Author Topic: Next Generation Antibiotics: Failed business model or Value opportunity?  (Read 2019 times)

DocSnowball

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Drug resistant bacteria are rising rapidly, and are projected by World Health Organization to be among the top causes of death by 2050, increasing from 700,000 currently to over 10 million annually and exceeding cancer deaths https://amr-review.org/sites/default/files/160525_Final%20paper_with%20cover.pdf. For antibiotics, the commercial return on R&D investment has historically looked unattractive until widespread resistance has emerged against previous generations of drugs, by which time the new antibiotic may no longer have patent protection or may soon lose it. After they hit the market, newer antibiotics are considered precious resources whose use is restricted by hospital-wide antimicrobial stewardship programs to limit both hospital stay costs and drug resistance.

The total market for antibiotics is relatively large: about 40 billion US$ of sales a year, but with only about 4.7 billion USD of this total from sales of patented antibiotics (that is about the same as yearly sales for one top-selling cancer drug). Given all of the above reasons, it is no wonder that big pharma has not been spending much into R&D to create next generation antibiotics, leaving it to small biotechs which they may end up acquiring after they are derisked. One player, Allergan, recently decided to sell its Anti infectives unit and get out of the business altogether.

On the other hand, resistance rates in the US are still much lower than EU and rest of the world, giving the total market plenty of room to grow and it is increasing at a compounded 20% rate yoy, and there is ongoing lobbying to change the payment models that could serve as tailwinds. The GAIN act now in place extends patent protection by an additional 5 years for newer “QIDP” designated antibiotics by the FDA . Newer business models are being proposed, including funding for companies brining new drugs to market either by a licensing based SaaS like business model https://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm610503.htm or  a transferable voucher to extend patent protection for one additional year http://www.cidrap.umn.edu/news-perspective/2018/06/bipartisan-bill-proposes-new-pull-incentives-priority-antibiotics . The probabilities of if and when any of these changes happen is not clear to me; if the latter happens it will be the equivalent of adding at least 500 million in market cap.   

Achaogen (AKAO) and Paratek (PRTK) are two exciting companies in this unloved sector filling unmet needs, have QIDP designated products in areas where generics do not work well or have significant toxicity, and save system costs by having a once a day FDA approved intravenous drug active against the most resistant bacteria on Earth (Achaogen) or an intravenous and oral formulation of a next gen antibiotic for pneumonia (Paratek) that can facilitate “go home (earlier)’ and “stay home” strategies reducing hospitalization costs. 

It is very challenging to value these early stage biotechs. At this point, fwiw, they are trading at 52 week lows and >10% below DCF intrinsic valuation even with inputs of 14-15% discount rates, and 20% likelihood of failure. Part of the reason is high costs of capital being cash flow negative at this stage of their life cycle, high operational costs for a small company to set up a sales force to market just one drug if no buyout, lack of recent big Pharma purchases, history of serial dilutions to raise capital, and high short interest. Baupost is a long term investor in Paratek, now at >50% decline from their purchase price.

After studying the area and companies for the last two years, seeing their market caps go up 1000% in 2016-2017 then down 70% in 2018, I'm scratching my head how this story unfolds. It seems valuations may be reaching margin of safety zones with the companies executing and getting the drugs FDA approved, but the business model remains broken keeping investors away.
« Last Edit: July 09, 2018, 11:15:47 AM by DocSnowball »


Jurgis

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This might not be a bad area to invest socially - unless you expect them to do Shkreli on the patients.
Financially though, biotechs are IMO tough. You really need to know what are the chances of the drug approval, the market of the drugs, the chances of takeover, etc. Might be best to hold a basket of small positions - which is what Baupost does even though they claim to have a coterie of experts in predicting things above.
Still tough to know when to hold, when to sell. E.g. you sell on X runup and then it runs up another 5X or whatever. Or you don't sell and it crashes back 70% or something.

My results with biotechs and even big pharmas are bad. I probably should not invest in the area. Currently I'm still holding some GILD and a tiny bit of something that's likely gonna go to 0.  8)

Edit: I should add that I'm not a medical/pharma/biotech expert or even knowledgeable at all.  8)

Good luck
« Last Edit: July 09, 2018, 12:09:48 PM by Jurgis »
"Before you can be rich, you must be poor." - Nef Anyo

DocSnowball

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This might not be a bad area to invest socially - unless you expect them to do Shkreli on the patients.
Financially though, biotechs are IMO tough. You really need to know what are the chances of the drug approval, the market of the drugs, the chances of takeover, etc. Might be best to hold a basket of small positions - which is what Baupost does even though they claim to have a coterie of experts in predicting things above.
Still tough to know when to hold, when to sell. E.g. you sell on X runup and then it runs up another 5X or whatever. Or you don't sell and it crashes back 70% or something.

My results with biotechs and even big pharmas are bad. I probably should not invest in the area. Currently I'm still holding some GILD and a tiny bit of something that's likely gonna go to 0.  8)

Edit: I should add that I'm not a medical/pharma/biotech expert or even knowledgeable at all.  8)

Good luck

I missed GILD back in 2012-13 when I was indexing, not sure what will happen to it in the future, could go either way.

Yes it is a great area to invest socially because it will save lives. That may not be enough for it to be a good investment or to discuss on this board. Personally, this is my area of specialization and studying it during my MBA and Valuation class has taught me a lot, alongwith a 50% plus return averaged over the 3 years of active investing (including the negative return in the last 12 months). Without having a corporate role, it is the next best thing to understanding the industry from a bigger picture level. It can also lead to tremendous confirmation bias though.

What does make the sector interesting from a value standpoint, as evidenced by wide price changes and drops while the companies continue to execute, is that
1) it is not an efficient market if the price has varied from 2.70 to 27 to 7.61 in one case or from 11 to 29 to 10.35 in the other example. We are all looking for areas where Mr Market has large mood swings, although the question here is what is your edge to parse through the situation. This is why Kalrman at Baupost or David Swenson at Yale have dedicated teams in the biotech field, and look at multiple shots at goal as the formula for success to decrease failure risk.  The edge could be analytical or some sense of intrinsic valuation or simply long time horizon.
2) either changes in business model, or a buyout or even consolidation among the little players to reduce the operational costs, will further increase intrinsic value and
3) current valuations have some pessimism baked in due to the perception that these companies will remain cash flow negative for a while even after bringing the drugs to market
4) they are poorly correlated with the broader indexes which is helpful given where we are in the cycle

Jurgis

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4) they are poorly correlated with the broader indexes which is helpful given where we are in the cycle

I cannot comment much about the other things you wrote.

Regarding this, my experience has been mixed. On one hand, you are right, companies like that don't necessarily drop when market drops. Their holders are likely holding them because of reasons that are not affected by recession, crisis or just market drop. On the other hand, if you have a prolonged or severe slump like GFC (though possibly less severe), at some point stocks like that crash too. Their holders start seeing other cheap opportunities with lower risk or start hoarding cash and they crash too, possibly even to ridiculous valuations (below net cash, etc.). Just FYI.  8)
"Before you can be rich, you must be poor." - Nef Anyo

DocSnowball

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One more bites the dust...Novartis joins the Big Pharma exodus out of antibiotics, dumping research, cutting 140 and out-licensing programs

https://endpts.com/novartis-joins-the-big-pharma-exodus-out-of-antibiotics-dumping-research-cutting-140-and-out-licensing-programs/


Cigarbutt

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DocSnowball,
-Do you feel comfortable with these biotech holdings constituting a large part of your portfolio?
-Are you considering other related or unrelated fields?

-It seems that no major new class of antibiotics has been developed since the 1980's
-New drugs seem to be effective for some time due to a different resistance profile only

Because of the above, for an industry perspective, I see the evolution of R+D giving rise to the possibility of diminishing returns on investments. IMO, the more difficult regulatory environment is used somewhat as an excuse to justify the exit of large firms that you describe.

Microbial resistance will get more complicated and hopefully the industry can connect with basic science in academia to look at alternative scenarios. But, during the transition, many alternatives may represent substitutes to what "traditional" small biotechs may eventually offer (keeping in mind the two examples mentioned).

https://www.nejm.org/doi/pdf/10.1056/NEJMp1215093

Amazing but progress in the antibiotics area is relatively recent. In 1924, President Coolidge's son died as a result of of a simple skin blister that became secondarily infected. Some pessimists mention that drug resistance may give rise to similar scenarios in the near future. Hopefully, multi-resistance will be dealt with and I wonder if the answer will involve more than simply developing relatively minor variations on already existing molecules.


DocSnowball

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https://www.nejm.org/doi/pdf/10.1056/NEJMp1215093

Amazing but progress in the antibiotics area is relatively recent. In 1924, President Coolidge's son died as a result of of a simple skin blister that became secondarily infected. Some pessimists mention that drug resistance may give rise to similar scenarios in the near future. Hopefully, multi-resistance will be dealt with and I wonder if the answer will involve more than simply developing relatively minor variations on already existing molecules.

Thanks for sharing your thoughts. The article you quoted is written by arguably three of the best minds in the field, which is perhaps why they saw in 2013 what is playing out now. Yes, novel approached to fighting infections are now closer to primetime, including monoclonal antibodies, modifying T-cells and phages to kill bacteria. All of them will still have to face the economic realties of return on capital being less than cost of capital unless the business model changes. Yes progress on infections is recent but not that recent - so much progress was made by 1960s and 1970s that  mainstream experts were enthusiastic about defeating infections and needing few infectious disease experts. Now we have come full circle, this publication from European CDC from 2016 shows countries like Greece and Italy with over 25% of some strains of bacteria with multi drug resistance, while leaving most of Europe (and US) with a lower rate with plenty of runway. https://ecdc.europa.eu/sites/portal/files/media/en/publications/Publications/carbapenem-resistant-enterobacteriaceae-risk-assessment-april-2016.pdf

DocSnowball,
-Do you feel comfortable with these biotech holdings constituting a large part of your portfolio?
-Are you considering other related or unrelated fields?

My personal journey has gone from beginner level Peter Lynch invest in what you know and >60% weighted to this sector in 2016, to more sensible asset allocation with around 50%-60% total US equity out of which just less than half is devoted to my field of Infectious diseases. I'm comfortable with a high allocation to the sector because of my day job is to watch it very closely, and being an active investor means I'm getting to learn a lot about the industry over time. Some companies in the sector are priced below what I feel is intrinsic value even if no changes to the business model occur, so it is an asymmetric bet albeit with a time horizon of >2-3 years and quite volatile. I think companies that can do very well in time will create win-wins for customers and payors by saving lives and helping people stay home instead of being admitted to the hospital thus decreasing system costs.

Interesting related fields are of vaccines or technology to prevent infections (like Novavax), companies working on newer diagnostics to diagnose infections quicker or better (like T2 Biosystems), and back end support companies including those providing IT or CRM infrastructure (Veeva). I'm not comfortable investing in any of them at present either because of my own lack of understanding or their being priced higher than my perceived intrinsic value.

Cigarbutt

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The article you quoted is written by arguably three of the best minds in the field, which is perhaps why they saw in 2013 what is playing out now. Yes, novel approached to fighting infections are now closer to primetime, including monoclonal antibodies, modifying T-cells and phages to kill bacteria. All of them will still have to face the economic realties of return on capital being less than cost of capital unless the business model changes.

I spent some time on the names you mentioned. Working on the assumptions that value added to antibiotic ecosystem will be adequately rewarded as there is still runway along the resistance spectrum, I agree that money can be made. Especially with a basket approach like Jurgis described above. Not a specific area where I have a significant competitive advantage though. Good luck to you and please provide feedback along the way.

An interesting component of this set of opportunities is that it lies at the confluence of biologics, pharma economics and public policy. Here's a relevant link that expands on the "innovation crisis" that the entire pharma industry is going through (not only for antibiotics):
https://www.bmj.com/bmj/section-pdf/187604?path=/bmj/345/7869/Analysis.full.pdf

It is fair to assume that, even if regulated and even if the process is not a straight line, investors are likely to be rewarded in correlation to the positive outcome provided. However, my opinion is that we have entered an evolutionary phase (not revolutionary) in the cycle for the biologic part.

There is a risk of generalization here but some suggest that this may be more systematic than just with pills but that's another story:
http://economics.weinberg.northwestern.edu/robert-gordon/files/RescPapers/NBER%20wp%2024554.pdf

Standards of living will improve but looking forward to increased volatility in the interim.

RUFeebz

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First post here, been lurking for a while.

Great post. Doc.  I actually was reading up on paratek and their CAP candidate today and was curious if anybody discussed it here. Looking way into the future if it displays the C.diff sparing properties of the the tetracyclines (i.e. doxycycline) it could have a nice little niche/market. Considering taking a position but still doing my DD. I was reading a nice little summary on upcoming candidates on www.infectiousdiseaseadvisor.com but I can't seem to find the article. I'm curious if there's any signal re: mortality. I'm concerned if it exhibits any of the issues associated with tigecycline.  Any thoughts on the liklihood of approval?

Also have an interest in the rapid diagnostic space, not ready to take a poisition but T2 and AXDX are pretty interesting.  AXDX's product is pretty neat, theoretically it should get better with network effects.

I'm primarily an indexer and am just getting into buying individual stocks.
@Jurgis - I'm long GILD
« Last Edit: August 02, 2018, 08:28:37 PM by RUFeebz »