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Biotech investing — a risk worth taking?

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Biotech investing — a risk worth taking?.

Senior Portfolio Manager Manuel Greenland tells us how we approach investing in biotechnology companies.

A good company is one whose key strengths, such as brands, scale or technology, raise barriers to competition, allowing it to earn superior profits over time. A great company can reinvest these profits into the development of new growth opportunities; a great retailer may roll out new stores, or a great manufacturer may build new production facilities. For biotechnology companies, growth often involves developing new drugs or medical devices, or finding new uses for old ones. Finding growth opportunities can be hard enough, but in the case of biotechnology companies, they have to do so while proving that their drugs or devices are both safe for use, and effective in treating ailments. Public health is at stake after all. Investors in biotechnology firms have to manage the risk that accompanies these efforts to prove new therapies.

Australian portfolio company Nanosonics' Trophon device disinfects ultrasound probes. Nanosonics recently announced results of a study that showed Trophon was the only disinfection system in its class that has been proven to kill human papilloma virus, high risk strains of which are the leading cause of several cancers. Nanosonics' announcement came as regulators in the United States began reviewing disinfection practices following an outbreak of a superbug in a California hospital, which is believed to have been spread by poor disinfection practices within the hospital itself. Nanosonics demonstrated its medical technology can solve a pressing healthcare challenge, causing the share price to rally 20% on the expectation of additional demand for its products.

In contrast, fellow portfolio company ResMed found that a therapy it was hoping would help patients who suffered from a combination of complex sleep apnoea and heart failure, in fact increased risk for these patients. Clearly this is about as negative a result a trial can deliver. "Losing heart", pouted sceptics, "Disaster" cried the press, and the share price fell 18% on the day. The only disaster we could see was for those people who had hoped the trial might present a safe and effective therapy for their medical condition. We knew that less than 2% of the company's sales were affected by the unsuccessful trial, and that the core business continued to perform exceptionally well. Over the balance of the month the ResMed share price rallied 14%, substantially recovering the bulk of its initial fall.

Companies we own in this sector have proven technologies and trusted reputations. We expect these companies to use their strengths to explore new growth opportunities and we appreciate that not every effort will be successful. We do not see Nanosonics as a better company because one study went well, nor do we see ResMed as a worse company because one trial went poorly. By virtue of their strengths, both are growing sales and profits, and have positive long-run prospects.

Benjamin Graham pioneered modern investment analysis long before the advent of biotechnology as we know it, but his advice remains relevant. "In the short run, the market is a voting machine but in the long run it is a weighing machine". We look through volatile investor sentiment around individual trials, and rely on the fundamental quality of our biotechnology holdings to deliver profitable growth over the long-term.

 

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