Josh Levine Names Three Biotech Game-Changers
Source: George S. Mack of The Life Sciences Report
Micro-cap biotechs must have creative, adaptive management first and foremost, says editor Josh Levine of Josh Levine's MicroCap Investor. A second key characteristic is a technology platform that can ultimately generate a suite of products. In this interview with The Life Sciences Report, Levine shares both his investment philosophy and his best three biotech ideas, all of which he expects will return huge multiples to investors.
The Life Sciences Report: You see micro-cap investing very much like venture capital (VC) investing. How so?
Joshua Levine: From time to time I talk about micro-cap investing as a form of venture investing for the public. We are not looking for a 25% gain. The micro-cap investor, like the venture investor, is looking for big multiple gains of three, five or 10 times over the life of the investment. There is a very big risk-reward factor for investors in micro caps, and the micro-cap investor should have the same long-term perspective that the venture capitalist has.
TLSR: Josh, you've recently written about and highlighted some differences between your investment philosophy, as you lay it out in the MicroCap Investor, and that of the Dow Jones' editorial staff and how they pick their Next Big Thing list for The Wall Street Journal. At the top of the Dow Jones guys' list are the track records of the VCs sitting on startup boards, as measured by merger-and-acquisitions activity and the total market value of initial public offerings. That sounds reasonable to me. But you differ with that. How?
JL: The Journal focuses on major investors who are involved in the formation of a company, and how these players have performed in the venture game in the past. For micro caps, I believe it takes a different perspective. Above all, it is management's track record and past experience that are crucial. The micro-cap management team is dealing with a different type of investor base and a different set of challenges and circumstances than the management team of a privately held, venture-backed company, with different mandates and obligations to meet in addition to growing the company.
TLSR: Does this mean that you won't invest in a company if its management doesn't have some sort of a track record that you can look at? Or, at minimum, do you insist on meeting management before you become an investor?
JL: With smaller micro caps it is very important for me to meet the management team, to spend time talking, asking questions and seeing how the team projects a strategy, a vision, and how that has been executed on. I also want to find out about the team's ability to adapt to inevitable changes. It's actually more a question of experience and character than track record.
TLSR: It's understandable that you want to invest in very small companies because that's where the big upside is, but the risk is also much greater in any way you want to measure it -- maturity of the enterprise, maturity of its market, access to capital, the certain risk of dilution in a very small company, marketability of shares and, of course, volatility of the shares. Can you give me some ideas on how you mitigate the risk in a sub-$100 million ($100M) market-cap company?
JL: Again, it starts with basic due diligence on the management team, and its ability to adapt to change and learn from earlier mistakes. Another important item on my checklist is capital structure. If it is too complicated to understand, then it doesn't make sense to go beyond that. I want to know how the shares outstanding are distributed and the makeup of the different kinds of placements and warrants. Have the stock offerings been well managed and controlled? It should be relatively clean and simple. When it's not, that usually raises red flags. I think there are enough quality companies and management teams that investors should be able to filter out "funkier" companies very quickly.
TLSR: It strikes me that micro caps are particularly vulnerable to intellectual property (IP) challenges, if for no other reason than the fact that they don't have bulging balance sheets to pay IP lawyers to defend patent challenges. How do you diminish the risk of being caught in this kind of squeeze?
JL: I certainly don't have the capability to evaluate 30 or 40 patents in a company, but I try to get a handle on the IP issue by looking at the patents, talking to the people behind the company and trying to get a sense of it all. Companies love to throw their IP around and talk about it as a great asset -- that their patents could be worth hundreds of millions of dollars by themselves. But 99% of the time, that's untrue. Most patents really have little or no value. Even with the ones that do, it's questionable what they mean to the company. In some cases, patents are obviously an important strategic tool and a form of defense against competitors, but small companies with limited capital resources can be vulnerable. In many industries, if a large competitor wants to appropriate a small company's technology in one way or another, it can take steps and the micro cap is probably vulnerable.
TLSR: Then, if a micro cap can't afford to defend its IP, even though it might be bulletproof, how do you mitigate that risk?
JL: An investor really can't. But, the positive side to this issue is that often the patents don't give away the goods. There's more to it than that. The most important part of IP is what's inside the heads of the people who work for the company and have a stake in it. The key people -- the lead engineers and scientists -- are an integral part of the IP. That often creates the defensive barrier against outside threats. In biotech, especially, you don't see the same kind of infringement issues you might see in some other areas of technology. The life sciences are very complex. If a larger company is interested in a smaller company's drug, it usually makes sense for the pharma to work with that company, either through a licensing agreement or a partnership of some sort.
TLSR: Josh, before we talk about your individual ideas, tell me how much of your current allocation is in biotechnology.
JL: Biotech stocks account for almost half of the current portfolio. It is my favorite area. There are a number of reasons for that. Several of the companies in the portfolio qualify as what I call game changers. They are stocks that I'm in for the long haul, and I see tremendous potential for them. These companies have created technology platforms that can enable multiple products, drugs or applications. In that sense they have some built-in hedge to risk because they are not dependent on a particular compound that might fail a clinical trial. The three companies I will talk about today have all of the characteristics that are favorable to micro-cap investing as I approach it.
TLSR: Go ahead first with your favorite idea.
(To learn about Josh's three biotech game-changers, read the complete interview here).