Download A Healthy Prognosis For Some Stocks: Drugs and Robots

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THE DOW JONES BUSINESS AND FINANCIAL WEEKLY
www.barrons.com
MAY 2, 2016
An Interview With Sam Isaly
Founder and CEO, OrbiMed Advisors
A Healthy Prognosis For Some Stocks: Drugs and Robots
By Johanna Bennett
Sam Isaly has been busy. The founder of
OrbiMed Advisors, the world’s largest independent health-care investor, manages a
$15 billion global portfolio of biotechnology
and health-care stocks, as well as some private-equity and venture-stage companies.
He and his colleagues — many of whom
have Ph.Ds or M.Ds, or are former CEOs
— look for companies with breakthrough
therapies, undervalued pipelines, or other
catalysts the rest of the market doesn’t see
yet. And today, he says, the market is missing a lot.
Isaly’s record is stellar. Though most of
his assets are in institutional accounts, he
also manages the $1.5 billion, 46-stock Eaton Vance Worldwide Health Sciences fund
(ticker: ETHSX). Its performance earned
him a spot in a recent feature (“The Market Beaters,” Jan. 9) for outperforming the
broad market over every major time period
going back 25 years. (Isaly launched both
his firm and the Eaton Vance fund in 1989.)
This past year, however, has been
tough. The fund is down 8%, further than
the benchmark MSCI World Healthcare’s
6.6% fall, though still ahead of two-thirds
of the other health-care funds tracked by
Morningstar.
Barron’s sat down with Isaly in his midtown Manhattan offices to talk about last
summer’s biotech bust, health care’s mergers-and-acquisitions landscape, and the scientific developments that he’s most excited
about. (Hint: It involves robots!)
Barron’s: What’s special about health-care
investing?
Isaly: Health care is the epitome of change.
That change isn’t just new drugs and medical technology, but also how health care
is delivered to patients. I can’t think of
anything more boring than steel, or retailers, or all manner of other pedestrian
businesses.
Health-care stocks have certainly been the
epitome of change recently. They fell 12%
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' from July through February, with some biotechs falling more than 40%. This year, the
sector has rebounded 11%. What’s going
on?
Before the selloff, health-care stocks enjoyed a five-year boom, but stock prices,
mostly drugmakers, overshot to the upside.
It was natural for a correction to occur,
but it fed on itself, fueled in part by a soft
broader market and investor panic. So then
stock prices overcorrected to the downside.
Not often have I seen a selloff this severe.
Was the selloff warranted?
No, given the pace of scientific innovation,
which is just as exciting today as it was
eight months ago. There are exciting developments that haven’t been properly reflected in many stock prices over the past
10 months.
Like what?
Look at the cancer drug Opdivo from Bristol-Myers Squibb [BMY]. It’s referred to
as an immuno-oncology therapy because
it harnesses the body’s immune system to
fight cancer cells. The drug has had enormous success since it was approved by the
FDA in late 2014. We expect global sales
to reach nearly $5 billion this year. Ono
Pharmaceutical [OPHLY], the Japanese
drugmaker that discovered Opdivo and
partnered with Bristol, has more than doubled in value in the past year; its portion of
Opdivo sales will be about $1 billion. Bristol’s portion is $4 billion, yet its stock is up
just 12%.
Among the big biotech names, Vertex
Pharmaceuticals [VRTX] has a new cystic-fibrosis drug that could be huge, and the
company has just started to turn a profit.
The share price, however, got crushed last
summer and is down 33% in 2016.
Are health-care stocks still cheap?
They are cheap across the board — especially biotech, which is trading at the same
price/earnings ratio as the broader index,
which is unusual.
Volatility throughout the sector will continue as new technology disrupts markets
and stock prices, but the outlook for the
sector is underpinned by continued M&A
activity. Today, biopharmaceutical firm AbbVie [ABBV] announced a $5.8 billion deal
to acquire Stemcentrx, a biotech start-up,
and Abbott Laboratories [ABT] unveiled a
$25 billion deal for St. Jude Medical [STJ].
Strategic buyers take advantage of stockprice distress.
So you’re optimistic.
Optimistic isn’t a strong enough word to
describe my outlook for the long haul. In
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the short term, my uncertainty stems from
the ferociousness of the selloff.
Which other drugmakers do you like?
We are also enthusiastic for Eli Lilly
[LLY]. It is a relatively new position in the
fund, based on solanezumab, the company’s
experimental drug for Alzheimer’s disease.
Several big drugmakers have tried and
failed to develop drugs that slow the progress of Alzheimer’s. So why Lilly?
Solanezumab subscribes to a leading theory in Alzheimer’s research that the accumulation of beta amyloid in the brain
contributes to the disease by gradually
building up into plaque. That has yet to be
definitively proved. But with Lilly coming
off a severe patent cliff, current earnings
forecasts are trough estimates. If you consider the probability of clinical success and
Lilly’s valuation, it is worth the risk.
Which innovations are capturing your attention?
We’re looking at gene therapy, which is
technology that attempts to repair a genetic imperfection or defect that causes
disease. There are some promising therapies being tested, including a sickle-cell
anemia drug from bluebird bio [BLUE]
and a hemophilia treatment from BioMarin Pharmaceutical [BMRN]. There are
also a handful of public companies working
on technology known as Crispr, which involves cutting away bad genetic material
and inserting good material.
Yet there are no gene-therapy treatments
available right now. So how do you invest?
It’s an exciting science that is coming closer
to reality. Right now, therapies for single-gene disorders, such as hemophilia and
sickle-cell anemia, show more promise than
those for multiple-gene disorders, such as
diabetes. We have dabbled with bluebird
bio because it is a leader in the field, but
we aren’t big participants. Ultimately, gene
therapy will be extremely remunerative.
What else are you excited about?
Gene sequencing — the technology that
maps the human genome and cancer DNA
— is widely used in research labs. The
equipment developed by Illumina [ILMN]
has made it possible to sequence a single
person’s genome for less than $1,000. So
now the technology is moving out of the
lab and into the clinic, where it can help
identify predispositions to certain diseases,
and develop better diagnostic tests.
Illumina cut its 2016 sales forecast two
weeks ago, and the stock fell 25% in a day.
It hasn’t recovered.
That was a disappointment, but the outlook
remains strong. Illumina isn’t cheap based
on valuation, but the expansion of gene
sequencing into the doctor’s office implies
huge additional demand for equipment and
reagents [a substance required for chemical analysis], both of which are made by
Illumina. Profit could double in the next
five years.
What’s new in medical equipment?
Intuitive Surgical [ISRG] makes and sells
surgical robots — the surgeon uses a joystick to maneuver robotic arms to perform
prostate and hernia operations, and hysterectomies. The procedures are far less
invasive than traditional surgeries, and require less recovery time.
It is still unclear if it is dramatically
more cost-effective for hospitals to use the
robots. The machines cost in the seven figures, while a scalpel can cost less than $20.
But recent quarterly results showed that
the company has placed more machines
in hospitals, and the number of surgeries
performed using the robots increased 17%.
Like Illumina, Intuitive Surgical is a razor/
razor-blade business model, generating
revenue from the sale of both the machines
and the consumables used in each procedure.
Is the Affordable Care Act still a profit
driver for health care? The expansion of
health benefits to millions of uninsured
Americans has provided a boon to insurers,
hospitals, drugmakers, and pharmacies.
Most of that expansion came in 2014 and
2015; in 2016, it has started to slow down.
And if the Republicans win the White
House and control Congress, the ACA
could be repealed and replaced. I don’t expect the Republicans to repeal the legislation without putting something in its place.
That said, we do like the hospital chain
HCA Holdings [HCA]. The cost of uncompensated patient care is rapidly falling as
hospitals treat fewer uninsured patients,
which is good for profit. Also, utilization,
measured by admissions and length of stay,
is rising at a pace in the low-single digits.
The push to control rising drug costs has
opened the door to so-called biosimilars,
which are lower-price copies of branded biotechnology drugs, made by combining live
cells. The pharmaceutical industry was devastated by the tidal wave of generic drugs
in the early part of the decade. Do biotech
companies face the same threat?
It isn’t likely to be as catastrophic. Companies that develop and make biosimilars face
some real issues, namely high capital costs.
Biosimilars are harder and more expensive
to manufacture than generic pharmaceuticals — a manufacturing plant and equipment
costs perhaps $100 million — and the clinical
trials can be more complicated.
Our biosimilar play is South Korea’s Celltrion [068270.Korea], one of a few pure-play
biosimilar companies. The stock has had a
good run, and we continue to own it because
the company has a series of products that
could soon reach the market.
Turing Pharmaceuticals bought a decades-old antibiotic and raised its price from
$13.50 to $750 per pill, and Valeant raised
cardiac-care drug prices as much as 525%.
Is the political outrage justified? Is it real or
rhetoric?
The real power to control drug pricing sits
with the health insurers and pharmacy benefit managers. We don’t need a central command. We are already seeing the effect that
pressure — most notably from benefit manager Express Scripts [ESRX] — is having
on drug prices. While the so-called list price
for prescription medications rose 12% last
year, what insurers and employers actually
paid rose just 2.8%.
We have to ask. Which presidential candidate would health-care investors fare best
with: Hillary Clinton or Donald Trump?
Changes from Clinton would be more traditional, probably more negotiable, and thus
less of a threat. As for Trump, we don’t know
where he might come down. He has mentioned the possibility of negotiating Medicare drug prices, which for the moment isn’t
allowed under current law. Trump isn’t well
known for his health-care position, and could
well become troublesome for investors.
Thanks, Sam. n
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