We've all heard of doubling down on an investment. How about doubling down 11-fold? This is exactly what RA Capital Management did, raising their holdings of ACHN from 2m shares to 23m as the stock moved against them from 2012 to 2014. Their conviction paid off when shares rallied from as low as $2.52 to over $13 in the summer of 2014.
RA Capital is a a Boston-based healthcare crossover fund, and according tothis study (original here), a great stock picking firm.
I have been following RA for a few years now, and had the pleasure of seeing this trade play out in real time. I also had the good fortune of following them through this trade for myself and client accounts.
RA Capital first disclosed their position in Achillion in the summer of 2012. You can see the shares held (green and orange) on the right side of the chart above, with the stock price as the blue line. Over the next year, biotech industry observers pontificated that Gilead would dominate the space HCV space with sovaldi.
However, things were just beginning to get interesting. The FDA put a clinical hold on Achillion's lead drug sovaprevir on July 1, 2013 due to toxicity concerns. On July 22, 2013 Peter Kolchinsky, Managing Partner of RA Capital Management, wrote a piece for xconomy, defending Achillion, and refuting the idea of Gilead capturing the entire market, stating that Achillion would compete on price, carving out its own niche in the HCV space. By this time, RA had increase their holding from 2m shares to 7.4m. For those interested, Kolchinsky's book The Entrepreneurs Guide to a Biotech Startup is a great read and can be found here.
When the FDA declined to lift the hold in September 2013, the stock took a beating from the $7's to the high $2's. However, RA Capital stepped up their buying in the rest of 2013, eventually owning 23m shares and over 20% of the company.
During this time,bulls argued that the liver toxicities only occurred in a small subset of HIV patients, and therefor could be overcome. Bears saw a drug with toxicity issues that was late to market (if at all), and a pipeline that was not mature enough to get excited over.The shares traded as low as 2x cash on the balance sheet. However, those paying attention to RA Capital noticed the buying, and had ample opportunity to buy during the nine months the stock was down, which I did.
In June of 2014, two events occurred that boosted Achillion price. HCV rival Idenix was acquired, and the next day, the clinical hold was lifted. RA Capital's stake rocketed from $65m to $217m in about two months.
Since then, RA Capital has began to unwind its very large position, selling it down, presumably for risk management purposes, and to book some monster gains. The willingness to go against the grain, the deep level of conviction, and the huge win makes this one of my favorite biotech trades of all time.
Notes for the data geeks:
Most people would say Warren Buffett, the famously tech-adverse investor who seeks "Wonderful Businesses", would never touch the biotechnology sector. However I believe this is simply a function of his circle of competence principal. Simply, if he doesn't fully understand a business, he won't allocate it his capital.
Do some investor's circle of competence include biotech? Of course, but does the biotech sector contain "Wonderful Businesses"? Let's find out.
Time is the friend of the wonderful business, the enemy of the mediocre.
So what is a Wonderful Business? Investopedia has a nicesummary of Buffett's wonderful business criteria:
Buffett's criteria for "wonderful businesses" include, among others, the following:
For the purposes of this post, I am going to focus on the factors we can easily quantify, specifically items one and three. Return On Invested Capital, item one, is certainly the most important. It's also worth noting that this criteria works.
"Leaving the question of price aside, the best business to own is one that over an
There are many "cheap" companies, but not many that earn high returns on capital. Let's look at Berkshire Hathaway's publicly traded holdings to see what Buffett considers an acceptable ROIC.
For those who completely dismiss The Oracle's interest in biotech, I will point to Berkshire Hathaway's quarterly 13F filing. As of December 31, 2013 Bershire owned shares in Sanofi Aventis and Johnson & Johnson. Although these are "pharma" and not "biotech", the truth is that the distinction between the two sectors has been getting blurrier every year. Biotech is simply next-generation pharma. Case in point, J&J is the world's fifth largest biologics company, and Sanofi's Tuberculin for diagnosis of tuberculosis is a Purified Protein Derivative.
Let's check out the ROIC's of Berkshire Hathaway's healthcare companies. (Yes, I know DaVita is not Buffett's position, but rather Ted Weschler's) Also, they recently sold out of GSK, but it's worth noting for our purposes.
So we've established that Berkshire Hathaway, and by extension Buffett, has invested (to a limited extent) in companies that sell biotechnology products. But what about the criteria outlined above? What about a pure play biotech company?
Gilead Sciences is the second largest component of the NASDAQ Biotechnology Index at 8.4%. This maker of Hepatitis and HIV antiviral drugs was founded in 1987 and then went public in January 1992.
Gilead has followed the path of many growing companies, operating at a loss for the first several years before finding success. It wasn't until the second quarter of 2002 that Gilead earned a profit, and since then it has earned an excellent average ROIC of 26.9% over the past five years, nearly as much as Buffett's fourth largest holding IBM.
Below I've shown regular ROIC, and Cash Return on Capital Invested, to smooth out some accounting charges that do not impact cash.
What about criteria number three, profits as cash flow? Turns out Gilead is pretty good there too, with the same exceptions of some accounting write downs, Earnings and Cash Flow from Operations have tracked each other very closely.
So we've established that biotechnology can, quantitatively, meet the definition of a "Wonderful Business".
Interesting side notes:
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
All data from ycharts.com
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
This is the personal blog of Emory Redd.
This blog is not investment advice. This is not a solicitation to invest. Don't take candy from strangers.
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