Monday, March 28, 2011

Biotechnology Investing - If It Was Easy, Everyone Would Do It

What makes biotech investing especially difficult is that 90 percent of the companies have no product revenues. Therefore, standard financial analyses (EPS, growth rates, etc.) are irrelevant. Unless you want to stick with the few dozen or so profitable players, you will need to do more than "crunch the numbers." And, because the unprofitable firms have become skilled at telling their better-than-sliced bread stories, unwary investors can get duped.

This brief piece provides several warning signs to help you avoid wasting time on "never gonna happen," allowing you more time to focus on "it's gotta chance."

Biotechnology

First, look for congruency across multiple data points. No single attribute (e.g., huge market opportunity) should drive the investment. No single red flag (e.g., nepotism) should be a deal killer. Each company is different from every other and requires in-depth, highly specific investigation. You can start with a generic checklist as a crude starting point. Such a list might include, for example, the company's age, what are the accumulated deficit and the paid in capital; bigger is badder for all three. A management team that has been at the helm for 15 years and taken the ship in circles is likely to be taking investors for a ride. It is said that if something looks like a duck and quacks like a duck; it's a duck until proven otherwise. By being circumspect, you may miss an occasional gold nugget or ten bagger, but you'll buy less fool's gold and your portfolio will get sacked far less often.

Biotechnology Investing - If It Was Easy, Everyone Would Do It

Second, spend some time looking at the company's history. Usually, their web site will provide an archive of press releases (PRs). Pay special attention to projections (initiating clinical trials, finding a corporate partner, announcing clinical results). You may be surprised at how much boiler plate text is in each PR. More importantly, by tracking company projections, you will quickly discern whether the firm consistently hits its time lines or whether they just overpromise and under-deliver. Again, look for consistency of behavior.

Many investors, professional or otherwise, claim to base most of their investment decisions on confidence in management. Many a venture capitalist or fund manager has told me, "...management, management, management." Maybe you have heard that strong management can drive success from mediocre technology, but weak management is more likely to fail even with the latest gee-whiz doodad. Perhaps. But let me temper that mantra just a bit. The con in con game is short for confidence. If you are fortunate enough to meet with management, always ask a question or two to which you know the answer. One source for such a question is the company's 10-K, the formal annual report filed with the SEC. For example, in the mid-90s I learned from a 10-K that a Florida-based biotech company could conduct a clinical trial in Florida (and only in Florida) without FDA clearance. During an interview, I asked the CEO why all of his investigative sites were in Florida. Clearly flummoxed, the CEO had no answer. His response helped calibrate every answer that followed. He was very confident of his company's future success. It was ten years after our discussion that the company went bankrupt.

Here are three more red flags that should urge caution.

Most often, nepotism is a liability if only because it hints at something less than a bona fide meritocracy at work. Similarly, if you uncover a preponderance of 1) alumni from the same college, 2) brothers or sisters from the same fraternity/sorority or 3) any other hiring pattern that suggests a silly but systematic bias, be hesitant.

Be wary when there are two classes of common stock. Often, Founders, family members, or a few early investors will own the super voting class (e.g., 10 votes per share) while the rest of us may only buy regular voting shares (one vote per share). Family-run businesses often take this approach in order to maintain control. Problems can arise when family issues do not align with investors' best interests. Count the votes because they are what count when important decisions are to be made.

With several thousand biotech ventures formed over the past 30 years, coming up with a catchy, informative company name has always been a challenge. There are only so many Greek gods and goddesses from which to choose. Clearly, the nova- prefix and -gen suffix have run their course. Early stage companies will often go through a name or two before settling down. However, for other companies, a name change can be more telling. Like people, companies change their name when 1) they get married, 2) they get divorced or 3) they are hiding from their past. To paraphrase the Bard of Avon, "That which we call a rose (or stinkweed)/By any other word would smell as sweet (or fetid)." Some name changes are innocuous, e.g., reflecting a changed business model; others really are camouflage for an inglorious past.

These are only a few of the warning signals I've picked up over the past 30 years. For over 12 years I was a researcher at a large agricultural biotech company, a large pharmaceutical firm and a small biotech company. I was a venture capitalist for three years (of sixteen investments, 15 went public or got acquired) and have been an independent buyside analyst since 1995. I've heard a lot of stories.

I'm a big fan of Penn State's football coach, Joe Paterno. [Full disclosure: I earned my Ph.D. at Penn State...Go Lions!). One of the coach's key strategies has always been to maintain a strong defense. If the first rule of investing is "don't lose money," then that strategy will serve most biotechnology investors well. See, that wasn't so difficult after all.

Biotechnology Investing - If It Was Easy, Everyone Would Do ItEmerald Anniversary Tube. Duration : 20.78 Mins.


When Chris' dad buys a Chaos Emerald for a gift, Sonic and Friends, and Eggman duke it out for the emerald but Eggman unleashes Weazo and escapes with the sixth emerald while Knuckles helps Sonic defeat the robot.

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Born at an early age, I have over 30 years of experience in the biotech industry. I was a laboratory scientist, a protein biuochemist, at Monsanto, Hoffmann-La Roche and California Biotechnology. At the behest of a head hunter, I joined the dark side of venture capital. Of my sixteen investments over three years, all but one went public or got acquired. But, the VC world just wasn't fun. So I started FourSquare Partners in 1997 providing independent, buyside analysis to investors. My web site at http://www.foursquarepartners.com has more.

1 comment:

  1. Lindsay Rosenwald http://www.lindsayrosenwald.com/category/lindsay-rosenwald/ Dr. Lindsay Rosenwald is part of the Republican Jewish Coalition as a member of the Board of Directors.

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