Chris McCarthy:
Hello, and welcome to another edition of Pathfinders, the podcast series from RBC Capital Markets that explores the fast-moving world of biopharma. I'm Chris McCarthy, Managing Director and Healthcare Desk Sector Strategist at RBC Capital Markets. And I'm here today with Otello Stampacchia, PhD, founder, and managing director of Omega Funds, and Ben Snedeker, Senior Pharmaceutical and Specialty Pharma Analyst at HealthCor Management, to take the temperature of biotech and the wider healthcare sector today.
Otello founded Omega funds in 2004 and leads the firm's Investor Relations and Strategic Initiatives. He is a member of the firm's Investment Committee and is also heavily involved in a number of Omega's therapeutic areas of interest, particularly in oncology, rare diseases, and inflammatory disorders.
Ben has been with HealthCor since 2019, after serving as Therapeutics Analyst at PointState Capital. He was also a Portfolio Manager with D.E. Shaw and worked as an Associate Principal in the Pharmaceutical and Medical Products Practice at McKinsey & Company from 2000 to 2006. Ben, Otello, thank you so much for joining us today.
Let's jump right into it. Let's talk about where we are in the sector. Maybe what's the one less-discussed dynamic out there that's affecting the market today? Otello, why don't we start with you?
Otello Stampacchia:
I do think there's been a bit of a negative trend in public markets for the last year or so. And I think there's been a number of factors mentioned as potential causing the downdraft, from renew discussion on drop pricing, perceived lack of M and A, drawdowns from funds, performance of IPOs. Perhaps one factor that has not been as discussed, I believe are two things, I guess. One is the reduced volume from retail traders, and as many of you know, there's been a lot of people with a lot of time on their hands in the early cases of the pandemic which led to an explosion of retail trading.
Some of that found its way into more speculative stocks like biotech. And I think with the reduction of those trading volumes and less attention from those traders, I think we've also seen a bit of a negative feedback loop with certain ETFs that have been quite exposed to the sector. The first one that comes to mind is the ARKG ARK Innovation Fund's ETFs, and those have been certainly very much redeeming a lot of capital in the last few months and probably the last year as well. So that creates a bit of a contribution to the trading dynamic we have seen, in my opinion.
Chris McCarthy:
Ben, what's your take?
Ben Snedeker:
Yeah, Chris, thanks for having me, and maybe just to start, just one quick disclosure. All of the opinions that I'm going to share today are mine and mine alone and I'm speaking on behalf of only me and not on behalf of HealthCor. With that said, as I think about your question and I think, okay, where are we right now? I think one of the topics that's really foremost on people's minds is where do we sit within what is currently the longest and some could argue the deepest biotech bear market that we've seen in nearly 20 years?
I think that as you look at long term performance in the therapeutic sector, the best correlation between long term outperformance in the therapeutic sector is really revenue growth and expectations for revenue growth. But what's interesting is if you look at the dynamic that drives the most short-term outperformance, it most closely correlates with fund flows, and what follows from that is new listings of companies. And so what's interesting here is that I think we came through a period in that 2019 to early 2021 where you were really seeing just incredible fund flows into therapeutics, an incredible number of new listings, and we saw a really meaningful increase in that short-term outperformance based on those fund flows.
I think the challenge has been that we weren't able to convert that explosion in fund flows into an opportunity to say, okay, now we can start to see meaningful, long-term revenue growth. And I think that where we find ourselves right now is that you have a market that is trying to correct for what was outstanding short-term performance, but it's not really set up for attractive long-term performance if we think about revenue growth as a primary driver of that performance.
Chris McCarthy:
Let's stick with you, Ben. Where are the investment opportunities? And by the way, I'm not talking about how the safer commercial names will trade up first.
Ben Snedeker:
Yeah. It's a great question, and I think that I'll go back to what I said previously, if we think about the best correlation with long term therapeutics outperformance is the opportunity for meaningful revenue growth, I think that's really where the opportunity remains in the current market. And what's interesting here is it comes back to the point you made which is you don't want to say, all right, the safe commercial names are going to move first. I think what we need to look at is we need to say, well, where are those companies that the potential for revenue growth, the potential for revenue outperformance are not appropriately priced? That risk is not appropriately priced?
And what I would argue is that for the safer commercial names, typically, those companies are well covered, those safer commercial names are pretty well understood, and I think that the revenue growth potential of those companies is, for the most part, well reflected in their valuation. So where that leaves you is you say to find the opportunities, you need to find those companies where that revenue potential is currently mispriced by the market. And that can be companies that are pursuing new drug launches, that can be drugs that are finding new geographies and new indications where they can grow. It can also be clinical stage companies where you're getting far enough along that you can start to de-risk the revenue potential from a clinical asset. And it doesn't have to be that the product's in the market and that it's selling. It just has to be that you have some line of sight to revenue growth, that you feel that you can appropriately adjust the risk that that revenue is going to become real.
I think one of the things we've seen is that we've seen a move toward companies that are very far from being able to generate revenue. You can't actually effectively risk adjust revenue, let's say for a pre-IND company or a company that's telling you that the key event for their investment thesis is the filing of an IND. That's not an event where we can actually risk adjust revenue potential. So where I'd finish here is, I'd say if we look at the opportunity, it really is in those companies where you look at them and you identify that the market is, in your mind, inappropriately pricing the risk of the revenue potential of the company. And those are, to me, the companies that are going to lead us out of what we've just been describing as one of the certainly longest and also close to the deepest therapeutics bear market that we've seen in 20 years.
Chris McCarthy:
Otello, where do you see the opportunities?
Otello Stampacchia:
Yeah, so we play in a slightly different part of the park, I guess, than Ben so we do predominantly company creation, private venture capital financing, occasionally pipes. And to be completely transparent, the last of years have been a little bit tricky on some elements of our investment strategy because all pricing expectations where people were benchmarking some late stage private financings to evaluation of public companies that were at least in the 12 months ago and further out, were pretty healthy. So we had to remain extremely disciplined on valuation.
I do think the company creation part of the ecosystem is fairly inflexible. The rate limiting steps there are really exceptional ideas for products and platforms, as well as exceptional management. There's just not a huge supply of that so there would always be capacity constraints in that segment. I think the opposite end of the spectrum on the private side is probably where there are, at least soon, if not already now, probably more opportunities. Because some companies were extremely bullish on being able to raise what they would call crossover mezzanine financing, then immediately go public and they realize now that there's no longer certainty. So I think going back to fundamentals is always healthy and fundamentals are you should finance these companies for several years and get good clinical data. And I think that was a little bit tricky in that segment for the last couple of years, so I look forward to getting back into it.
But there's also, to be completely honest, there's also probably a lot of opportunities in the public markets right now. There's, I forget what the exact number is, but I believe over 120 companies that are trading below cash and at some stage that is in an efficiency that needs to be arbitraged out.
Chris McCarthy:
Otello, sticking with you. COVID-19 has certainly changed the healthcare industry, and it's something of an irony that biotech created the vaccine and more or less saved the world, but now the sector's down 50%. That's how I think about it, but how do you see the impacts of COVID?
Otello Stampacchia:
I mean, removing a little bit the discussion from the public performance, and if you try to take a step back and, to be clear, it's always hard to understand history as you are living it. And I do really think we are living through an historical inflection point at many, many levels, including lately the geopolitical. But, you're right. I mean the race for vaccines, antibodies, oral antivirals, has been nothing short of miraculous. And I don't really know how much people appreciate this, but in a span of less than a year, we had antibodies approved and several vaccines, two of which were arguably the most effective vaccines in history of mankind.
There's been an incredible focus shift from the academic industry on research on this virus. And again, this is giving a ridiculous amount of insight on how our immune system works in interacting with viruses, but also in interacting with host factors. So I think the repercussions in terms of dividends from this research for not just antiviral research, but in general, for autoimmune, rare diseases, and so on, is going to be phenomenal. And I really think there's been a massive step up in the pace.
Ben Snedeker:
I think Otello makes a fantastic point when he mentions that we don't always appreciate history while we're living it. I think when we look back and we really start to understand just how much impact coronavirus has had, and I'll focus just on the industry, I think it's going to be massive and it's going to be in a lot of ways that we didn't necessarily appreciate at the time.
One of the biggest changes with coronavirus is that it's forced us to completely rethink the speed with which companies can innovate and the speed with which regulatory bodies can review and support those innovations. And also then the speed with which you can ramp production and distribution in order to meet some urgent need. And then for those products to actually have an impact, a tangible impact on the trajectory of disease, I think we've had to completely rewrite what we assume in terms of the speed with which the industry can move.
I think that one of the challenges we see is that I think that many investors especially, and to my sense, some companies have viewed this as a difference in how the market's going to operate going forward. And I think that's created one of the challenges on this idea that accelerated pathways to market, accelerated ramps in product launches, very rapid moves toward substantial revenue potential for newly launched products, I think these are all dynamics that are currently believed to exist in the market because of what we saw from coronavirus and how it changed our outlook on how industry can take a product from early innovation all the way to market.
And I think that we're dealing with some of that fallout now where we need to recognize that a product being developed sort of run of the course for important diseases, but not necessarily for global pandemics, are going to have a different looking path to market than what we saw for pandemic therapy or pandemic diagnostic or whatever it happens to be.
Chris McCarthy:
Ben, let's stick with you. How do biotech bear markets end? I think we often hear about M&A hope, but is the reality more a combination of pipe transactions, what I'll call a merger of weakquals, bankruptcies, and fund closures running their course? What's your take there?
Ben Snedeker:
That's a great question. Merger of weakquals, by the way, is a pretty humorous term. In public equities, if we look at prior bear markets, and if I kind of think of the last 20 years, depending on what metric you want to use, maybe what index you use as reference, there have been either two or four bear markets.
And I think in all of those cases, the way that bear markets end is that they end quietly, and they end with positioning getting cleaned up, valuations falling, I'll say back to earth, but valuations dropping to what investors start to say is a more reasonable level. And I'll say more reasonable as defined by a willingness to deploy capital into those opportunities. And if we look back historically, what you see is that following a bear market, it's a slow grind back. You have a few companies that lead the way initially, others start to a catch up. Sometimes there are elements, things like M&A activity, merger activity, but that's really more the exception than the rule in terms of how bear markets end.
Chris McCarthy:
Otello, what's your take on biotech bear markets and now they end.
Otello Stampacchia:
It's a contribution of various factors. Some people like to over perform, the FDA needs to go back to do assessment and give out less CRLs. There's now new leadership at the FDA, which I think is helpful. I do think M&A will play a role. I don't know how meaningful it would be, but if you look even at the last couple of years, people have been complaining there isn’t enough M&A, but the reality is less dollar volume, but in terms of absolute volume, in terms of number of deals it's actually up. And this is because in the current context it's going to be really hard for pharma to do mergers of equals on the pharma side, or large company side. So I think that skews potential discussions in favor of smaller companies, which is where most of the innovation is anyway. So I do think it would play a role, but I agree it's not going to be a week where there's five, six mergers, and that the XBI goes up 60%. It's going to take a little bit longer.
I do think the drug pricing rhetoric, just because of the change in attitudes in Congress, is something to keep an eye on. I'm encouraged by the latest news there in terms of focusing a little bit more on the role of PPMS versus innovators. And I do think, by the way, the pandemic has had an influence on lawmakers making them understand how strategic this industry is. And by the way, I'm starting to see the same in Europe. But again, Ben is fundamentally right. There's going to be a number of factors over a period of time, and I think that will create a lot of opportunities for people with conviction to make some great investments.
Chris McCarthy:
Ben, let's stick with you on biotech catalysts. Why is the batting average so poor lately? Most I speak to don't think it's a run of the mill slump at the plate, but attribute it to more inside baseball. What's your take?
Ben Snedeker:
Yeah. Chris, it's a great question, and it's one that I think everybody is wrestling with and trying to understand. And I would agree with you, I think. My view is that this isn't just run of the mill. It's not just, "Hey, this is how risk goes and we just happen to be in a lull." I think there is something more structural that's going on, and I think that the question encapsulates a lot of the topics that we've been touching on. And again, this is strictly speculation. I don't think anybody really knows, but if I had to share with you my guess on why it seems like we're in such a slump on the catalysts that have been coming through, yeah, I think it comes back to a few things.
I think part of this is that, the funding cycle which we talked about earlier has been so robust, and there's been so many companies attracting so much capital, that while there are without a doubt multiple outstanding companies that are attracting that capital, I think there are others that are also attracting a larger amount of capital at either an earlier stage, or with less external diligence than tends to occur in a period where maybe the funding isn't quite so available. And so I think that we skew toward potentially some higher risk events as a result of that dynamic. I think a second piece is that anytime you're in a biotech bull market, and we talked about it earlier, but I would say the bull market really start started to pick up in 2019, and it ran through the early part of 2021, but you could even roll it back a little bit further and say even in 2018 we were starting to see signs that we were moving into an attractive biotech market. And I think what we see in these big bull markets is that you see a substantial amount of employee turnover. And it's the opportunity for employees in the therapeutic space to take some risk, to move to smaller companies, to work on really cutting edge, innovative science.
I think part of the challenge with that though, is that you get so much employee turnover in bull markets, and we all see the articles about how challenging it is to hire and keep people. I think that turnover invariably can lead to risk within an R&D organization. There tends to be, I would say, a core group of people that tend to be most focused on any individual program or individual catalyst, as we're calling it. And when you get a lot of turnover among that employee base, I think it can increase the risk in that program.
And I think a lot of the catalysts they're reading out now are programs that were maturing in that period of time when we were figuring out how to work in a new way. And I do think that while it's absolutely possible to work either in a remote setting or a hybrid setting, I do think that a lot of these programs may be suffering from maturing during a period when we were still kind of trying to figure out how to do that; which I think in some cases may have raised the risk on how those catalysts were going to read out.
Chris McCarthy:
Otello, what's your take on this?
Otello Stampacchia:
Yeah. It's hard to disagree. Right? So again, Ben makes some, some excellent points, as always, is a multifactorial issue. In terms of batting average, a little bit depends on the definition. Right? Are we talking Phase 2, Phase 3 success rates? Or are we talking meaningful commercial launches? I think in a pandemic, there's been real challenges to enrolling patients in some indications, particularly oncology and other very vulnerable populations. So that's been, in my opinion, a huge factor that has delayed with recruitment, and in some cases, made very difficult. And in some cases, that also increases friction, in terms of the positive outcomes of some of these trials. So that's definitely something that we have been extremely worried and had many, many discussions across our portfolio in how to correct for.
Again, FDA, also another issue. I think that they dedicated so much time and resources to the emergency in the pandemic, that some of the other areas have probably suffered. I think at the end of the day, it also depends on the diseases that you focus on, that we treat, really, really focus within the firm on areas of extreme medical need, where I think some of these factors are less of a concern, in terms of attention from the FDA on recruiting and so on. But still, it's hard to say that nobody's affected.
So I think the denominator effect that Ben mentioned probably deserves an extended look, because there's a lot more companies now that are public after the pretty unprecedented, in my opinion, number of IPOs over the last two, three years. And I think that that is also an implication, in terms of the attention span from public investors. It's really hard to focus on such a much larger universe; and because it's so much larger as a universe, some people probably are not doing the same depth of work that they were doing in the past. And there's also been a number of new entrants.
So I think it's all interconnected. I do think with some pause for reflection for higher quality programs, I think we will hopefully see some of these batting averages improve over time. But this is a business of exception, and it builds and it behooves investors like ours to understand, "How do we get better at picking up those exceptional companies?" That's really our job.
Chris McCarthy:
Otello, let's stick with you as we wrap it up. Let's get more granular at the end here, in how you both invest in healthcare, and how all the topics discuss impact your forward view. Otello?
Otello Stampacchia:
Yeah. This could be again a whole conference on its own, or podcast on its own. But I think we always try to be extremely granular, for lack of a better word, in identifying errors of a medical need: what's missing, what right drugs, or modalities will make sense?
Another area where we spend a lot of time internally is really clinical trial development strategy and competitive analysis. This is an area that I think is incredibly difficult to get right; because there's just so much out there, and it requires quite a very, very deep understanding and analysis. I have to say, I'm extremely proud of the fact that we invested in companies that have launched 47 products, which I think is quite unprecedented in our segment of the industry; and each of those drugs and products have come learnings that we apply through our investment strategy. So having perhaps a certain amount of staying power, if you will, in the industry, I think it's disproportionally impactful.
Chris McCarthy:
Ben, what's your take on how all these topics shape your forward view?
Ben Snedeker:
Thanks, Chris. To Otello's point, we could probably talk about this all day and then some; but to try and distill it down as much as possible, I think we continue, like Otello mentioned, we focus very much on the individual company, at the most granular level. And the investments still need to be fundamentally driven; companies with outstanding products, excellent innovation, a track record of success, management teams with a strong execution track record, the ability to communicate effectively, companies that are well-funded and match up against important themes that we see, let's say from a disease perspective. All of that remains absolutely true.
I think one area that we've been very focused on, it started with coronavirus, it's continued through discussion on things like inflation and rates, and now into geopolitical uncertainty, is just more focused on always being certain that we're being macro-aware in the portfolio. We're going to remain fundamental investors, focused on individual companies within the healthcare ecosystem; but that all needs to be viewed through the lens of being again, I'll use the term macro-aware.
And, as much as possible, we've built elements into the investment process to make sure that we are macro-aware. But at the end of the day, it comes back to finding great companies, great products, where we believe that the market is mispricing the risk around that company in some way. And I'll kind of circle back to the point that I made early on. We really do focus on the opportunity for these companies to drive tangible revenue growth. And if we can find great products with a great team, where we believe that opportunity, whether near-term, medium-term, or long-term, but the opportunity to drive meaningful innovation for patients that will translate into outstanding revenue growth; when that risk is mispriced in an outstanding company, that continues to be where we're going to focus our investments.
Chris McCarthy:
Well, thank you, Ben and Otello, for your time and your insights. What else can we expect from markets and this constantly evolving industry in the year ahead? We'll be tracking them right here on Pathfinders. So until our next episode, thank you for joining us. And if there are any topics we discussed that you'd like more information on, please contact us directly, or visit our website for more insights, at www.rbccm.com/biopharma. Thank you.