Larry Feinberg has a great "commute" now that he runs Oracle
Partners, his highly successful healthcare and biotech hedge fund group, from some quite nice offices quite near his Greenwich, Conn., home. All the more time to obsess over the prospects, products portfolio performance of companies he follows -and lower rent than Manhattan, to boot.
But the market gods, evidently, weren't pleased. Oracle's move was accomplished around the middle of last year -and the market, as the nearby chart illustrates, has been beating up on Larry's favorite sector pretty much ever since. Oracle, to be sure, has done considerably better than the index, leaving Larry scoffing at rumors that Oracle is foundering -and eagerly anticipating big gains on biotechs bought at bargain-basement prices.
Biotechs aren't going to zero like many nets, Larry?
People just don't seem to understand what is going on in the world. You can understand why they don't, because they're losing all their money in the stock market. I certainly can understand that. But biotechnology isn't a fad. It's science that will fundamentally change everything. Especially medicine. I'm not happy, because I got long and my stocks just won't go up enough. Every day, they start rallying and in the middle of the day, they hit them. I'm not a technology investor, anyway, but the Nasdaq does have Amgen (AMGN) in it, for example.
So you haven't exactly been immune to the Naz's swoon?
Clearly not. But the good thing about truly awful days in the market, like last Wednesday, or Tuesday, is that we can't have many more like that because then there'd be nothing left. Somebody taught me that, a famous commodities trader.
There's some good news for long-term investors amid all the carnage, isn't there? Some great little biotechs were probably thrown out by investors along with the Internet bathwater.
A couple of things are going on. Normally, the healthcare sector does very well in this type of a slowdown. This year, it hasn't, to date. It's been one of the worst-performing sectors in the marketplace. This has been more than just selling. It has been people taking profits in winners and selling the stocks that have held up, also people looking for "valuation shorts."But there's no change in the healthcare sector's fundamentals -they are the best they've ever been. The political climate is the best it has ever been. As I like to say, "Hillary has moved to Chappaqua. We don't have to worry anymore."
Yet healthcare's been really under-performing dramatically. Looking at the various sectors, the large-cap drug stocks are selling now at about a 20 percent P/E premium to the market. Although I'm not a huge fan of big pharma, I think there's already a lot of bad news in the stocks, given that over the last 50 years, they've traded at between a market multiple and three times the market. And in an environment where the economy's slowing, where everybody's earnings are questionable, we know these guys are, for the most part, going to come through with steady predictable earnings growth.
I'm even more optimistic on generic drug companies because I think there's a big political groundswell to allow the generic companies to introduce their drugs and not be blocked by big pharma. We've got to figure out how to pay the bills. If you want to have a Medicare drug benefit, it's not going to cost $150 billion, like Bush thinks. It's going to be $1 trillion. That's what it's going to cost over a 10-year period and you're going to have to push lower-cost drugs.
But in the meantime, every time something goes off patent, the generics get submarined by branded drug companies trying to file new patents to block them. We saw generic Taxol being kept off the market for months just by some political maneuvering, which was eventually thrown down. But for every day that Bristol-Myers Squibb [BMY] kept generic Taxol off the market, it was making $4 million in profit.
No wonder they thought the legal bills worthwhile.
Sure, why not? You can file lots of specious lawsuits. There are all sorts of little games that can be played. We've bought a lot of Barr Laboratories (BRL), for example, recently. The stock has been cut in half because the government has deemed that because Eli Lilly (LLY) has done pediatric studies on Prozac, its six-month period of exclusivity for pediatric Prozac should overlap with the patent expiration. So Barr, in effect, doesn't get its first six-month period of exclusivity on its generic version.
I've got a letter on my desk here to the Acting Commissioner of the FDA, signed by Edward Kennedy, John Dingell, John Rockefeller and Henry Waxman, basically telling them, "You better approve this generic Prozac."
But you just saw the BuSpar patent expire at Bristol-Myers -the anti-anxiety drug, with over a billion dollars in annual sales. They'd been keeping the generic versions of BuSpar off the market for about four months, with patent suits. But Mylan Laboratories (MYL) and some small generic companies just got to launch their generic versions. So it's taking place one at a time, but I can see the groundswell coming into the generic side.
I take it you like the generic manufacturers in here then?
Yes, Barr Labs, the stock's down from 100 to 50. I think they're going to earn, with generic Prozac, $3.50-$4 next year. Andrx (ADRX) was, -Well, AstraZeneca (AZN) has filed for new patents on Prilosec, the ulcer drug, which is the biggest-selling drug in the world. Andrx has a generic version, which AstraZeneca is obviously trying to block from coming to market since its original patent expired this month. It could be just a massive drug for Andrx. They'll get it. The generics of these huge drugs coming off patent are going to come to market one at a time. But, you know, the biotech sector has been in somewhat of a free-fall this year. The indices are down 30-40 percent year-to-date, it depends which index you look at. Every time I think they're going to stop going down, they go down another level. But I think they have bottomed. I see a big support level that the index has come to. So both technically and fundamentally, there's really nothing wrong with the sector.
We're in this huge new product cycle. There are 350 products in late-stage human clinicals. There are, right now, about 120 biotech products on the market generating $30 billion in sales this year, growing about 50 percent a year, in terms of product. The industry, if you look at the large caps, like Amgen, Biogen (BGEN), Genzyme (GENE) stocks like that, the six largest are now selling at 60 percent -70 percent premiums to the market, which is the lowest valuation in their history. You can actually value them based on earnings, although that is probably silly because their R&D levels are so high. Their P/E-to-growth rate is about the same as the S&P 500's.
You sound like a bull!
I am. No. 1, we're buying biotech companies, with earnings, at a time when the stocks have come way down. They've all been cut in half, or many of them are a third of where they were a year ago. Companies like Idec Pharmaceuticals (IDPH) -we have a very low cost in this stock. It exploded last year. We sold a lot of it. It has come way back. We started buying it again about a week ago. Their drug Rituxan for non-Hodgkin's lymphoma will do about $800 million in sales this year. They have a new drug coming later this year, another drug for lymphoma. It's a radioactive version of their current drug. But this one, they don't have to split with Genetech. They'll own 100 percent of it. For every $100 million in sales, it adds about 50 cents a share to earnings and we think it's potentially a $400 million drug. The stock's at 35.
What others excite you?
Amgen is about to launch NESP, and go after Johnson & Johnson (JNJ). That's why J&J is making acquisitions, because the largest product at Johnson & Johnson, Epogen, is about to lose its patent protection. So they're acquiring Alza (AZA). I wouldn't be surprised if they acquired somebody else. J&J wants to use their stock while it's still up. Alza is a good company. But I think J&J is very vulnerable to losing billions of sales out of EPO. EPO sales run $3 billion annually, of which $2 billion is J&J. But the new Amgen product which will replace EPO only has to be taken once every two weeks or so versus three times a week, and it gets around J&J's original agreement with Amgen, so Amgen can now market it in Europe for both dialysis and chemotherapy and in the U.S. for chemotherapy. They've been approved in Europe. They have not got approval yet in the U.S., but it's imminent. In the meantime, the quarter's not going to be great. So we have sort of half a position in Amgen.
What about the gene-splicing companies?
In the genomics area, many of these companies, like CuraGen (CRGN), are some of the greatest drug discovery engines we've ever seen. It's very difficult to value because we're talking about product revenue actually being three to five years away. But the company has identified 800 protein targets from the human genome and 80 of them are going into human studies. Many of them are already showing very strong efficacy. The company's got about $13 a share in cash. It's not burning that cash because of all the deals they're doing. They did a deal with Bayer (BAYG) earlier this year where Bayer is investing about $1.5 billion over seven years in the company, to have it develop drugs. What's most profound about the deal is that on the drugs that are discovered, the royalty split will be 55 percent to Bayer and 45 percent to Cura-Gen. So they get a 45 percent royalty on drugs that haven't been discovered yet. It used to be that biotech companies would settle for a two percent royalty.
And basically give away their firstborn, for it.
Absolutely. But at this point, they're negotiating from strength. Do you know that 36 percent of the value in the biotech industry today is cash on balance sheets? Cash on the companies' balance sheets equals 36 percent of the industry's market cap. These guys were smart. The bankers were smart. They did jump into the market and fund the industry heavily in the last few years.
That certainly doesn't differentiate the biotechs from the Internuts.
The real difference between the biotechs and the Internets is that the biotech industry has $30 billion in sales right now -and has over $10 billion in operating income. And the industry's profitability is actually much higher, if you take out R&D. It's growing 50 percent. There were 15 profitable companies last year. This year, there'll be between 25 and 30 profitable companies in the biotech industry and, it's at its lowest valuation ever.
The other thing is that we know the business model here. The business model is to discover drugs and to either market them yourself or to have other people market them for you, and therefore to generate cash. The business model in Internets is still, I believe, up in the air.
What else intrigues you?
There's a company we own, a special situation. It's called Texas Biotechnology (TXB). It's at $4.75 right now, down from in the 20s. It's got $3 a share in cash. So it's got $115 million in cash. It'll spend about $10 million this year. It should be profitable next year. Their first product is on the market with GlaxoSmithKline (GSK). It's going to start out slowly, but it could be a $400 million drug. It's a Heparin replacement, called Argatroban. Its second product is in a late phase two, early phase three study with ICOS (ICOS). It's a new class of cardiovascular drugs. It's a small molecule. The science guy is the ex-No.2 guy in R&D at Merck. Another value that I just find the most incredible right now is WebMD (HLTH) at 4 3/4. It got hit when Pfizer (PFE) made an announcement that they're going into the physicians' office information and connectivity business with Microsoft and IBM as partners. It makes no sense for a drug company.
What are they going to do? Push Pfizer drugs through their systems? It's one of these vertical integration strategies like when J&J went into the nursing business, back in the 80s. Somehow product companies don't have a service company mentality. So I think this Pfizer announcement was one of the more amusing I've heard, but it clipped WebMD's stock for a buck when it came out. I actually bought more WebMD on the news, under $5 a share. It's got a $1.7 billion market cap. It's got $800 million in cash.
Their base businesses generate about $750 million of annualized revenues. It is generating about $90 million of operating income, pre-all its overhead. So they're now cutting costs. They're ahead of budget. They're telling the Street they'll be breakeven by the fourth quarter of this year. I believe it'll be the third quarter. Next year, I look for revenue growth of about 30 percent, so revenues of about $1 billion. Next year, we're talking something like 60 cents in earnings. The year after that, it could be $1-$1.50. I think it's going to be the fastest-growing company in the healthcare industry. WebMD has spent billions putting this together. They've lost billions of dollars in value, too. But at this price, I think it's just an incredible value. A year or two from now, we're going to be looking at exponential returns from here. I like 10-baggers.
Thanks, Larry.
Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co. L.P., Greenwich, Conn. http://welling.weedenco.com
