Even in a year where the S&P 500 gained over 30 percent, one of the hottest segments of the entire economy last year was the biotech industry, with the iShares NASDAQ Biotechnology Index ETF (IBB) gaining almost 70 percent in 2013. However, the first half of 2014 has seen a sharp pullback in biotech stocks that may indicate the start of a broader retreat, making it difficult for any investor to be sure what to make of the industry’s future.
Greg Simon is the CEO of Poliwogg, a crowdfunding site committed to funding early-stage health care companies. Prior to working at Poliwogg, he held senior positions in both houses of congress, acted as a strategy consultant to tech CEOs, and co-founded a patient advocacy non-profit.
Simon talked with Equities.com about how smarter approaches to investing can help guide our health care system to a better future.
EQ: What goes into a successful health care start-up? For a company at the very beginning of its life cycle, what are the most important elements for building long-term success? What are you looking for when you consider investing?
Greg Simon: Well, if I knew that, I’d be living on an island somewhere and I wouldn’t share it with the world. I don’t think there’s one formula for it.
We look for two things in companies we think we should offer for investment. The first thing is: has the company matured to the point where people would care about what they’re doing. It’s past the hypothetical phase, it’s past the rat-testing phase. You can say “we’re doing a trial to do this and if it works we’re going to treat that.”
So we look for maturity of an idea. A lot of early ideas have to get to a different level before people are going to invest millions of dollars, and there are early stage companies that cannot even use millions of dollars. They need thousands of dollars to get to the point where they’re real, so to speak.
The second thing we look at is harder to quantify, but it’s what we call investability. Is the management team prepared for what they’re trying to do? Is the amount of money that they need going to take them to a new milestone? Is the technology possible? Is it something that hasn’t already been tried and failed ten times? Is it feasible? And if it’s feasible, is there a market for it? Would it make a difference? If they’re just one more product to throw in the mix, if it’s not going to change health outcomes, you’re not going to get reimbursed and it’s not going to be a success.
So we look at maturity and investability. Is it ready for prime time and is the money we’re raising going to take it to another milestone?
Now, in terms of what makes for a great company, some people say it’s all about the team. Some people say it’s all about the science. Some people say it’s all about the addressable market. The fact of the matter is, there are some bad companies that get better management and survive. There are some great managers that have bad science and can’t do anything with it. There’s some great science that has bad managers and fails.
I wish I had a formula, but there really isn’t one. It’s a combination of things and the bottom line is: if you’ve seen one biotech company, you’ve seen one biotech company. It’s really hard to generalize from one to the next.
EQ: The market for small-cap biotech stocks often defies most traditional methods for fundamental and technical analysis as you have a lot of companies that don’t have marketable products, don’t have revenue, and have valuations that hinge entirely on uncertain results from clinical trials. What should investors be considering before investing in biotech companies? Is there an approach that can account for the uncertainties in the market?
Greg Simon: We like to look at it as a class and in terms of verticals. Our medical breakthrough index looks at 45 companies under $5 billion market cap that have a drug in a late-stage trial. Now, in that scenario, picking one of those companies would be a really difficult thing to do. But, if you bet on all 45…
One thing we know about those 45 companies is that a lot of them will fail, some of them will do middling, and some of them are going to blow the doors off. So, as a group, you’re going to have a lot of failures and a few big successes. And the big successes often make up for the losses.
If you knew in advance which clinical trial was going to work, they wouldn’t call it a clinical trial. The whole point about the trial part is that you don’t know what’s going to happen. So, investing through our indexes, people would be able to have the opportunity to make the best of the future of a given sector, whether it’s diabetes, cancer, Alzheimer’s, neural science, stem cells, genomics; the indexes give you a way to measure where you are today, here are the companies that are doing things right now, and then you can make a bet on the future depending on whether you want to go long or short.
And that is the simplest way to invest in the sector is to invest in the vertical knowing that some of those companies are going to be breakouts, some are going to fade away. But if you try to pick in advance which one’s which, you’d have to be really lucky. Being smart won’t do it.
EQ: There’s been a lot of focus on how the Affordable Care Act (ACA) should affect providers, insurers, and patients, but how do you see it changing the world of small private and public companies developing novel devices and treatments? Is this a segment that’s going to see any major shifts in the way they do business?
Greg Simon: The health market is now a 100 percent market. Because of the affordable care act, everyone’s in the same boat.
And the ACA does several things that would promote investing in health innovation. It penalizes hospitals for readmissions, so outcomes matter financially now. For a long time, outcomes did not matter financially, so we didn’t focus on that. We focused on how many people were in the beds. Now we have to focus on who those people are and why they’re there and if they come back for the same reason or a similar reason that they were in in the first place, you don’t get paid for that. So there’s a lot more interest in outcomes, which means a lot more interest in better therapies.
The second thing, one that the most people don’t even know about, is that the ACA reversed a presumption that we had for a long time about testing new therapies. A few years ago, if you wanted to try a new health technology or a new monitoring program for people who are at home with diabetes, the Centers for Medicare and Medicaid Services (CMS) would not let you get paid to do that because, to them, it was just going to be an increase in expenditure. The thinking had been “we have to assume that the costs are fixed and real and the benefits are hypothetical. So if, in the very beginning, we have to spend money before we know we’ll save money, we’re not going to do it.”
And so a lot of innovative products never got tested because people couldn’t afford to without CMS reimbursement. Now, in the ACA, they reverse this presumption. Now you can go to CMS and say “I have a technology that’s going to lower the incidence of people with diabetes going to the ER” and they will let you do a pilot and they will reimburse you for it while you’re gathering the data. This is a big, big difference. So there’s just a whole lot more economic incentives for people to invest in health innovation than there were before the ACA.
Greg Simon is the CEO of Poliwogg, a firm dedicated to finding innovative health care investments and connecting them to capital.
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