Biotech financial engineering is also making it hard for institutional investors to make intelligent investing decisions, making these markets even more irrational.
Take Rocket Pharma (RCKT), which recently had KRESLADI, a cell therapy, recently approved for children with severe LAD-1 deficiency. RCKT’s stock price increased by about 70% in the 3 weeks leading up to FDA approval. I listened to the call with institional investors, who were surprised to learn that KRESLADI’s not a commercially viable drug. The unit economics are horrible and the TAM is miniscule. RCKT told them it is planning a “minimum viable rollout” to US patients only. The stock immediately fell back to its pre-runup baseline.
According to RCKT management, the whole point of developing KRESLADI was for RCKT to gain experience taking a drug through FDA approval and get a PRV. The PRV sale will give them non-dilutive cash to see through their commercially viable gene therapy for Danon disease. Success in that indication will also substantially de-risk the rest of their pipeline, which is focused on using the same AAV delivery system for other monogenic heart diseases.
But institutional investors appear not to really understand these critical details. They see “drug approval” and they think “commercialization,” not “PRV to extend runway for a different drug,” or “we already sold off most of the future value to fund the runway,” or “PRV, but we only own a fraction of the subsidiary, and they licensed out a substantial fraction of the PRV, and the subsidiary also has warrants that are going to get exercised on this news that will dilute the upside further.”
It has similar issues to the 2008 financial crisis, except there aren’t even standardized metrics we can turn to in order to understand these arrangements. There’s no table of FICO scores. All these deals are boutique, with critical details often considered proprietary and not published (though sometimes they can be inferred).
Take MaxCyte (MXCT). Their main product is a commercial-scale electroporation device, which punches holes in cells so that you can force them to take up large molecules, like a gene. Electroporation typically is harsh and low throughput, and using it would entail serious manufacturing risk. MXCT’s technology is so well established that they have an FDA master file, meaning that using it for your cell therapy de-risks that aspect of manufacturing. They’ve also just finished expanding it to discovery-scale devices that academic wet labs will put on their benches. This will enable them to scale up smoothly as they take leads on a commercialization journey.
If you’re an investor in MXCT, however, their main business isn’t selling devices and disposables. It’s SPLs, which are royalties on cell therapies approved using their electroporation device. They have hundreds of SPLs, most of which will never pay off. The first sickle cell therapy (Casgevy) uses their device for electroporation, and is in the early stages of a commercial ramp up, with the number of patients on a trend of roughly doubling each quarter. Cool, but MXCT doesn’t actually publish what % of revenue they get on sales of these cell therapies. Also, several of their other late-stage SPLs are also for sickle cell, so there’s a huge amount of not only correlation but also race-to-the-bottom dynamics involved.
Also, because these are rare diseases and cell therapies have horrible unit economics, there are huge challenges with getting them paid for. Even if in the long run, a cell or gene therapy pays for itself in lifetime healthcare costs, asking the insurance company the patient happens to be on when they receive the therapy to eat the entire large cost of the treatment doesn’t work well for the insurance company, which likely would have absorbed only a fraction of their lifetime health costs. It’s a natural choice to be government funded. Right now, there is a solid program for doing that through medicaid—it’s genuinely a really well designed govenrment program.
However, as we see an explosion of cell and gene therapies coming online all at roughly the same time, we are likely to see a sudden massive increase in the cost of delivering these treatments through that program. If the government only funds a limited quantity of those therapies, every single company in MXCT’s portfolio becomes less valuable.
I enjoy micro-cap biotech investing (I’m invested in both RCKT and MXCT), and I have the scientific and financial background to investigate these issues. I can sift through 300 such companies to find a basket of undervalued gems capable of absorbing as much of my investing capital as I want to put into them. It’s my money on the line, so I am directly incentivized to do a good job of vetting these picks.
But most investors simply do not typically have the right mix of incentives, training, interest, and autonomy to invest in these companies. Their understanding of biology, healthcare, and the FDA are far too limited to accurately assess the prospects of a company’s pipeline. And I suspect that these financialization schemes are going to make investing even more complex, with more hidden pitfalls, degrading willingness to invest in the sector further, unless we can execute them in a way that makes the thing you’re buying more legible and composable, not less.
Thank you for the detailed comment, super interesting! I have relatively little experience with biotech investing beyond long positions on established companies I find scientifically interesting, so it’s very fun to hear how all these financial complexities alter your own thinking on positions. One of my future articles is going to be about how biotech hedge funds think about trading edge (empirically bad endpoints, etc), and your stories may appear in it :)
Biotech financial engineering is also making it hard for institutional investors to make intelligent investing decisions, making these markets even more irrational.
Take Rocket Pharma (RCKT), which recently had KRESLADI, a cell therapy, recently approved for children with severe LAD-1 deficiency. RCKT’s stock price increased by about 70% in the 3 weeks leading up to FDA approval. I listened to the call with institional investors, who were surprised to learn that KRESLADI’s not a commercially viable drug. The unit economics are horrible and the TAM is miniscule. RCKT told them it is planning a “minimum viable rollout” to US patients only. The stock immediately fell back to its pre-runup baseline.
According to RCKT management, the whole point of developing KRESLADI was for RCKT to gain experience taking a drug through FDA approval and get a PRV. The PRV sale will give them non-dilutive cash to see through their commercially viable gene therapy for Danon disease. Success in that indication will also substantially de-risk the rest of their pipeline, which is focused on using the same AAV delivery system for other monogenic heart diseases.
But institutional investors appear not to really understand these critical details. They see “drug approval” and they think “commercialization,” not “PRV to extend runway for a different drug,” or “we already sold off most of the future value to fund the runway,” or “PRV, but we only own a fraction of the subsidiary, and they licensed out a substantial fraction of the PRV, and the subsidiary also has warrants that are going to get exercised on this news that will dilute the upside further.”
It has similar issues to the 2008 financial crisis, except there aren’t even standardized metrics we can turn to in order to understand these arrangements. There’s no table of FICO scores. All these deals are boutique, with critical details often considered proprietary and not published (though sometimes they can be inferred).
Take MaxCyte (MXCT). Their main product is a commercial-scale electroporation device, which punches holes in cells so that you can force them to take up large molecules, like a gene. Electroporation typically is harsh and low throughput, and using it would entail serious manufacturing risk. MXCT’s technology is so well established that they have an FDA master file, meaning that using it for your cell therapy de-risks that aspect of manufacturing. They’ve also just finished expanding it to discovery-scale devices that academic wet labs will put on their benches. This will enable them to scale up smoothly as they take leads on a commercialization journey.
If you’re an investor in MXCT, however, their main business isn’t selling devices and disposables. It’s SPLs, which are royalties on cell therapies approved using their electroporation device. They have hundreds of SPLs, most of which will never pay off. The first sickle cell therapy (Casgevy) uses their device for electroporation, and is in the early stages of a commercial ramp up, with the number of patients on a trend of roughly doubling each quarter. Cool, but MXCT doesn’t actually publish what % of revenue they get on sales of these cell therapies. Also, several of their other late-stage SPLs are also for sickle cell, so there’s a huge amount of not only correlation but also race-to-the-bottom dynamics involved.
Also, because these are rare diseases and cell therapies have horrible unit economics, there are huge challenges with getting them paid for. Even if in the long run, a cell or gene therapy pays for itself in lifetime healthcare costs, asking the insurance company the patient happens to be on when they receive the therapy to eat the entire large cost of the treatment doesn’t work well for the insurance company, which likely would have absorbed only a fraction of their lifetime health costs. It’s a natural choice to be government funded. Right now, there is a solid program for doing that through medicaid—it’s genuinely a really well designed govenrment program.
However, as we see an explosion of cell and gene therapies coming online all at roughly the same time, we are likely to see a sudden massive increase in the cost of delivering these treatments through that program. If the government only funds a limited quantity of those therapies, every single company in MXCT’s portfolio becomes less valuable.
I enjoy micro-cap biotech investing (I’m invested in both RCKT and MXCT), and I have the scientific and financial background to investigate these issues. I can sift through 300 such companies to find a basket of undervalued gems capable of absorbing as much of my investing capital as I want to put into them. It’s my money on the line, so I am directly incentivized to do a good job of vetting these picks.
But most investors simply do not typically have the right mix of incentives, training, interest, and autonomy to invest in these companies. Their understanding of biology, healthcare, and the FDA are far too limited to accurately assess the prospects of a company’s pipeline. And I suspect that these financialization schemes are going to make investing even more complex, with more hidden pitfalls, degrading willingness to invest in the sector further, unless we can execute them in a way that makes the thing you’re buying more legible and composable, not less.
Thank you for the detailed comment, super interesting! I have relatively little experience with biotech investing beyond long positions on established companies I find scientifically interesting, so it’s very fun to hear how all these financial complexities alter your own thinking on positions. One of my future articles is going to be about how biotech hedge funds think about trading edge (empirically bad endpoints, etc), and your stories may appear in it :)