[Ed. This is the twenty-third part in Wayne's series. You can access the whole thing by clicking here. Please leave comments or questions on the blog and Wayne will address them in future posts in this series.
As with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.]
Many Canadian small cap investors have probably done most of their investing in resource companies. Although monoclonal antibodies, gold, copper and oil have substantially different chemical properties, discovery activities, manufacturing processes and commercial uses, the investment strategies used are more similar than one might expect because the commercialization processes are similarly long, expensive and high risk.
Read on for similarities, differences and strategies…
- The most critical success factor for investors is an experienced management team that has done it before.
- Initial capital requirements are small – drilling some test holes versus animal models.
- Capital requirements grow as the commercial opportunity needs to be more accurately defined – more drilling and some test processing versus preclinical and Phase 1 clinical testing.
- The largest capital requirements are then needed to reach commercial production – building a mine and processing facilities versus Phase 2 and 3 trials.
- The project can fail at any point for a number of reasons – resource too small, processing costs too high, drop in commodity price versus safety concerns, inadequate efficacy or reduced commercial opportunity.
- Government regulatory hurdles for resource companies are primarily environmental whereas safety and efficacy are the hurdles at the U.S. and E.U. drug regulators.
- Political factors are important to mining companies where a resource`s ownership can be arbitrarily changed. The biggest political factor for pharma is differing reimbursement between countries.
- A mining resource can stay in the ground for decades until the factors for development are all positive. A biotech product has a finite commercial opportunity, which shrinks and can eventually disappear as new products enter the market and change disease therapies.
- Manufacturing cost should be less than 10% of sales for a biotech product but perhaps up to 50% at times for some natural resources.
Investment strategies (for informational purposes only!):
The ‘buy value and hold’ strategy was mentioned in the prior post in this series. Measuring value for early stage companies is very difficult. However, assuming that an investor is comfortable with the value assessment, the hold component of the strategy also has to be considered. It may take a decade or more before an asset is commercialized – a mine in full production or a drug receiving regulatory approval. A junior mining company will need to do numerous financings, the price of the commodity may swing wildly, capital costs may escalate as a mine is constructed, commodity supplies may exceed demand, and the risk appetite of capital markets may also vary widely. A junior biotech company will need to do numerous financings, it may have numerous competitors which report new data, it may have gaps without significant news and it is also subject to the risk appetite of the capital markets. A look at the share price charts of both types of junior companies will show substantial volatility.
Whatever investment strategy is chosen, the strategy should also include a trigger to sell the stock. Triggers could be result and time-based (i.e. 2 years to show acceptable growth levels), pre-set share prices (both higher and lower than the purchase price) or unexpected news.
How do you choose a biotech portfolio? The simplest way is to let somebody else make the choices by buying a mutual fund or an exchange traded fund. These funds are generally biased to large cap stocks and some of the health or healthcare funds will also include service companies. I am not aware of any funds which focus on public micro and small cap biotech companies.
The following investment strategies could be applicable to both junior mining and biotech companies.
- Invest in success: an experienced management team that has done it before will probably give a junior company, regardless of the sector, its best shot at success.
- Invest in later stage projects: Later stage projects presumably have a lower risk of failure.
- Invest in ‘hot areas’: hot areas in the resource sector could mean specific commodities, such as rare earth metals, or geographic areas adjacent to successful mines. Hot areas in biotech could be disease categories, such as orphan indications, or drug targets which have been validated by a drug approval or large partnering transaction.
- Invest in acquisition targets: the most probable fate of a successful junior resource or biotech company is to be acquired by a larger company. This is partially due to the nature of the larger companies, for which growth can more easily be achieved through acquisitions. It is also partially due to many investors focusing on short term gains and not on building companies. However, investors should be aware that companies generally need to have multiple bidders or commercialization options to get the best price.
- Bottom-fish: when investors ask why a stock is at a 52-week (or longer) low share price, the answers could include broad market conditions, low cash position, poor company or sector results, or just lack of interest in the company or sector. Investors also need to ask whether it is a real bottom or just a stop on the way down.
- Buy on momentum: if investors are not willing to try and pick the bottom, an alternative is to invest in sectors or companies where share prices are moving up from a bottom.
While I have used the term investing in many of the points above, I could also have used the term trading. The only real difference is the period over which the stock will likely be owned.
In the next post, I will discuss event-based trading, a strategy which takes into account the series of clinical and regulatory events which comprise a product’s pathway to commercialization.