A Day at the Races – Betting on Biotech

?Originally published at?Empire Financial Research.?

? Investing in biotechnology is like going to the racetrack...

Everybody has the inside track on who's going to win. This guy knows the trainer. That guy knows the jockey. And look at the odds... look at those odds.

You know the rest of the story... That horse barely made it out of the gate, let alone over the finish line.

I learned that lesson in the early 1990s when I was a business columnist in San Francisco, then the hub of emerging biotech.

Everybody seemed to know a doctor who knew the real story about what was really going on, and who said that some particular drug was going to be huge... Until that drug failed Phase III clinical trials, causing the stock of the company behind it to get bludgeoned.

If there was ever a lesson about biotech, it's just that: Nobody knows anything until the Phase III results are released.

After all these years, it's the lesson that never seems to resonate, but always seems to rear its head.

? And while there's no way of eliminating that risk, there are ways to reduce it...?

That's how I came across Jason Napodano, a longtime biotech analyst who runs Bio5C, a research firm with a novel approach to doing just that.?

I first ran across Jason when he was interviewed by my colleagues Enrique Abeyta and Gabe Marshank early last month on their Hard Money's Million Dollar Podcast.?

It was one of those interviews that was more compelling than most – so compelling, in fact, they broke it into two parts.?

It wasn't just Jason's discussion about the way he tries to sort out the promising from the less-than-promising biotechs, but also how much harder it has become given the sheer number of public biotech companies... It's a number I would suspect would surprise most investors. (I know that it surprised me.)?

? Before we go further here, one big disclosure – something Jason includes in the disclaimers on his website and right up front on his Twitter account...

?He's a convicted felon.

He's also a smart guy, who had a very good reputation before he did something stupid that landed him in prison for four months for insider trading. That's barely enough time to know your cellmates, but enough time to ruin a career and reputation. (You can read more about it here, and Jason also has a blunt discussion of it during Enrique and Gabe's podcast interview.)?

In going back over stories, tweets, and forums after Jason was charged, one thing is clear: He had a solid but also hugely disappointed following in biotech, including some folks I know and respect.?

I believe in second chances. And given that Michael Milken and Martha Stewart also went to prison for much longer, but then went on with their lives... it follows that Jason should be able to, as well, within the limitations posed by the courts and regulators.

? I should also mention that Jason didn't seek me out...?

I just liked what I heard, so I gave him a ring.?

And in our interview, Jason didn't disappoint. It's the jaw-dropping setup, however, that counts...?

And that is the number of public biotech companies, many if not most of them with a single product that is in the early stages of development. The below chart of all U.S. biotech companies trading above $3 per share – courtesy of market research firm Kailash Concepts – tells that story...

As of now, nearly 400 public biotech companies are trading above $3 per share versus around 98 in 2012.?

But Jason figures there are a few hundred more in his universe if you include companies that trade below $3 and pharmaceutical companies, which today blur the line with biotech. Many came public via a traditional initial public offering ("IPO"), but the recent boom in special purpose acquisition companies ("SPACs") also sparked an unprecedented wave of barely developmental stage biotechs racing to take the cash.?

As Jason explains...

"It's just insane to me. Outside of maybe the dot-com age, [in] what other industry are there hundreds of little guys trying to form a business? Maybe mom-and-pop retail, but they aren't publicly traded...?

"You have a lot of these large health care funds and they're starting all these startups and throwing boatloads of money at them because life sciences has been so good over the past five years. But many of them, with just one asset in clinic, shouldn't be public."

Not just that, but...

"Science is moving at lightspeed. You could do your homework on one and come in one day and find out that company's science has been leapfrogged by a new gene-editing technology that didn't exist a decade ago."

The trick – especially with the early-to-mid-stage companies that Jason focuses on – is figuring out a way to sort through those that really have a chance of succeeding... or science that so good they're bound to be acquired.?

? Listening to doctors – as I learned a few decades ago – might be good for diagnosing your health...

But as Jason says, they aren't so good at picking biotech stocks...

"One reason I started Bio5C is because doctors are horrible investors. They think they understand the science. But lots of things that matter, like the '5Cs.'"

These "5Cs of biotech," as Jason calls them, are charisma, credibility, catalysts, cash, and capital structure. (He elaborates here.)

While that may sound gimmicky – truth is, there's no foolproof approach to stock selection – at least it shows a process in a market where many are just buying symbols, stories, and press releases... and in an industry where investors are often going on little more than hope and hype.

Or as Jason puts it...

"If you really know what to look for when you're analyzing clinical data, you have an edge over people who just read the press release."

In a year during which biotech has been blasted, that's helped Jason's model portfolio, which is beating the SPDR S&P Biotech Fund (XBI) by around 7% this year. The spread was much bigger until October, just before there was a bloodbath in all biotech.?

And it's only getting harder.

? With so many new companies trying to develop so many therapies, data is being pumped through a firehose at medical conferences... Such as one last week for cancer.?

At that conference, out of 5,000 submissions, the American Society of Hematology accepted 3,000 for presentations. "That's a huge number," Jason says.

And yet, the chatter in the biotech world was that there was nothing earth-shattering, causing Jason to write to his subscribers...?

It just continues to be a difficult environment to navigate right now in biopharma because there are so many oysters and not enough pearls inside!?

I'm not sure if that's good or bad for a guy like me, but I think the days of just buying biotech and making money are over.

Stock selection is really important – knowing what to expect and what's good data and what's bad data, and that's getting really hard when you have to look at 3,000 abstracts to find one or two winners.

? Right now, Jason's favorites include Chimerix (CMRX), Cardiff Oncology (CRDF) and Liquidia (LQDA)...

He mentioned all three on the Hard Money interview, which I keep mentioning because to hear his explanation is better than a few quotes in this column.

Since then, Liquidia has been a standout. It had been trading around $2.50 per share throughout the summer. By the time the podcast aired, it was in the $3-per-share range, with a drug that wasn't yet approved... and which had the additional overhang of a patent lawsuit.

Since then, the company's drug was tentatively approved, and LQDA shares popped above $5 before settling back to around $4 with the biotech sell-off.

Here's the kicker: Even with the stock having doubled in a matter of months – with full acknowledgement cognizant of the patent issues – Jason still likes it... because with emerging biotech, he believes sometimes it's a better investment after the stock starts rising on news of an approval.

After all, a big element of risk has been removed. And besides, he says...

?"Big pharma doesn't buy stocks at their 52-week lows. Big pharma is buying names at 52-week highs."

?If a drug has cleared Phase 3, for these emerging companies it can be like betting on a horse when it’s about to cross the finish line.

__________________________________________________________________________

As always, feel free to reach out via e-mail at [email protected]. And if you're on Twitter, feel free to follow me there at?@herbgreenberg. My DMs are open. Or just leave a message here. I look forward to hearing from you.