Well, there is not much to say about the market and sector other than selling is in vogue and there does not seem to be a clear catalyst that could change the tone of the market. I would also remind you that the apparent catalyst of this negative turn (pricing letter from Congress to GILD) was not expected, so I would not be surprise to see the news that reverses this move lower come out of nowhere as well (so to speak).
1. Earlier in the week I hinted about a relationship between the AGIO data and EPZM and I have received some questions about this. There is really nothing hugely insightful but I was thinking that the AGIO price action is relevant for EPZM in that both are going after genetically defined patients in hematologic cancers, have a platform technology, and are a CELG partner. EPZM has seen significant selling (like every stock) and I thought the AGIO move might make people rethink EPZM and how it could move on reporting positive data. Clearly the move lower in EPZM was investors increasingly discounting the prospects of positive data (or selling for other reasons but with the outcome of pricing in increasingly lower odds of success). My thought was that the AGIO data/move could get people to either stop lowering the possibility of positive data or even start increasing it. While EPZM has not moved dramatically higher, it has done pretty well this week all things considered and perhaps it is this AGIO pin action. In either case, I do think EPZM has the potential for an AGIO like move later this year if(when) they report positive data from their trials. When is data coming? I do not have a strong sense of when but I suspect that they would want to maximize the PR value which would likely be around ASCO or ASH. This is not the say they would present there (if it were ASH then they likely could present the data); rather, these are times when investors are focused on oncology companies and positive news could be most effective.
2. So what is going on with the sector and when will it end? Those seem to be the most relevant questions going forward. The short answer is that investors are progressively increasing their discounting rates on early stage products and future cash flows of the commercial stage companies. Why? There are any number of plausible reasons but what matter more is the values that this increased discounting is creating. I said before and I will say again that cheap can always get cheaper, which I why I buy in nibbles on the way down. At this point, it is time to look at your high conviction names as there is a high probability that the market is pricing in a fairly pessimistic view. This is not to say that they will not get cheaper but if you noticed there are a lot of analyst notes coming out highlighting values in the large cap space. Large cap biotech is trading at par with pharma valuations and close to ISI’s bearish base case DCF. I think it was RBC that noted that on a forward basis a number of large caps are trading at close to the S&P forward P/E despite forward growth rates that are 3 to 4 times higher. These are all true but the forward P/E and DCF are based off of estimates and when fear is rampant people discount even base case estimates, so cheap can get cheaper. I seem like a skipping record but my plan is the same. There is no way I sell at these levels because they are relatively cheap and selling now locks in losses (ones that I doubt I would have if I hold for 12, 24, 36, … months). I will not try to pick a bottom but be opportunistic and buy on the way down on names I like. At this point there are a lot of good values out there, so I will be more selective as I go back and do deep dives on the names I like.
3. So what are my high conviction names at this point? I am still working this out but among the large cap, it has to be CELG. I think the patent issues are a red herring at this point. The Markman documents look favorable and I suspect that within the next year or so they settle on very positive terms and unlock significant value. On top of that there is high visibility in future cash flows, so buying CELG close to a bear base case DCF seems like a low risk long term investment. In addition, there is no value in CELG for its partnerships and while these are not near term, it is all upside at this point. I am also seriously looking at REGN. I do not have a position but this is a company that I like but it always seemed too expensive for me to pull the trigger (and it of course ran away from me). This market sell off is looking like a chance to get REGN and not have to chase it higher. There are other ideas that I will talk about over the next week or so but among cash flow positive biotechs those are the two I am looking to buy (add).
Hopefully, we can change the tone of the market soon enough but even if it take longer, I hope everyone has a great weekend.
Disclosure: Long CELG, EPZM, and GILD.
