How to invest in pharmaceutical and biotech companies? Why, despite many scientific breakthroughs and sales hits such as Ozempic or Wegovy, does the pharmaceutical sector lag behind the technology sector in capitalization growth? What companies and products should an average investor follow and what mistakes should he avoid - these and other questions were answered by Ilya Yasny, co-founder of LanceBio Ventures, a fund specializing in biotechnology and investments in the pharmaceutical industry, in a video interview for the program "Oninvest: What's Next".

Who is Ilya Yasny

D. in Chemistry, a graduate of the Faculty of Chemistry of Ma Lomonosov Moscow State University, from 2002 to 2005 he worked at Algodign, where he was engaged in computer-aided drug design, in 2008 he defended his thesis on protein engineering, at the same time organizing a laboratory for recombinant protein production.

Since 2010, he has worked as a scientific expert at the biotechnology company Generium, and since 2013, as Head of the Expert Department of LanceBio Ventures, a venture fund investing in biotechnology startups and drug development. Scientific interests: translational medicine, oncoimmunology, pharmacology. Author and editor of Biomolecules, a popular science publication on the molecular foundations of modern biology, runs the LanceBio Ventures Telegram channel.

- Investing in the pharmaceutical sector requires both knowledge of the capital markets and a deep understanding of the industry, and even fundamental knowledge. In this sense, you have both. But unlike you, the average investor often doesn't understand the logic of the market; there are times when pharmaceutical stocks are not just about their financial and economic performance, but also about big trends in the market. What the investor is dealing with depends heavily on the scientific breakthroughs of pharmaceutical and biotech companies.

In your experience, what classic mistakes do investors in pharmaceutical and biotech companies make? What would you warn the average investor who suddenly becomes interested in shares of pharmaceutical or biotech companies against?

- If a person is completely inexperienced in this area, I would caution them against investing in early-stage companies that don't have revenue yet, and there are quite a few of them. Unlike other sectors, in biotechnology and pharmaceuticals, companies that are many years away from the market are coming to the public market, and they are actually trading on expectations. They are very volatile, they are very dependent on both external factors and their own operations.

Not only without specialized knowledge, but also without long experience of public investing in this particular field, it is very easy to lose a lot of money. We started by investing in private companies developing medicines. When we started investing in public companies, for the first two years we had to study, to get a feel for the specifics of this market.

If people are well versed in biotechnology, they are tempted to trade biotech stocks. And they, for example, choose the strategy of guessing the outcomes of binary events. But the specificity of biotech companies is that if it publishes research data, the stock can rise or fall sharply, depending on the success or failure of the drug or technology.

Often people try to pick companies that they think are more likely to publish successful data. This is quite a dangerous strategy, because after such binary events the company can certainly grow several times, but it can fall by 80-90%. Of course, if you have a large portfolio of such companies and you managed to pick the right successful companies, the strategy can bring success.

But we now try to avoid those situations. We try to invest in companies that have been growing their value for a long time and have more fundamental and diversified growth strategies.

- You just said about the portfolio of different companies. Do I understand correctly that this classical way of reducing risk also applies to this sector?

- It is absolutely necessary, because trying to pick one or two companies and guess is a completely losing way of investing. This market is so risky that only a well-balanced portfolio can protect you from high risks.

- How do you build a portfolio? After all, you probably have some rules from your investment experience

- Yes, there certainly is. Every investor in this area has slightly different rules. Some are focused on binary events. Some prefer to invest in earlier companies, some in later companies. Some in companies on exchanges other than the US, some exclusively in US exchanges. More specifically, in companies that are traded on a US exchange, but they can be European, Chinese, and others.

Some people prefer companies that have one product and all their efforts are focused on developing it, while others prefer so-called platforms - when a company has the technology to spawn many products. Our strategy is based on several principles. The first is that we invest in companies traded on NASDAQ. The second is that the company we invest in must have a lot of cachet in the account so that there is necessarily enough to last until one or more of the following events. These events, called Milestones, are when a company publishes research results or something happens that potentially changes the value of the company.

The third condition is that they must be clinical stage companies, i.e. those that have already started human trials.

The fourth rule is that we try to balance our portfolio so that it also includes companies that have already brought their first product to market. We expect that their revenue will grow well, plus they have something else in the pipeline, i.e. something that is still in clinical trials, which will then come to market and also raise the value of the company.

Based on these rules, we form a longlist of potential investment targets, which we then narrow down based on deeper research, such venture-like due diligence.

In addition, we analyze data on preclinical and clinical trials, and conduct competitive analysis. And then we build financial models to determine the fair value of the company, to understand whether it is currently undervalued or overvalued. Another rule. We try to communicate with the managers of the companies we are going to invest in. If the company is public, of course, it cannot tell us anything that would not be on their website and in SEC documents. Nevertheless, the company's management is happy to answer questions such as "how is your product better than your competitors, what will you do if your flagship product fails?

In the process of communication, we realize how good the company's management is, how capable they are of guiding the company through all the bumps and problems in difficult times. And we know many companies from the time when they were not public. We were in contact with them before the IPO, so we had the opportunity to track how they were developing.

- While preparing for this interview, I came across a J.P. Morgan study on the short- and medium-term prospects for investing in pharma and biotechnology. It was prepared by Michael Cembalest, head of market investment strategy for Asset and wealth management at J.P. Morgan. The report was published earlier this year, and its conclusions are very unoptimistic. As the study suggests, big pharma stocks, Pills stocks, are lagging far behind the technology sector.

And we are not even comparing pharma to the Magnificent Seven stocks, we are talking about other companies. What's more, over a five-year stretch, pharma companies have underperformed even many companies in traditional sectors, commodities, or food. And the report claims that right now, stocks in this sector are trading at the largest discount to the S&P 500 in 30 years. Meanwhile, the average investor is constantly hearing about breakthrough drugs or platforms, such as weight loss products, cancer drugs, longevity, and so on. And the sector is undervalued. What's going on?

- I believe that this is not a reason for pessimism, but rather for optimism, because it is a great time to get into stocks. I agree, we can't guess when the bottom will be passed, as in the joke "we thought we were at the bottom and then the bottom came knocking". The sector is indeed going through the biggest and longest decline in the history of biotechnology. This is partly a consequence of the coronovirus epidemic - in February 2021, amidst the covid and successes of Moderna, BioNtech, Pfizer in producing and marketing vaccines, a bubble inflated in the market. Money from big funds and private investors came into the market, probably expecting such successes to be repeated continuously. Later it became clear that this was not the case, that the covid pandemic was a unique case.

At the same time, the sector has become so flush with cash that a lot of companies have gone public that, frankly, didn't deserve it at all.

Then, when frustration set in, money started to leave the sector and other factors started to come into play. First it was the ongoing covid. Then there was the increasing international political uncertainty, wars.

"A "special joy" for investors in this sector is that the role of regulators and their policies are very important in pharmaceuticals, especially in the US. In the US, there was an added pressure on the value of companies, such as the lack of a head at the FDA, the main drug regulator. Then it came along. Some factors went away, but others appeared. In the US, for example, the Fed Funds rate went up, which had a big impact on small biotech. Bigpharma, of course, is more resilient to these events because they have huge revenue, people need drugs all the time. But big pharma has its own problems. For example, the proposed decisions in the US to regulate drug prices are bad for the shares of large companies.

In addition, large companies are under constant pressure from the "patent" factor. These are situations when the previous "blockbusters" of pharmaceutical companies, their cutting-edge drugs and remedies, which gave steady revenue, lose exclusivity, and cheap generics enter the market. Therefore, "big pharma" constantly needs an influx of new innovations, new sales hits.

But the race for patents has a downside. It forces pharmaceutical giants to invest in acquiring small companies that have developed something interesting and potentially with big sales. By the way, the number of acquisitions in the market has increased. Scientific activity has not decreased either, as you rightly point out. There are a lot of discoveries and innovations in the market, and that is a good sign.

- And what discoveries and areas should investors keep an especially close eye on?

- We live in an incredible time of discovery. Before there were only small molecules, then there were antibodies and proteins, and now, on top of that, there is gene cell therapy, RNA therapy. New directions in pharmaceuticals - different ways of drug delivery, different ways of acting on targets. Today it is possible to cure diseases that used to be incurable. If earlier stage 4 melanoma was a death sentence, now 30% of patients have a hope to be cured, and completely. And also in lung cancer, in various rare genetic diseases. All this seems like miracles, but this is real science.

But so far this news background, alas, is not enough to change the long-term market sentiment. The main market for pharma is the US, and the situation there has a strong impact on the entire sector. The market is most of all frightened by uncertainty, in particular, by the statements of the US administration about the need to regulate drug prices. If the US government had already said that we regulate prices in this way and that way, this could have been incorporated into financial models. There would have been some drawdown, but it would have been clear what happens next. But when you have uncertainty, there is a probability of the worst scenarios, few people are ready to take risks. By the way, this leads to a very interesting phenomenon. In theory, when a company publishes good data about a treatment trial, its stock usually rises. And in these bad times, there's this interesting effect that a company can fall on good data. Why does that happen? Because some big hedge fund has been wanting to get out of this investment for a long time, but they can't sell their stake in the small company because there's not enough liquidity. If they were to sell a big stake, they would immediately drop the price. So they wait for the liquidity moment. It comes when a company publishes data that attracts new investors. The stock goes down. And instead of rising on good data, the company drops 20-30%. It's a good moment to pick it up because it's completely paradoxical and irrational market behavior.

This underestimation of the sector has a long-term risk. If the situation does not change, it may turn out that we will simply have fewer medicines in the future. So far, this effect has not yet occurred, because the trials launched 10 years ago have been funded and are coming to market. But what will happen in five to 10 years? We may well see a dip in the number of drugs approved. Because private investors are waiting for IPOs. For them, this is the moment of exit. And there are a bunch of good companies with cool technologies that have already raised multi-million dollar rounds. It's time for them to go public. But because the IPO window is closed, they are standing in line.

- In the J.P. Morgan report, there is a thesis that large pharmaceutical companies have low research and development (R&A) efficiency and cost growth does not lead to a proportional growth in the number of new drugs. Do you agree with this thesis?

This problem has been talked about for a long time. Let's look at why it is difficult for big pharmaceutical companies to do research effectively. First of all, because their most important function is sales. And this indirectly contradicts research, because the sales function implies a rigid hierarchy, rigid procedures, less flexibility and a different work culture altogether.

And R&D presupposes a freer atmosphere, close to academic - creative, with horizontal relationships. It can be difficult to combine them within one company. And every large firm solves these problems in a different way.

But I would say that such a harsh assessment as was made in the J.P. Morgan report was fair 5-10 years ago. And now there are certain positive changes. Firstly, big pharma is actively buying up smaller companies with discoveries and patents. By the way, this is why big companies have recently stepped up their takeovers of smaller companies.

There are other approaches - some outsource R&D, others, like AstraZeneca, are specifically engaged in improving the efficiency of research activities, and even specifically report on it.

And an important detail. You have to realize that the probability of success in R&D is very low. Out of hundreds of products developed in the pharmaceutical industry and reaching the stage of clinical trials, at best ten reach the market. In other words, the failure rate is 90%. In essence, this is a venture capital business, and within "big pharma".

- One of the news items attracting attention in the pharmaceutical industry was the appearance of the slimming agent Ozempic, which immediately inflated the shares of the Danish Novo Nordisk. At a certain point, this company even became the most expensive in Europe. It is impossible to bypass this topic, if only because the consequences of the appearance of this product and its analogs are already affecting many other sectors of the economy. Analysts are revising growth forecasts for retailers and food companies, as the mass use of these remedies reduces product consumption.

However, the effect did not last long; Novo Nordisk's capitalization is rapidly falling. In your opinion, has the potential of this area already been exhausted? Are we waiting in this area for another magic pill that will allow us to look slim and beautiful?

- Right off the bat - both Novo Nordisk and Eli Lilly, who produce such drugs, have made an official statement that they strongly discourage the use of these drugs in people who are not obese, i.e. for cosmetic purposes. Only with a doctor's prescription and only in people with indications, as these products have not been properly tested on healthy people.

Now about the predictions - I'll disclaim that this is not my own analysis, it's based on third-party data. But I have read quite a lot of different things. And if in 2023 the market for these funds amounted to about $6 billion, the forecasts for 2035 are already in the neighborhood of $100 billion. That is, the growth potential is huge. There is also the potential for the emergence of new drugs that will be better than the existing ones, because, naturally, everyone has moved there - both big pharma and small biotech companies. Now the list of developments already includes more than two hundred products in this area. At a fairly advanced stage are improved injectable and oral agents (taken in the form of tablets). Separate directions - reduction of undesirable side effects of such products, and means, thanks to which in case of drug withdrawal the weight did not return.

Why is there still a huge growth potential in the market? Because in addition to obesity and type 2 diabetes, it turns out that products in this class can treat and prevent many other diseases. No one could have predicted 7-10 years ago that heart attacks and strokes could be prevented in people who were even mildly obese but at high risk of cardiovascular disease. This is an amazing result, and they are now approved for this indication. You can prevent liver and kidney disease, the onset of type 2 diabetes.

Now there are studies underway on the possible use of these agents against Alzheimer's disease or against drug and alcohol addiction. And this is not the end, there may be autoimmune diseases and so on. The first data are very encouraging, but of course we have to be extremely cautious in our assessments.

- You're talking, in a sense, about a revolution. It is unexpected that all of this has come from an area such as the fight against obesity. Are there any other areas in research, in drugs that are close to release, that could have the same revolutionary effect on the market and, as a consequence, on the capitalization of the company? In what areas should a non-sophisticated investor follow the news and look closely at what is happening there?

If a person decides to seriously pursue this field, he or she should carefully study the news stream on the topic, listen to podcasts to understand everything that is going on.

What's going to be the next big thing? Everyone wants to know, but it's unfortunately very hard to predict.

There are many areas. Traditionally, interest in oncologic diseases does not subside, because there are successes in this area.

Research into autoimmune diseases is also well-funded and there have already been great successes in developing treatments for psoriasis and multiple sclerosis, and many other diseases. For example, two years ago, there was an explosion of interest in the use of cell-based technologies, so-called Carta (CAR-T), to treat autoimmune diseases. There was an academic study published in Germany that said 15 people were treated with these cells and they all responded positively to the treatment. And these were people with severe stages of systemic lupus erythematosus, systemic sclerosis. These are diseases that affect the joints, do not allow people to walk and move normally. And these people started running a year later, they refused to take immunosuppressive drugs after just one injection of their own cells modified by genetic engineering.

And then, naturally, a bunch of companies rushed into this sector. They have started a lot of research. The results already seem not so impressive to the market, and so far the enthusiasm has waned. We are now looking forward to the next results of clinical trials to finally understand whether or not this will be promising.

Rare diseases are, of course, an extremely promising area of research for both "big pharma" and biotech companies. First of all, because in total they are not so rare. 5% of the world's population suffers from rare genetic diseases, of which there are about 7,000. Of these, 95% are not treated at all.

The field of women's health is still very underfunded. There are many common diseases for which there are no effective drugs, but they are trying to create them. But the efforts are disproportionate and so far there have been no great successes.

- There is a lot of talk now about the boom in artificial intelligence and the possible effects of its application in various areas of the economy. To what extent does this new technological revolution affect pharmaceuticals?

- Biopharmaceuticals is certainly an innovative field, open to any breakthrough. Yes, there are people who hope that artificial intelligence will lead to a dramatic increase in the probability of success in clinical trials, which is the biggest obstacle to developing new drugs. Because you starting clinical trials in humans, you can't be at all sure that you're going to succeed. But so far the hopes for a breakthrough have not been realized. That is, there are already a number of drugs that have used artificial intelligence in their development, but for early stage development.

But so far we are seeing more of a cooling of enthusiasm. Shares of biotech companies that are involved in the application of artificial intelligence in biotechnology are still falling.

Artificial intelligence can be applied in many different ways. For example, it can be used to predict the structures of new drugs. Artificial intelligence is undoubtedly useful here, but it has not yet led directly to a clear breakthrough.

It can be used to conduct clinical trials more effectively, to plan further drug development more effectively. In other words, everything to do with collecting information, helping people to make decisions and so on, it is certainly very useful here, because there is a lot of disparate information that needs to be summarized and presented in such a way that it helps people to make a decision. And I can share it now - I am advising Andrei Doronichev's startup, which is doing exactly that. Creating AI-agents to help pharmaceutical companies and foundations make decisions. And it is very interesting work.

Watch the full version of the interview on the Oninvest Youtube channel

This article was AI-translated and verified by a human editor

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