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My Developmental Biotech Due Diligence Factors

|Includes: ATHX, CLBS, CUR, EDAP, ImmunoCellular Therapeutics, Ltd. (IMUC), MBOT, ONCS, PSTI, SLS

Some people call Developmental Biotech roulette, but not me. I believe with reasonable due diligence, you can pick more winners than losers. Having picked up a few followers here on Seeking Alpha, wanted to briefly describe both my overall strategy for my Developmental Biotech portfolio, and my due diligence criteria for individual stocks. This is going to be a short and sweet posting just to get the basics down in writing for those who may be interested.

Overall strategy (guidelines, not rigid rules, but I stick pretty close to these)

  • Longer term trades (months to few years)
  • Pick entry points carefully, pre-hype.
  • Watch the short interest, when it gets too high, take a bit of profit and catch a new entry point at a lower price in the cycle, as the shorts seem to get their way when they own a high percentage of the float.
  • Take profit on a portion of any position that returns over 100%, but stay in if the data looks good, the split to be determined by a reading of the due diligence factors at the time (typical for me is something like 1/3 profit taking, retain 2/3rds of position).

I am not a day trader, nor do I wish to be. When investing, my strong preference is to play the fundamentals for mid to long term growth, but not just the FINANCIAL fundamentals, also the INNOVATION fundamentals. I do product innovation for a living, and like applying my knowledge from that field to the investment domain. I'm strongly attracted to developmental biotech partly because there is real breakthrough, world-changing science going on here, and partly because I can see innovation principles that I've mastered over the years in the consumer products domain at work in another exciting sector of business and science. What are these innovation fundamentals, you may ask? I've developed a personal due diligence list for my Dev Biotech stocks that reflects a blending of the financial and innovation fundamentals that I believe are the strongest indicators of future success.

Dev Biotech Due Diligence list, in bullet point form:

  • Mechanism of action vs. other treatments in development - is there good bench science behind the mechanism, is it well supported in multiple non-human models, have multiple labs confirmed the mechanism, is the mechanism the better one to pursue among alternatives, is the mechanism consistent with broader trends and developments within the relevant branches of science?
  • Pre-clinical and phase 1/2 results - these small-based test results CAN be meaningful if a first of kind result is obtained, say in humane use, or if phase 1/2 treatments are extended or show unusually positive outcomes in addition to the dosing safety results that are the primary focus - still risky as the results may not scale, but useful in finding the good ones earlier than others might, especially in combination with positive data in the other Due Diligence factors.
  • Clinical pipeline and design - is the clinical pipeline "right sized?", i.e., is there more than one planned, but not so many that cash flow causes failure - do they have partners helping to support the clinicals - do they cover the right mix of possible indications for the treatments - are the clinicals well designed to lead to the next scale step vs. having to repeat at the same scale - and generally NO one-trick ponies.
  • Grants/external support - is the firm receiving outside support from NGO or Government Agencies, a strong indication of someone ELSE's positive due diligence, and a huge help to cash burn.
  • IP - is the patent portfolio strong and broad enough, and growing - are they acquiring relevant IP from others, how does their IP stack up against others pursuing similar approaches, do they look like they hold enough IP space to carve out multiple income streams vs. narrowly defined or single treatments?
  • Cash/burn rate > key milestone timing - a simple metric, divide the cash/financing on hand by the burn rate and compare to the clinical milestone map, do they have enough to get through one or more key milestones before needing to seek additional funding - do they have non-dilutive sources of funding, in general, if they are constantly diluting without any other funding sources or partnership, I stay away.
  • Management team - here I look a bit at the who, but mostly the what, i.e., how sound is their financial and innovation strategy and how well focused is their development - too narrow and the ultimate value may be low, too broad and nothing gets done.
  • Science team - what is the buzz by OTHER scientists about the results the science team is presenting - how well do their academic or medical clinical partners support not just the science but the underlying mechanisms?
  • Multiple potential indications/income streams - does their primary innovation have many potential indications OR do they have several different innovations in development that all have good due diligence factors OR do they have a nice blend of phase 1-3 clinicals plus perhaps an income stream or two from other products.

This broad range of factors is one reason why not everyone is attracted to or competent to succeed when investing in Developmental Biotech, but the financial and personal rewards can be quite satisfying.

My portfolio now contains PSTI, CUR, IMUC, NBS, ONCS.OB, and STEM 10-15% each, with smaller positions in ATHX, EDAP and GALE. This approach helped me find some good folks early, for example, PSTI, CUR, IMUC and NBS all have nice double to triple digit % returns to date. ONCS.OB is the latest to pass my due diligence standards.

In general, I believe the cellular and immunological approaches to treatment of disease are powerful new scientific paradigms that will, over time, deliver better results than small-molecule drugs for many diseases, especially those that have been the toughest to treat historically - auto-immune, neurological/nerve damage, de-myelination, many cancers, etc. - so that has guided my selection of investments. Of course, all Developmental Biotech has high risk, it is, after all, business based on cutting edge science, but it is still subject to financial and scientific analysis, as long as that analysis is structured to reflect the nature of the business and the underlying science, and one is willing to deal with the inherent uncertainties in the sector.

I know this is quite a daunting list, but I hope it is a helpful one to those who are currently investing or considering investment in Developmental Biotech. I'm sure there are many other factors other smart SA members use, and look forward to hearing from you!

Disclosure: I am long IMUC, CUR, PSTI, NBS, ONCS, STEM, GALE, ATHX, EDAP.