phase 3 trial recently commenced) or IgAN (registrational trial should commence later this year). RE-024 in PKAN should add some value as well (though much lower than sparsentan, I believe), while the recently acquired CNSA-001 seems like a very interesting candidate for PKU. I am sure Retrophin will acquire additional clinical (or commercial) assets in the following quarters which could create additional shareholder value. Retrophin is currently a $1.1 billion stock and depending on how things go from here, I believe it could be at least a $5 billion stock if some or all of the mentioned programs are successfully brought to market. Perceptive has a solid position in Retrophin and has added 540K shares in Q1, which brought its stake to 3.2 million shares (2% of portfolio).

I don't think all of the stock mentioned in this article will be winners or continue to be winners in the long run, at least not 1,000% gainers, or even 200% gainers. Some of them will likely get acquired (for less), some of them will fail in the clinic and some of them will fail commercially (and I wish I knew which ones).

I rarely talk about the long-term potential like I do in this article, as saying a stock could rise 1,000% sounds like a pipe dream or pumping, but with a timeframe long enough, it happens and I am sure it will happen to some of these stocks. Significant gains can happen even in a shorter timeframe.

Conclusion

I hope that I have clearly outlined what the point of this article is. It shows how a biotech-focused hedge fund operates, how value is created in the biotech industry and how I try to invest and what my long-term goal is – to find and hold onto winners and achieve strong long-term performance. My highest conviction names are at the same time the companies that I expect to deliver the gains similar to those Perceptive achieved with Neurocrine or Amicus over a period of 3-4 years or longer - and those include the above-mentioned stocks - NBIX, SUPN, GBT, FOLD, ASND, and RTRX.

Disclosure: I am/we are long NBIX, GBT, FOLD, SUPN, ASND, RTRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article reflects the author's personal opinion and should not be regarded as a buy or sell recommendation or investment advice in any way.