An Analyst’s Take on Drug Pricing and Catalysts in the Biotech Industry

INN sat down with Hartaj Singh about a variety of topics about investing in biotechnology. In the first of a two-part series, he talks about the industry in 2016 and 2017, drug pricing, and catalysts for growth in the sector.
Singh is a Managing Director and one of the Senior Analysts covering biotechnology at investment firm Oppenheimer & Co. He has spent over 10 years in drug development and marketing, as well as over 10 years of successful investment management expertise.
Some highlights of our conversation include Singh’s thoughts on the following:

• Sales and earnings: “A lot of momentum money went out of the sector as sales and earnings slowed in 2015/16.”
• The future of investing in biotech: “I think towards the second half of this year, we’re going to start to see generalist money and a re-energization of people looking at the sector and saying, it’s still a great sector.”
• A timeframe for investing in biotech: “If you have a minimal five, ten year timeline, invest for the mid to long term.”
• What types of companies to invest in: “When I look at investors that don’t have the resources or the education or the background I have to look at this. What I tell them is do this: you need to focus on companies that are just starting to hit breakeven.”
• Investing tip: “ I’m not going to waste your time by telling you how to invest in small cap biotech because it would be a waste of your time.”

Continue reading below for the full transcript of part one of our conversation with Singh. It has been edited for clarity and brevity.

Hartaj Singh: From a thirty thousand foot perspective, the thing where biotech has taken it on the chin in the last eighteen years, drug pricing has been an issue. One of the other things that’s less known, for example–I spoke about this, Bob Pisani at CNBC actually highlighted this at a segment last year–you actually see sales and earnings of large cap biotech companies, they’ve really slowed down the growth after 2014. 2014 was peak sales and growth, it drew 40 percent on the top line, and 50 percent on the bottom line for the seven large cap companies. That reduced by half in 2015, and that reduced again by two thirds in 2017.
A lot of momentum money went out of the sector as sales and earnings slowed in 2015/16.
The reason why I point that out, is it’s not just drug pricing and it’s not just presidential elections, there was (sic) actually quantitative factors also–sales and earnings do matter. Gilead (NASDAQ:GILD), Regeneron (NASDAQ:REGN), Alexion (NASDAQ:ALXN), they’re still growing well but the 30, 40, 50 percent bottom line growth now is more like in the teens.
The sector is kind of rationalizing. Also, NBI Index (INDEXNASDAQ:NBI) which is one of our default indices, is now a biotechnology Index. There was two hundred and fifty billion in market cap in 2009, financial crisis, it’s now eight hundred billion market cap.
It’s gone up three and a half times and that’s after the Index is down almost 30 percent since August of 2015 which was the peak.
So even after that 35 percent reduction, we still have an eight hundred billion market cap so this sector now that used to be what we call idiosyncratic, meaning only specialists used to invest in it in the 1990s and 2000 not because the eight hundred billion market cap plus these companies’ sales and earnings are growing in the teens and the twenties.
A lot of generalists are coming into the sector saying, “We’ve got to have exposure in biotech”. So it’s not just the specialists anymore driving the sector, it’s a lot of generalist are coming in and saying, “You know what, I need exposure to this because the S&P grows every year five, ten percent and this sector can be up ten or twenty percent.” And it was up until 2016 30, 40, 50 percent so I need to own it, some part of it in order to boost my portfolio.
I think that trade would start coming back now, not so much in ’17 but definitely in ’18.
I think in 2017, we will see the first parts of it, and that’s where I’m going with this is, what you’re seeing in 2016 is a compression to the industry as people left, generalist and momentum money. Now slowly, the sector has gotten the valuations, gotten much more interesting and I think towards the second half of this year, we’re going to start to see generalist money and a re-energization of people looking at the sector and saying, it’s still a great sector.
INN: And what do you think the catalyst is going to be for that?
HS: You know, I don’t think that they’ll need one specific catalyst. I do think that one specific catalyst would be the lack of a catalyst, which is that in the first three months of a Trump administration people will want to see: are there going to be any tweets or anybody that he makes head of Medicare, for example or Department of Health and Human Services, who has a drug pricing bent, who wants to clamp down on the ability of pharmaceutical and biotech companies to basically not have drug pricing negotiations. I think if in the next three to six months, people see that he doesn’t hire somebody like that, which Hillary Clinton would most likely have done. So the lack of that catalyst will be very important, that will be number one, then generalist money will start looking at the sector again. Number two will be people look at the sales and earnings profile of the sector over the next three years.
I tell people from 2015, and we have this—actually in our note that we sent out — Alexion (NASDAQ:ALXN) all the way to Vertex (NASDAQ:VRTX), there are seven large biotech companies, if you actually look at the next three years their median growth in the top line is about 60 percent.
Earnings growth is about 55 percent. Which other sector, that’s almost a trillion in market cap, on the NASDAQ Biotechnology Index has that kind of profile?
So what’s going to happen is once drug pricing gets out of the equation–hopefully it will–Trump will—dim the noise because Republicans have historically been friendly towards that.
The lack of that, coupled with the trajectory of this earnings growth. Over the next three years, we really believe that the second half this year is when the sector really starts working.
I think the probability is more that the sector will work–if it works–more likely in the second half than in the first half.
The run up that we’re seeing right now is most likely a JP Morgan Trade–the JP Morgan Trade has been well-known in the sector. Basically the sector tends to work in January and February, those are the two strongest months of the year for the sector over the last nine years. And then it kind of gives about a third or 50 percent of that back in March and April.
INN: That’s really interesting. With mining, we run until March where their big trade show is PDAC in Toronto, so all the stocks tend to run until March and then by May, everyone leaves the sector and doesn’t come back until September.
HS: That’s actually interesting that you say that. There are levels of information that people want. For our sophisticated investors, the thing that I point out to them is that biotech—we could spend a couple of hours and explain this to you, but essentially the takeaway is that the sales and earnings of biotech companies, the large cap companies, which their sales and earnings still constitute about 85 percent total sector sales and earnings.

There are 190 companies in the NBI Index of which the seven large cap basically make up 80, 85 percent of those earnings, so it’s still very disproportionate.
Think of it this way: biotech right now is kind of like European football, in the good old days there’s like five or six or seven great players that pretty much made a team. Nowadays the level of technical sophistication of almost every player is very, very good. Now what you want is a conglomeration of stars, the galacticos, as they used to call them.
INN: In the mining sector, there are regular catalysts that engage investors: you have a piece of land, you drill a hole, you pull the core up, you say we’ve got lots of gold catalysts. You drill 10 more holes, catalysts. When I talk to the biotech guys, their runways are so long–they’ll raise 30 million, they say we’re good until the end of 2018 because we’re doing our phase three trial. What do investors look for to know that’s a company to stay engaged with over that time?
You just asked a really good question. I tell people biotech is very idiosyncratic… clinical trial readouts that you don’t want to spend the time trying to figure out.
I give people a much easier framework. I say, look, let’s take a step back. Now, of course, there’s a very important caveat to this new plan, it is that you’ve got to have a minimum five to ten year timeline, that’s the caveat. The reason I’m going with this is, they’re not going to give you a more specific trading-oriented insight.
If you have a minimal five, ten year timeline, invest for the mid to long term, then, you know, let’s look at the 20th century. In 1955, the semiconductor was invented by Intel. The graphical user interface or the GUI as it was called, was invented by Xerox PARC and commercialized by Microsoft and Apple. The late 60s was when Xerox PARC invented it. The World Wide Web came into existence in 1995.
In those 40 to about 50 years, if you actually look at the amount of market cap that was created, it’s phenomenal. There was a tech tsunami that occurred in those 50 years. Market cap moved from zero to, I think, something like five or six trillion.
In biotech, we had our seminal event analogous to the semiconductor being invented — in 2000 with the human genome sequence. I don’t know what our next seminal event will be, maybe it’s some of these gene therapies, these car keys, as they’re called. But what we’re going through is, I tell people that if you’re a generalist and you don’t want to take the time to get to know biotech inside out, you’ve got a five to ten year timeline, think about the tech tsunami in the first half of this century. We’re going to be having the biotech tsunami. As I’ve told you, the NBI Index went from 250 billion market cap to almost a trillion, a hundred billion. Ten years from now if we meet at JP Morgan and we’re talking this year, I’ll bet anything that that 800 billion is probably a trillion, two and a half trillion.
In my lifetime, in the next 20, 30 years, we’re having a similar creation of a massive amount of value that’s going to occur in biotech. The latter half of the 20th century was for technology, the first half of the 21st century will be the century of biotechnology. The reason why I can say that with a high degree of certainty is very simple–I don’t have to walk you through numbers or anything–I can say HIV. In the 1990s, it was killing people left, right and center, and is now a chronic disease. We’ve made a deadly killer that people were scared, people were scared to get spit on each other because they thought that’s how you contract the disease.
We are slowly taking diseases that were basically killing people, making them into chronic diseases. Some diseases we’re actually curing, Gilead: Hepatitis C. You take their pills, yeah, those pills are expensive, they make a lot of people in the press very angry. But you ask the almost seven hundred thousand people now who can live the rest of their lives—well there’s about 10% of them that didn’t get a full cure. Six hundred thousand patients that now can live the rest of their lives full well knowing with a hundred percent certainty that they’re not going to need a liver transplant, ever. Because that’s what Hepatitis C does to you once your liver fails. What kind of value can you put on that, I mean, aside from the gnashing of teeth– “oh it’s a pill that’s like, you know, a thousand dollars a day,” but we’re actually curing diseases.
So that’s the long rise. Now the short rise is what you’re talking about is what do you look for catalysts? What I look for essentially is that I don’t want to—my job is to get to know these companies very well. When I look at investors that don’t have the resources or the education or the background I have to look at this. What I tell them is do this: you need to focus on companies that are just starting to hit breakeven. Biotech companies like Vertex–it was break even in earnings in the fourth quarter of last year. This year it will be breakeven for the full year. Companies like that if you look at them historically, there’s a very high certainty that in the next three years, once they break even, they tend to outperform the market, they even tend to outperform their peer group.
What happens is, biotech companies when they become break even, that means the sales are now covering the cost base which tends to be about 30 percent of sales on average. As the sales keep on accelerating, the earnings accelerate at a faster pace because biotech is, unlike pharma, we only focus on specialized diseases. Tens of thousands of patients as opposed to hundreds of thousands and millions of patients. And because of that sales and earnings acceleration, the market pays that company for it. So Vertex, for example, right now, maybe the first half of this year doesn’t work, the second half of the year if you actually look at what consensus expects over the next three years, doubling and tripling of sales and close to anywhere from four to six times growth in earnings.
You don’t have to get to know their business model, all you’ve got to do is say,ok, historically companies that have had this fast a growth, the market sees it when the company is getting close to it, jumps on top and then rides it and then gets out.
Click here for part 2 of this interview, where Singh talks about his stock picks.

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Securities Disclosure: I, Pia Rivera, hold no direct investment interest in any company mentioned in this article.
Securities Disclosure: Oppenheimer & Co. Inc. expects to receive or intends to seek compensation for investment banking services in the next 3 months from Sarepta Therapeutics and uniQure.