Viren Mehta

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Dr Viren Mehta formed his own investment advisory group in 1989 specialising in the pharmaceutical and biotechnology industry investment, after working in related areas for Merck & Co, Wood MacKenzie, and S.G. Warburg. As a 'boutique' Wall Street firm, Mehta Partners has honed a specialty niche both with its science (R&D) expertise and an integrated global perspective aimed at understanding the critical success factors in the global pharmaceutical and biotechnology sector. Mehta Partners provides asset management, institutional research, and strategic advisory services to pharmaceutical and biotechnology investors worldwide.

The innovative therapeutics sector

Introduction

I use the term 'new science' to refer to all the scientific progress that has been unfolding since the mid-1970s, including recombination biology, combinatorial chemistry , high throughput screening, genomics, proteomics and so forth.

This evolving new frontier will continue to yield new drugs, or 'innovative therapeutics' that go well beyond treating just the symptoms. During the next generation, if not sooner, these innovative therapeutics will capture two if not three percent of the industrialized world's GDP as compared to the one percent today.

What is most exciting is that this growth may well come without increasing the overall healthcare spending and, with a bit of luck, may in fact help reduce total healthcare spending over time by replacing many of the expensive but ineffective healthcare services of today. The biopharmaceutical (pharma and biotech) sector accounts for about three quarters of the healthcare sector market value and lends itself much more readily to fundamental analysis than the rest of the sector - thereby justifying this 'innovative therapeutics' focus.

Invest globally and across all market caps and stages of maturity.

This reduces volatility and increases performance because no one group has a monopoly on the next flash of inspiration. Also different markets and currencies follow divergent trends - Global (multinational profitable companies), Emerging (specialty profitable companies), and Rising Stars (unprofitable biotech companies) often participate in opposite rotation cycles. Such diversified investing also enables a more comprehensive valuation framework that is critical for investments based on fundamental analysis, perhaps the safest way to invest in this sector.
Focus on 'innovative therapeutics'.

Companies discovering and developing more cost-effective drugs based on new science account for about three quarters of the health care sector market valuation and their share prices are driven much more by their fundamental progress than the rest of the sector. Also, drugs account for about one percent of the GDP in the industrialized countries today, but this figure should rise to two percent, and possibly three percent, in a decade - at the expense of the other segments of the health care sector as better drugs replace much less cost-effective modes of healthcare.
Invest for the long term, but take advantage of near term volatility.

Innovative therapeutics take a shorter time to get to market nowadays than they used to, but discovering, developing, and marketing a new drug is still a long term and risky business. Invest a majority of your portfolio for the long term when fundamental value is definable and an inflection point is at hand, then avoid the temptation to sell your winners.

The 'inflection point' in this sector is almost always driven by the emergence of a significant innovative therapeutic product on the horizon. However, the investment window is usually between the first confirmation of the product's potential and its market approval. Unless the company has a solid stream of products, experienced investors are exiting by the time doctors find out about the drug.

The convergence of information technology and new science is causing greater volatility, and thoughtful near term fundamental longs and fundamental shorts around hypes, falsehoods, and missed milestones can yield large gains.
Find proven management teams .

Only one in sixteen products entering the clinic, or human testing, succeeds in the marketplace . Having the skills to manage through the failure that is a normal part of this sector is critical. In the exciting but high risk phase of transition from 'old' to 'new' science, an able and scientifically astute management team makes all the difference.
Invest primarily in products, and only very carefully in tool-kit or technology companies.

Products usually have a long life cycle, create global enterprises , and build substantial equity value. Tool-kit and technology companies, by contrast, sell their time, and their skills quickly become commoditized.

Combinatorial chemistry, for example, was rapidly commoditized, with a random chemical compound now going for pennies compared to dollars during the early days of this technology. Similarly, gene sequencing is a technology today that is already becoming a commodity. Proteomics is all the rage today, but it is only a matter of time before it too will be a set of tools a dime a dozen . The real value of these tools and technologies will accrue to those who are first to identify validated biological targets and, better still, product candidates with solid patents that have a good chance of becoming innovative therapeutics.

This of course is easier said than done, and fewer than one in ten that try will succeed as a product company.
Invest in products with sophisticated marketing.

Innovation alone can only go so far in a free market environment, and a unique marketing platform is critical for achieving full potential of any product.
Invest only very selectively in money-losing biotech companies.

And only if they have critical innovative scientific pathways with an attractive patent portfolio, and adequate cash balance to survive for at least two years . Also, watch for dilution - thanks to maturing options and warrants - especially when a company is about to enter sustainable profitability.
Prepare to invest in emerging markets.

Today, 10% of the world population consumes 90% of drugs. Many emerging markets are maturing in their economic policies, thus increasing wealth among the middle class who will demand newer , better drugs - even at western prices. Both local and multinational companies will benefit for decades to come.

The key word here is 'prepare' as the liquidity, transparency, and regulatory issues are not at a stage where investors can feel comfortable. Multinational companies are too large to register this opportunity as yet in their share price, so high quality domestic companies in selected major emerging markets (Brazil, Mexico, India, selected Eastern European countries, and perhaps China and Russia) will need to be analysed for these opportunities once they mature over the next one to five years.
Double up in good names when the sector goes out of favor.

The market's penchant for sector rotation is the best friend of fundamental, long term investors, and at appropriate times justifies an over-weighted position.
Sit out the sector (or short it) when valuations reach silly heights.

Avoid the hype and remain true to your convictions. Take the time necessary to develop a first hand feel about the breakthroughs of the new science that will benefit both your personal and financial health.