Submitted by The Life Sciences Report as part of our contributors program.
How do the best investors detect life science companies with the potential to generate significant wealth? Michael Berry, publisher of Morning Notes, found that traditional growth and value models didn’t measure up, so he developed his own “discovery” strategy. He looks at companies that haven’t gone public yet. He’s not afraid of the penny stock. Find out more about Berry’s technique, and about five companies that fit his profit-generating profile, in this interview with The Life Sciences Report.
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The Life Sciences Report: Mike, you and I have talked about life sciences investing before. Investing in any sector is difficult, but the life sciences, and particularly biotechnology, are complex. What general advice can you give a growth investor who wants to speculate in micro-cap biotech? Particularly, how does the retail investor intelligently understand his or her investment in a company engaged in molecular biology?
Michael Berry: My style of investing in the life sciences is not really growth investing, George. It’s a technique quite different, called “Discovery Investing.” I’ve developed it through the last decade because neither the growth nor value styles really fit the mold in picking winners in the life sciences segment.
But some of the advice is generic. If you want to play in the life sciences space, you must diversify. With FDA hurdles and the expensive nature of preclinical and clinical trials, micro caps tend to burn money quickly. Focus on two or three applications in the life sciences space, and understand that you cannot possibly know everything about those applications. Diversification will dilute those risks.
Another piece of advice is to know the space. If you are interested in stem cells, for instance, find the literature and the top scientists, and get to know them. Many are university professors and really easy to reach out to. If cancer interests you, read the literature. From personal experience, I know that tremendous strides have been made in treatment of skin cancer. Roche Holding AG (RHHBY:OTCQX) has a pill (Zelboraf/vemurafenib) that shrinks melanoma tumors with a high degree of success. This was a Genentech development.
You must be invested in themes that interest you, and that you naturally are attracted to. That makes decision-making so much easier.
Finally, zero in on public—and especially nonpublic—companies in your space of interest. I like to track companies that are not yet public and get to know the management. You reduce your risk of being diluted into outer space, as so often happens. Then use our 10-point grid and the Discovery Scoreboard to grade and rank your companies of interest.
The Internet greatly facilitates all these tasks. It is an interactive research tool investors should take advantage of. There are no excuses!
A word of warning: In this space, investors must be prepared to take profits to manage risk intelligently. That, perhaps, is the more important aspect of wealth creation in the discovery space.
TLSR: Do you look for growth where you can find it? Or do you try to find specific themes in biotech?
MB: In the life sciences discovery space, the broad topics are thematic. Great wealth is created at the beginning of the cycle. Inovio Pharmaceuticals Inc. (INO:NYSE.MKT), which has a cancer vaccine platform, soared 400% earlier this summer based on the broad realization that new cancer therapy discoveries may be possible. Neuralstem Inc. (CUR:NYSE.MKT) has its stem cell therapy approach. I have owned Neuralstem for years; sometimes it takes that long in discovery to see value grow. It now looks like this company, with stem cell therapy having matured, is ready to reward investors. Neuralstem is just another example of great wealth creation and the theme investment approach we have in the life sciences.
TLSR: You are not afraid to invest in penny stocks—I mean very, very low market cap stories. Do you have to be an active investor in a company to be involved with a name with a market cap under $5–10 million ($5–10M)?
MB: Interestingly enough, most of these stocks go from penny status to dollar status and back several times in their life cycles. You really have to trade.
We are not afraid of penny stocks. However one of the 10 discovery factors is sustainability. So we look carefully at a company’s balance sheet, and its sources and use of funds through clinical trials, to ascertain how well the company can survive. We also look for positive catalysts, and how near and likely they might be. And if management is composed of scientists—so often this is the case and scientists are usually such poor managers—we want to know if they understand the more general management issues involved in taking a product to the market, or generating a monetizing event?
In some markets you must weight your portfolio toward mature life sciences discovery companies, versus less well-known incubator companies that could possibly generate greater wealth. Incubator companies are the most risky because their intellectual property (IP) is not yet as well developed. But such companies often do pay off in great wealth creation.
TLSR: A penny-stock story will most certainly require some dilution. Is that just the price of doing business?
MB: Not necessarily. For example, good general management may be able to take advantage of a market and/or a world-class discovery to effectively dilute, rather than by using the stock market. Too many management teams use the penny market—they could utilize callable convertible preferred securities, which would limit dilution or at least place it under the company’s control.
I have written extensively on the strategic use of dilution by management, and the way investors must anticipate dilution, hedging against value destruction from percent (control) dilution. Such dilution tactics, judiciously used, often result in value accretion. Neuralstem is a good example. We hope that Senesco Technologies Inc.’s (SNTI:OTCQB) massive shareholder dilution will result in the same level of value creation. Senesco, a company developing a cancer-fighting platform, has been trading several million shares each day recently, anticipating the vote on the 100-to-1 share reversal.
TLSR: Senesco’s SNS01-T is in a phase 1/2 trial, with just 15 people, in multiple myeloma (MM), relapsed MM, refractory MM, mantle cell lymphoma (relapsed) and diffuse large B-cell lymphoma (relapsed). This trial is not a controlled study; it’s a dose and safety trial. What will we know when we get data in January 2014? Could it be any sort of catalyst? Can give me your theory here, as well as a general update?
MB: I have been a faithful shareholder of Senesco for many years. The company’s gene therapy is clearly world-class, but I think Senesco misconnected on monetizing its agricultural opportunities—its technology can bolster the productivity of plants—early on.
However, the trials on multiple myeloma (and the two other blood cancers) have gone quite well, with the exception that it has been difficult to recruit patients. Cohorts 1 and 2 were very low dose, and were really safety trials. To participate, the patients had to have failed two standard therapies, and were considered terminal. This is quite a high hurdle to jump. You have to wonder about the rules the FDA puts in place—high barriers and very costly hurdles.
Currently, the company is enrolling for cohort 3, which will be a 4x increase in dosage. I am hopeful we will see a significant therapeutic effect, as we have seen in animal studies. If this new megadose of the company’s Factor 5A therapy works in the third cohort, as I expect it will, the stock dilution won’t really matter. Enrolling participants is the critical issue. I will be attending the company’s annual meeting in New York City, where I anticipate the trial status will be updated.
TLSR: Are you still in Neuralstem? This company now has a $113M market cap and could actually be owned by some small mutual funds now. Again, its stem cell therapy is in a phase 1 safety study with chronic spinal cord injury. The study has only eight patients. The company’s phase 2 study for amyotrophic lateral sclerosis (ALS; also known as Lou Gehrig’s disease) has enrolled 18 patients. We will get data in April 2014. What do we know now, and what will we know then?
MB: George, we will know a great deal very soon.
Neuralstem now has tenbagger discovery potential. The company is advancing on several stem cell fronts. There seem to be indications of efficacy and safety of the company’s therapies in several applications, including ALS, ischemic and chronic stroke, and possibly major depressive disorder. These quality-of-life markets are huge, multibillion-dollar and global, and Neuralstem has little or no competition in these markets at present. The company has clinical research studies underway in China and Korea, and may move aggressively into Mexico.
Neuralstem has two stem cell therapies, NSI-189 (in a phase 1 trial for major depressive disorder) and NSI 566. It has patented NSI-566 for regenerative treatment of ALS. The original research base has spawned such a powerful array of therapeutic approaches that larger pharmas will certainly begin to take the company seriously once its clinical trials advance further.
My only concern is that Neuralstem should maintain strict focus on one or two of the major targets—ALS, depressive disorders and/or ischemic stroke, perhaps. There are surely more spinoffs in this very rich stem cell pipeline. If management can carry off the huge clinical trial load, then Neuralstem is a much more valuable wealth creator.
The company is clearly a mature discovery investment. We own it. It ranked highly on all 10 factors in our Discovery software. The company is well underway to derisking its stem cell technologies and we would be buyers on any market weakness. Finally, there are lots of catalysts in the near future for Neuralstem investors.
TLSR: Mike, when we last spoke, it was clear you have high regard for OPKO Health Inc. (OPK:NYSE) chairman and CEO Phillip Frost. This company has a new molecule, rolapitant, in a large-scale, international, phase 3 trial for nausea associated with cancer chemotherapy. The acquisition of PROLOR Biotech Inc. will add phase 3 candidates to the pipeline, and the company is preparing to launch the 4Kscore prostate cancer test, which will prevent unnecessary prostate biopsy or confirm the need for it. The company has a net cash position of $181M as of March 31, 2013. I understand that this is a growth story, but when will it become an earnings story? And will that question become a stumbling block for investors?
MB: George, how can I say more? I have great respect for Dr. Frost. Having just gone through a prostate biopsy procedure myself, I believe that he innately understands the needs and economics of the prostate cancer space, and has assembled a powerful pipeline of therapies. The 4Kscore test alone has major discovery potential, as I can personally attest, and is being readied for commercial launch. Monetizing it will take some thinking.
OPKO is well diversified into diagnostics, pharmaceuticals and opportunistic healthcare products, including vitamins and human growth hormone. Perhaps more important is the strong share price action, with shares currently selling at $8.58 and in terrific volume. The shares have almost doubled in the past year. They are up 17% year-to-date. What’s not to like? Earnings are not far in the future, but wealth creation in this story is about monetizing many of these assets as well.
TLSR: Are there any new ideas you want to share?
MB: Yes. I have one name that is classic discovery play— PLC Medical Systems Inc. (PLCSF:OTCQB).
The company’s therapy addresses the aging boomer generation and a problem that current dialysis procedures tend to cause, contrast-induced nephropathy (CIN). Dialysis procedures will explode in the next decade, as the world’s population ages and Type 2 diabetes takes a grim hold on seniors. CIN will explode too, and with it the need for less toxic examination procedures. CIN impairs renal function and is one of the leading causes of renal failure, and 10–20% of dialysis patients are impacted by CIN—a huge proportion.
PLC’s RenalGuard is a therapy that reduces toxicity in the kidney by removing the toxic contrast dyes used in dialysis procedures. It is commercialized in Europe now, and European patients have experienced a 70% lower incidence of CIN problems.
We estimate this market to be worth $500M today, and it is sure to grow. There are more interesting applications here as well. This is one company to keep an eye on.
TLSR: Thanks for your time, Mike.
MB: My pleasure, George.
From 1982–1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published a book, Managing Investments: A Case Approach. He was the Wheat First Professor of Investments at James Madison University. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.
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1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an employee or as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Neuralstem Inc., OPKO Health Inc. Streetwise Reports does not accept stock in exchange for its services.
3) Michael Berry: I own or my family owns shares of the following companies mentioned in this interview: Senesco Technologies Inc., Neuralstem Inc. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.