Five Companies In The Casey Portfolio Worth Watching: Alex Daley

May 21, 2012 11:36 PM ET
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Portfolio Strategy, Biotech, Long/Short Equity, Healthcare

Contributor Since 2012

The Life Sciences Report features leading investment coverage of the life sciences sector, including biotechnology, pharmaceuticals, tools & diagnostics, and medical devices. A Streetwise Reports publication.

Five Companies in the Casey Portfolio Worth Watching: Alex Daley

Source: George S. Mack, The Life Sciences Report (5/17/12)

Biotech and medtech expose investors to rapid growth in healthcare innovation. In this exclusive interview with The Life Sciences Report, Chief Investment Strategist Alex Daley of Casey's Extraordinary Technology matches science to unmet needs to bring big ideas and big returns to investors.

The Life Sciences Report: How do you find the companies that you recommend?

Alex Daley: We look for the science first. There are a lot of companies in the biotechnology field. Some pin the number at more than 7,000 biotech companies, public and private, in the U.S. alone. That is a lot of data to sort through. The sector possesses a great mix of hype and expectations, which can bewilder investors at times. We focus on finding the right therapies first, the right management team second, and the right investment payback timeline third. There are many very promising compounds in university and private labs. We start with the scientific literature and the data, looking for proofs of compound capabilities. We try to focus on those companies that are going to provide the most compelling investment opportunity in the near term, meaning in the next two to three years maximum, for our subscribers.

TLSR: You look at the science first, and then you want to see market-moving activity occur in the short term. Is that right?

AD: Absolutely. You can have a public company with a potentially great therapy in the pipeline but the product might realistically be a decade from the market. That might be OK for some investors, but it's just not right for us.

TLSR: Do you have a theme within healthcare currently?

AD: Our theme is to focus on markets with the most profit potential, and those shift over time. We concentrate on a couple of large, underserved markets. We focus heavily on cancer because over the course of the last decade or so, laboratory progress in oncology has been absolutely incredible. However, advancement in actual patient care has not kept up with what has been going on in the laboratory. We are seeing a backlog of great opportunities with huge potential in new targeted therapies that focus on any one of the 140 or so conditions that comprise cancer.

Another focus is the orphan disease market. Orphan diseases can be underserved for any number of reasons. One is simply that the disease has never gotten research funding. Just as with anything, research funding is to some extent a popularity contest. Things go in and out of style, and governments tend to support certain core areas. Diseases can be out of the limelight even though there is no standard-of-care therapy. A disease can also be an orphan because we simply don't understand how the disease works-and even if we do understand it, we may not have the tools to build a therapy. That is especially true of genetic diseases. We like to focus heavily on genetic diseases.

Our third and fourth areas of focus are on what we call the nonregulated or less-regulated spaces in genetic testing/diagnostics and medical devices. These fields make it easier to treat patients with chronic diseases, both to determine what treatments will be effective and to actually administer treatments.

TLSR: Are you saying that in addition to cancer and orphan diseases, you like diagnostics and medical devices that may not require long periods of time for development and approval the way drugs might?

AD: Yes. We are constantly looking at what is available in terms of the science and how that market is being served today.

TLSR: You have written that biotech is ripe for speculation. Why is that?

AD: A couple of things make for a good speculative market. First, there is a lot of opportunity in the market. The average public investor can get involved in a large number of companies. If you only had 10 companies in a market, it would be very difficult to speculate. A large number of players also enables you to spread your risk. When you are dealing in speculative markets, the last thing you want is only one or two positions. No matter how good your research is, you're bound to get something wrong. You want to diversify across a reasonable number of investments, and we like large markets for that reason.

TLSR: When a drug trial fails, do you expect a company to have a lingering hangover, even if there are secondary candidates in the pipeline? Do you find opportunity in these situations?

AD: There is no question that whenever a trial fails-or doesn't meet its primary endpoint or other expectations-there is hangover. That can be a huge potential opportunity for investors in some cases, but certainly not in all.

For example, a company may have conducted a poorly designed trial, in which the primary endpoint was the wrong one. The therapy doesn't cure a disease but does significantly extend patient survivability. It could be very successful in the right trial.

You may also find a company that has a large pipeline, but only one of its lead candidates makes up the bulk of market value for the company. If that drug fails, investors panic and run away.

A third type of likely hangover that can be advantageous is just a delay. We saw this with Amylin Pharmaceuticals Inc. (AMLN:NASDAQ), which made a significant return for our investors over the last year. Amylin was three years late to market with its next-generation diabetes drug, Bydureon (exenatide). However, despite all of the setbacks, the company had a solid drug with absolutely great efficacy data. It was much more convenient for patients, being a once-a-week injection versus a once-daily injection. Everything was going for it. There was a large market, existing experience in that market and a strong management team. Very little was going wrong for the company other than the time delay. Just by being willing to wait it out, we were able to make a significant return for investors.

TLSR: How do you decide when a company is overvalued?

AD: Deciding that a company is overvalued, especially at the extreme end, is often much easier than finding an undervalued company. Generally, when a company gets really overvalued, the market cap gets out of whack with the company's market potential. You saw that with Human Genome Sciences Inc. (HGSI:NASDAQ), which had huge run-ups in its stock price over a number of years. I believe that the market cap hit a peak somewhere around $7 billion (B). Even if it had a 100% success rate with its entire pipeline, the company never could have justified the market capitalization. For it to be in line with the average large therapeutic company trading at about three times gross revenue, the company would have had to pull in $2.5-3B/year. The company simply didn't have the pipeline to bring in that kind of revenue.

The math is usually pretty simple. If a company with a large market cap is successful with a reasonable percentage of its pipeline, can its revenue and earnings bring it in line with its peers eventually? If there is no way, it is clearly overvalued.

TLSR: Can you speak about some of the companies that you are recommending?

AD: We tend to invest on a 24- to 36-month time horizon. A good example of a company that has been in our portfolio for a year but hasn't yet performed is Isis Pharmaceuticals Inc. (ISIS:NASDAQ). Isis is a combination of a pick-and-shovel play, supplying an industry, and a direct-therapy play.

Isis is one of the leaders in antisense drug development. Antisense drugs generally block genetic activity. Basically, they flip a temporary on-off switch for genes. We like Isis is because its platform for discovering drugs is the strongest out there. Almost every major company working in RNA interference (RNAi), from the largest pharmaceutical companies down to the smallest research-stage private companies, uses Isis' tools to discover their potential therapies. And Isis is using its tools the same way, to build a strong pipeline of genetic therapies.

TLSR: Isis has filed its lead candidate, KYNAMRO (mipomersen), with the U.S. Food and Drug Administration (FDA), and last summer with the European Medicines Agency (EMA), correct?

AD: Yes. With mipomersen, which is targeted for high-risk patients with high cholesterol, Isis has a near-term portfolio candidate that should help boost its revenues, make it less dependent on outside cash and shore up its ability to do long-term development. Mipomersen itself is one of those drugs that has been overhyped and overvalued by 30-40% over the last couple of years. As that has shaken out of the portfolio, Isis has become a much stronger buy over the last year or so. We have had it in our portfolio since its price was high, but we see a lot of long-term potential in the company and, in general, in the RNAi and antisense therapy areas.

TLSR: Mipomersen's lead indication is for a small population of patients, but if the product is approved, doesn't it prove the platform for many of the products in Isis' pipeline?

AD: Absolutely. Mipomersen is the sacrificial lamb at some level. It is the first infantry. No RNAi or antisense therapy has been approved for human use by the FDA thus far, so this is the first drug going through what is bound to be a much longer and harder evaluation process than the standard for average drugs. That is saying a lot, given how long and complex the FDA approval process has gotten. The fact that it is going to be the leading drug candidate in its area is great. It shows the major confidence of management in its own science.

TLSR: Another company?

AD: One of our favorite companies is Curis Inc. (CRIS:NASDAQ), which is focusing on pathway inhibitors, an area where it has first-mover advantage. A lot of major pharmaceutical companies are spending their resources in this area these days. Curis is focused on the hedgehog signaling pathway to shut down the growth of cancer cells. What's interesting is that the company is currently focusing on just a few small cancer areas, like basal cell carcinoma (BCC), where it is furthest along. However, behind its initial indications and trials is a whole pipeline of potential therapies for many different cancers, all using the same basic approach. Even if Curis was focused only on BCC, it would be interesting at its current valuation, with some potential upside. It is very much a small-cap biotech company with large potential. Before the BCC treatment was approved, we told our readers that the stock, which now trades just under $5, would either go to $25 or to zero. A binary investment. With one therapy approved, the story is much stronger than it was.

TLSR: The hedgehog pathway is extraordinarily important in metastasis. The small-molecule tyrosine kinase inhibitors, which inhibit the hedgehog pathway, may turn out to be chronic therapies that prevent metastasis and make cancer treatable in the way we treat atherosclerosis with statins today. What do you think about that?

AD: That is a potential risk and a potential benefit at the same time-but yes. What is unique about Curis' product is that it holds cancer at bay. It is not necessarily a cure for the underlying disease. However, if accepted by oncologists who are less accustomed to maintenance therapies, it has the potential to generate very lucrative income for the company as it becomes a long-term treatment regimen.

TLSR: Do you have another favorite?

AD: One of our favorite companies in the biological area is Genomic Health Inc. (GHDX:NASDAQ). We like it because it is involved in cancer, but not in treatment. It provides an assay of genetic tests that help guide oncologists in choosing the appropriate therapies for patients. Samples of thousands of tumors from many different patients have been studied to see how they behave and whether tumors with certain genetic profiles will respond better to chemotherapy or to radiation, as well as to determine how likely they are to metastasize and how quickly.

TLSR: The tests are designed to help the physician make the best choice the first time, correct?

AD: Yes. The results of the tests are changing what oncologists prescribe for patients in a significant way. In more than 30% of cases, after getting results of the tests, doctors actually take a different course of action than they originally intended, which means significantly less money spent on therapies that are ineffectual and more money spent on therapies that are effective up front, and potentially lifesaving.

TLSR: I'm looking at Curis, with a small market cap of $382M and a powerful therapeutic pipeline versus Genomic Health, a prognostic/diagnostic company with a market cap of $840M. Other companies may come along and, in a two- to three-year period, develop a better diagnostic/prognostic. Doesn't that hurt the margins of a company like Genomic Health?

AD: Of course. Genomic Health is always at risk from lower-cost competitors, but that is why intellectual property (IP) protection is important. The company has to manage its IP portfolio well when it is in a space like this. It has to take advantage of the fact that it is a first mover to become synonymous with the field. Brand identity and the value of a particular diagnostic are very much tied up together. Doctors have to trust the tests and trust the company and believe in the results and consistent performance. Genomic Health has performed on all those fronts. It has not been slow to follow up on the success of its breast cancer test with other tests. It is moving as fast as possible to establish market leadership, and it is producing an overwhelming amount of data to back up the efficacy of its tests.

TLSR: You follow a variety of companies, from drug development to genomic-related diagnostics, and you also have some medtech in your coverage. Do you want to mention some of those?

AD: Yes. For instance, we have followed NxStage Medical Inc. (NXTM:NASDAQ) for some time. This is a major change from what we've been talking about to this point, and that is why I bring it up. Not all of the opportunity in healthcare is in cancer. Not all of the opportunity is in genetics and biologics. There is a side to care that just uses good old-fashioned analog technology.

NxStage was focused on kidney dialysis centers, but these facilities are very expensive to run. The care that people got at dialysis centers was lifesaving, but it wasn't of the highest possible quality. Sitting for four or five hours twice a week at a renal care center to go through dialysis is an incredibly boring, painful and depressing experience. The company has invented a machine it calls System One, which allows patients to go through home dialysis. This is great for all kinds of reasons. Number one, the company can sell the machine to insurance companies or to patients directly. It is more of a cash-up-front business. Significantly fewer capital costs exist for the company because it doesn't have to own buildings, operate centers and pay as many employee salaries. The business' margins are much better. On the flip side, System One is better for patients, who would much rather have treatments at home. The home environment is good for patients, and that better environment means better outcomes. The machine allows patients to do daily hemodialysis or every-other-day hemodialysis, and the more often they have dialysis, the better the outcome as well.

TLSR: The company's stock is close to your target price of $20. Are you reevaluating that target?

AD: We reevaluate all of the stocks in our portfolio consistently. We have yet to raise our target price on NxStage Medical formally. However, I would say the company has shown every sign of good execution. We are waiting to see it turn the corner into solid, consistent profitability and to show that it can successfully make the remaining few steps in the transition from dialysis centers to home hemodialysis. We are not ready to tell subscribers to buy again today, but that could potentially happen.

TLSR: I'd like to hear another story if you have one.

AD: I can provide one more: Techne Corp. (TECH:NASDAQ). It has been one of the staples of our portfolio and has been there for quite some time, with slow, consistent annual growth of 13-15%. Techne is not the kind of company that is going to double overnight. Rather, it is the ultimate pick-and-shovel play for the biotechnology business. It provides different types of biological compounds to companies doing research, and supplies every major pharmaceutical company in the world that is getting into biologics, as well as a good majority of small upstarts. Techne has been a great addition to our portfolio in the sense that it gives us exposure to the biological revolution without having to bet on any particular horse. It is like saying, "I think the racetrack will be profitable, but I don't know which horse is going to win."

TLSR: Thank you so much, Alex.

AD: Thank you. I've enjoyed it.

Alex Daley is the senior editor of Casey's Extraordinary Technology. In his varied career, he has worked as a senior research executive, software developer, project manager, senior IT executive, and technology marketer. He is an industry insider of the highest order, having been involved in numerous startups as an advisor to venture capital companies. He is a trusted advisor to the CEOs and strategic planners of some of the world's largest tech companies. And he's a successful angel investor in his own right, with a long history of spectacular investment successes.

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1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: Isis Pharmaceuticals Inc.

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 services. Interviews are edited for clarity.

3) Alex Daley: I personally and/or my family own shares of the following companies mentioned in this interview: Amylin Pharmaceuticals Inc., Human Genome Sciences Inc., Isis Pharmaceuticals Inc., Curis Inc., Genomic Health Inc., NxStage Medical Inc. and Techne Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.

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