RTW: Investing across Healthcare - [Business Breakdowns, EP.184]
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Welcome back to Business Breakdowns. This is Matt Russell. And today we are covering one of the most impactful sectors in the world, yet one of the most unique sectors for investors. That is healthcare. My guests are Rod Wong, founder and CIO of RTW Investments, and Stephanie Sirota, Chief Business Officer of RTW Investments.

RTW was founded in 2009 and operates a sector-specific strategy in healthcare. And we talked through the evolution of their own model, which feels particularly important given how much it aligns with the healthcare investment process. So I thought it was particularly interesting to dive into how they approach this as investors, and it sheds a light on the broader industry. We

We cover the various phases of drug investments, the unique dynamics of founders and team building, and we get into some of the more philosophical discussions around regulation in the industry and how to factor in investing in these businesses that have very specific life cycles in terms of the revenue that they produce.

As you'll hear on the episode, I've always found the business models in healthcare to be so unique relative to traditional sectors. And Rod and Stephanie paint an excellent picture into the realities of investing in this space.

Please enjoy this breakdown on healthcare. Stephanie and Rod, very excited to have you here. Typically, we will break down an individual business on this show, but sometimes we like to zoom out and cover an asset class or a sector. And for your particular sector, healthcare, life sciences more broadly, I thought it was a perfect opportunity to do that.

And before we get into everything that makes it so unique for investors, I thought we could just sketch out who you are, a little bit about RTW, and how you fit into the overall equation there, making it what it is today. And then we can jump into the fun stuff about the sector as well. Thanks, Matt, for having us. We're a healthcare investment firm. We've been around 15 years. I've been a healthcare investor for about 20 years.

I have kind of the background that you'd expect these days of someone doing the job, got a medical degree, got a business degree, and then had a pretty linear career. I started in research and progressed from there. So that's my story. Steph? I actually thought I was going to be a journalist, and then I decided to be an investment banker because I thought you could actually have more impact on people if you could put money behind your ideas.

And when I first met Rod, I realized that he also wanted to have a career with impact or meaning, but then also ended up in finance. So we took very different paths to end up in the same place under the same roof. I like it. I often find that the journalist skill set actually has quite a bit of value in the research world in terms of willingness to dig, willingness to understand what's going on and get to the bottom of something versus just the surface level. Somebody actually has to pull that out.

I like the backgrounds. And like you said, they make for two interesting things coming together around a very interesting space and a very interesting sector. And I thought we could just start there. Healthcare is so unique, especially relative to traditional industries where you have a simple price times volume. These are long cycle, takes a lot of time to get these things out there. Maybe you could sketch out how you would describe healthcare.

investing in healthcare or how you even just approach it relative to other asset classes, which at least to me feel much more approachable. I think it is actually one of the most important things to start with that people don't think enough about. So healthcare is super unique.

The healthcare product lifecycle, and specifically drugs, is different because it has three phases, which are unique. The first phase is you have this decade-plus long period of time where there's no revenues at all. And that's very rare, especially for public companies. And at the same time, it's extraordinarily capital intensive. As you know, it takes a billion plus dollars to get a drug across the finish line. So that's number one.

Number two, you have this revenue phase, which people focus on a lot. That phase is a really strong phase versus other industries. It's not cyclical. You have relative pricing power. On average, it's easier to forecast. That's a very strong part of the product lifecycle. But then the third phase, which is also completely different from most all industries, is the revenues disappear very, very quickly off of a cliff.

So companies always have to reinvent themselves. Because of these unique attributes about our industry, it has a lot of implications. One is biotech is something that can really only exist in a very major way in America. And that's because we have the deepest public capital markets in the world. Really the only ones deep enough to fund that billion dollars for each drug.

The result is you also get tons and tons of tiny little public companies, hundreds of them. So it's really venture capital in the public markets. And that's a very, very unique thing. On the other end of the spectrum, you have these large multinational pharma companies. And if you actually study their history, because of what I described in terms of the life cycle of their products, it's very, very hard for these companies to actually stay on top.

Their long-term growth profiles actually aren't that great because they are constantly having to reinvent themselves. You do have some companies that have been around a very, very long time. The Merck's have been around for close to a century, but there are basically no founder-led giant companies and the growth is so-so. So I would say those are the key attributes that then make investing, doing our job in the industry so unique.

Another something that's unique about what Rod just said, that you have very few founder-led companies, is in tech, you have the profits accrue to the founder or the innovator. But actually, the ones who gain the most if a biotech company succeeds in doing what they're doing is the patient, is the end user.

We all may benefit from having Uber in our phone or having a smartphone full stop, but it's not the same thing. So there's an impact to society that is underappreciated. The point on the larger than life founders, which are so common to see in other sectors, is there something specific that's driving that? I'm curious what you would point to as the key reason that hasn't played out here.

I think it boils down to developing each drug is this superhuman endeavor that's like landing a spaceship on the moon. So at the end of the day, each founder, certainly of a startup, is usually just focused on one. If they have an incredible technology and an incredible team, maybe on trying to get two or three drugs across the finish line. And that's the extent of what they can do in their career.

And you have many, many, many teams trying to do that. And then the way the industry structure ends up working is at the end of the day, once you're getting close to that success, getting that drug to patients, it's much more efficient than to put that drug in the hands of one of these few large multinationals so that they can efficiently get that product to patients all around the world. It also doesn't make any sense.

to replicate a distribution system that exists for one product when a Pfizer or Merck could do it way faster and way more cost effectively. So that industry structure makes it that your giant companies will never be young or founder-led companies.

I think one key point, though, is that you're working for years to get proof of concept in the biotech world. Whereas in tech and other industries, you kind of know upfront, does this work or not? We sometimes talk about

where there's low barrier to entry, but high barrier to scale. And you can look at cosmetics where you can have a big product in cosmetics, but at a certain point, scaling from there is tougher. You sell to a L'Oreal, they have the distribution and you can take it to the next notch. Here, it's high barrier to entry and high barrier to scale. It's an even higher threshold and a higher hurdle, which makes it even more interesting. Getting to the point on the...

the investing framework, investing in this space, you brought up, you have these drugs where you won't see cash flows for 10 years. I can remember working with a colleague. I had an IPO I was working at at the time in a traditional sector. This was the Smidcap biotech analyst. And I looked at his model and I was thinking to myself, this feels like an option trade. It's 10 years out. So it's a completely different mindset. But at

But as an investor, when you're thinking about investing in different stages of these companies, you have a wide mandate. How much does that change with what's going on in the environment? Is it something where you can have a traditional approach to this at all times? Or do you have to be flexible depending on what's going on in the broader environment?

Now that we've laid out there to start what the different phases are, then when you think about the universal or timeless skills that you need to be a successful investor, it really just fits the phase. So if you're going to invest in development stage companies, your research needs to help you assign odds to success. If you're going to invest in the revenue phase, you need to be able to project the commercial opportunity, where the revenues are going to go and how long they're going to last.

And then because we've talked big picture about how costly it is and how long it takes, a key skill of investors to be able to navigate is to know how to navigate the capital markets and help companies access capital.

You need all of those things all together. But of course, investors can choose to focus on one phase more than others. Those with all of those skills can then different parts of the market cycle focused on the types of companies where there's the most opportunity. You see both specialization and you see people that surf to where the opportunity is.

Stephanie, before we started recording, we were talking about the size of the team and all the different people that you have inside the organization. I think there's a lot of scientific background to everyone working there. So it is very much involved in the specifics of what's going on here. Do you set up your fund in a way where you have specific teams focused on those specific stages of companies? Or how do you approach it from your own style where you can have a skill set in one specific area?

portion of the life cycle of a company or a drug or whatever it might be. It's certainly really important to think about how you want to structure your business to take advantage of the things that you do best. Rod, as RTW's founder, was really always in it for the science first and prioritized that piece of it. Our business evolved tremendously over the last dozen or 15 years

First of all, Rod talked about one component of good investing is also knowing how to navigate the capital markets. Well, if you are the investor, you also need to get investors of your own. We need to fund our business and we need a stable flow of capital and we need to manage those flows. So that was a very, very...

tough thing 10, 15 years ago when most smart institutional investors that we would go to didn't even invest in sector funds. Or if they did invest in a sector fund, it would be something like energy or maybe tech. But it certainly wasn't biotech. This was a sector rife with binary outcomes and it's human nature to avoid what you don't really understand.

So I think that there was a very important several years spent educating people. And I think that what RTW did really well, and that was in the early days, it was me and Rod on the road. I think something that was really important is that Rod delivers a lot of passion and a lot of incredibly deep knowledge and a terrific pedigree, but he's also a natural teacher and has low ego.

And when you combine all of that, that really resonated well. And that was the beginning of how people started to trust us. And they said, well, maybe what they're saying might be right. And maybe this is a pretty big opportunity. Maybe we should pay attention.

That is, I think, what got us to our start. Now, in the beginning, in the early days, we certainly couldn't have the team that we have 75 people around the world today who are subspecialized in different therapeutic areas, different modalities, but also in different functional areas. So we have bankers, lawyers, we have dealmakers, we have people that came from industries, we have company operators. We have a number of people who are very narrow and go very deep and then other more strategic people.

thinkers. And so it's a very collaborative business, but we've only gotten there because we're big enough to support all of these critical executive functioning roles. You can see why I like to work with Stephanie so much. She's the best at what she does. And of course, she makes me feel very good about myself. Good hype, man. The one thing I would add to that is the last

15 years since we've been in business, the industry has really evolved a ton. When we started out, you still really had people with generalist backgrounds as the portfolio managers for healthcare. It's evolved a lot since then. Now the dominant player is not just a portfolio manager with a specialist background.

but it's firms like ours, firms that were built, designed, structured, everything about it specifically for investing in healthcare. So you've seen capital flow to firms that look like ours that are really just designed to do what we do because of all these unique attributes. And that includes what Stephanie mentioned in terms of what our team looks like as well. We've

Now got, I think, north of two dozen people with terminal scientific degrees. And they're not just scientific athletes. They're people that subspecialize and have domain expertise on different scientific areas, as well as different functions, that when you put it all together, then gets you hopefully higher quality investment decisions. In terms of the mandate, the flexibility of being able to go into the private markets,

earlier stage. Was that always built into what you wanted to do? I wouldn't say that was the plan when we started. When we started, we were a hedge fund in the classic sense that we invested in publicly traded stocks.

We started reaching into the private markets really because we were compelled to. We would find exciting private opportunities. And we said, look, drugs don't care whether they're in a public vehicle or a private vehicle. And our investors were okay with that. And so we started reaching into the private markets. And what we've learned over time, as well as a handful of other firms that did the same thing that we did,

is that there's really a lot of benefits from being quote unquote full lifecycle or public private investors. And I'll just mention a couple of those things. One, getting comfortable with management teams is much easier to do when they're private than when they're public.

That's probably stating the obvious. Maybe a little bit less obvious is that once a company goes public, there's a lot of scientific data that you cannot access, that private investors can access. So from a research perspective, there's a big advantage. But interestingly, in our space, as you can imagine, companies, because they need all this capital, they go public very young at relatively low valuations.

And if they're going to be successful, 90% of it happens after they're a public company. So if you think about the combination of those two things, a lot of your comfort and research advantage happens or you can get when a company is private. But a lot of the reward for that work or learning comes when a company is public.

then when I describe it that way, the conclusion is obvious. There should be advantages to being a public-private investor. And you've seen a whole group of investors like ourselves where that's what they did. And as a group, it's been a successful strategy.

There's a common theme about being long-term oriented as an investor. Sometimes that just means owning something long-term. Here, I think it means something different, but I think you laid out the benefits of that and the reasoning very well. I am curious on the funding dynamics in this space. You articulated it well in terms of the realities, the required capital, and oftentimes the success coming after it's a public entity.

Going into the private markets, my understanding is you typically have some research being done. A lot of that can be government funded. Where does private capital start coming in? And is there an attractive point where you can come in as investors, potentially have an impact? But what stage would that actually be?

It's actually very, very early in the life cycle of companies. So if you think about government dollars, and it's very important, but it's important from a basic science perspective. So that's actually the mandate

of NIH grants is to fund basic science research. So once the project that you're working on is starting to look like it's a therapeutic, this is very, very early in preclinical research, the government is no longer the funding source. So if you think about the average journey of a medicine as taking roughly 15 years, half of that in the lab and then half in human clinical trials and registration, then

then it's really that first year.

Sometimes not even. Now, that's not to say super basic science research on a platform technology like the concept of antibodies before there are any antibody-based drugs, or more recently, the concept of using mRNA before there were any mRNA drugs. You do need the government to do that kind of work because there's no business model associated with some of these early platform technologies. But that's the extent of it.

It's also, I think, very helpful on our team to be able to parse through different modalities you might want to get in earlier or later. And it matters. And you need to know the reasons why you can predict something or the data that you have will lead you to a conclusion sooner.

earlier than a different disease area or a different modality. And just to put it in dollars and cents, now excluding again the importance of platform basic science research, if you look at any given drug like a lot of companies we've worked with, for the, let's call it average billion dollars it takes,

I would say the average company or program, somewhere between a few hundred thousand dollars and maybe $5 million of the billion might have come from the NIH. It's not a lot.

You mentioned that there can be certain modalities or things that you can identify as potentially being more opportunistic to come in at certain stages. Are there ones we can maybe use historical examples that would be simple to bring that to life? Examples where that's been the case where you think you've been able to identify there's been this opportunity and getting in there earlier made sense based on something you've identified?

Maybe Rod can tell you the story of one of our first actually gene therapy private investment we made in a company called Avexis. And we got in at the pre-IPO round. I think it was about a $500 million company at the time. They IPO'd in early 2016, which was a terrible year for biotech. The stock was under pressure. And because they had a lot of venture-backed investors, six months to the day that they went public, everyone sold.

You had those two things, heavy selling pressure plus terrible market. That stock was way underwater. And we only had preclinical data when we first got into it. It was only in animals, but we were pretty convinced that this was going to work in humans. And we kept adding to that position. And I think within two years, it was sold to...

Novartis for almost $9 billion, and they had an approved therapy. The Avexis story is part of this bigger story of one of the new modalities that hit the scene in the last decade or so, which is gene therapy. And this goes back a little bit over half a dozen years. When you first started seeing both industry-sponsored and academic gene therapy programs start to show some cool experiences,

experimental data, initially some of the most exciting, like the Avexis one, was in animals. One of these cool technologies that you have now in basic science or in early discovery work is you can create animal models of a particular disease by knocking the gene out that then causes the disease. That was the case in Avexis and this disease, spinal muscular atrophy, or SMA for short. So there are these pigs that have SMA

And when you have the disease, basically your muscles don't work. And it's like being a floppy baby is how human patients are described. So these pigs can't move around on their own. And then some folks at Nationwide Hospital in Ohio

dosed these SMA pigs with the gene therapy and you see these pigs completely recover. So they're running around. That was a huge light bulb moment for us for two reasons. One, it told us, hey, gene therapy might be enabled as a new modality where you can actually develop drugs from. And then two, of course, spinal muscular atrophy might be one of the first diseases to be transformed.

That turned into that great investment of Exus, which was not a linear road, as Stephanie described. There's lots of ups and downs, scary moments along the path from private to public. Ultimately, it was an incredible success. I remember when the first patient data was presented at a medical conference, we were there to hear it. It was one of the rare times where the entire audience, several thousand doctors, patients, just stood up and

and gave a standing ovation. It was tear-jerking. It was just an incredible moment to be a part of. Since that time, gene therapies continued to make progress. It's unleashed many companies, several successful therapies for horrible diseases.

And now gene therapy is going to be one of these modalities where you're going to get a steady stream of drugs from over the next 10, 20 years. If I were to isolate that example of the testing on pigs and seeing the reaction and say, was the key insight or opportunity, for lack of a better term, alpha there,

Just being in the room or being aware of the test and seeing that outcome, was it some type of insight that you had in the quality of that test, which might have driven you to have more conviction than others who are aware of that same test? Trying to isolate that, and obviously it doesn't prove anything. You're still making a probability-weighted forecast on it. But if I were to isolate the various things in that, could you pull out what you think is the key difference there?

Avexis is not the best example of that because this one is literally knock your socks off. So as long as you're there, when things are that transformational, you can do a lot of things poorly.

and things will still work out. And that was one of those examples. But honestly, most development in medicine is not like that. It has an extraordinarily high failure rate. The success rate is still single digit from when you start in man to the finish line. And part of the problem is that it's hard to know what things are, quote unquote, predictive of success. So part of our job or a key part of our job on the odds making part

is to know what things are predictive of future success. So that's one of the things that we're students of. There are certain types of experiments that translate nine times out of 10. And there's other results that translate one out of 100. And the key is that pattern recognition and institutional knowledge to know in which bucket you're in.

How often is it changing in the sense that there's either new predictive tests that either don't have a lot of data, but you might have data on or how much is it set in stone where once you know this is a predictive indicator, I can rely on that versus consistently looking for new ways to come up with predictive indicators?

It's constantly evolving. It's in a very interesting phase right now because we've had this explosion of innovation and explosion of new modalities. We just talked about one so far, which is gene therapy, but there's a huge long list.

RNA we're all aware of because of the COVID vaccine. There's cell therapy, things that some people are probably less aware of, like protein degraders and bispecifics and antibody drug conjugates and radiopharmaceuticals. So there's so many new modalities that we're seeing a lot of firsts. In those things, less mature technologies, it is a constant learning process, and sometimes we're learning by failing.

Now, if you were to ask me in small molecule drugs and antibodies and proteins how often that happens, there we have a lot of history.

And we kind of know what we know. And the new things are sometimes when you're developing a drug for the first time for a disease that's never had anything developed for it. So it's less about the technology, sometimes more about the disease. But with the new modalities, it's the Wild West again, which is both exciting and challenging. That level sets it a bit in terms of with each modality, perhaps there's new things introduced where you can start all over again with the predictive success.

I'm going to give the very basic understanding that I have of modalities over time. And you can correct me, but also then follow up with some description of the forward outlook. But I think back to 50s, 60s, this boom in antibiotics, 80s, 90s, you had biopharma, things like insulin, and then innovation slowed down at least for some period of time. And it really feels like all the things that you mentioned with

with gene therapy, RNA, there's this potential for a future explosion going forward. One, is that a fair characterization? And then two, if it's at least close enough to fair, what does that mean just in terms of the space and the opportunity set and regulatory dynamics of change? So sketching that out, it's a very broad question, but I would be curious your views on that. You nailed it. That's the way we describe it to people when we're trying to teach as well.

To give you a sense quantitatively of how that translates, the new modalities that we took through all hit the scene roughly around the same time in the last five to 10 years.

They've been maturing at different stages or rates, but they're all producing drugs now that are more than one a year. So for a very, very long time, you've averaged about 40 novel new drugs approved per year in the United States. And last year, you hit an all-time record, which was 61. Just under a quarter of those were from these new modalities.

You don't have to believe in science fiction or be a visionary to do the extrapolation just based on the drugs you see in development right now that look very promising to then make the forecast and say, okay, five to 10 years from now, that 60 per year should continue to break new records and hit probably 80 to 100 new drugs per year since you have so many more new modalities.

and an increasing proportion of those should be the new techs. So it could be up to half when we fast forward five to 10 years. So that's basically, I think, where we are. That means we are in the golden age of the discovery of new medicines because of all this that we've been talking about.

We recognized this several years ago, for sure, if not even more years ago. We made a very conscious decision in the early days. We were a small team. And I think a lot of investors like that. They thought, okay, you're not empire builders or gathering assets just for the sake of being bigger. And you're small and nimble. And that means that you can take advantage and exploit all of these small biotech companies. And then we decided that

If we really want to do this correctly, and if we want to do this for the long haul, we need to scale. And so I think if you look at RTW today, we're really this modern assembly line with all of these experts in different fields covering different modalities. But the coverage is...

is pretty thorough and it's pretty comprehensive. And you can't replicate that by having one ex-surgeon on a team of generalists. That's just not how we think about it. We try to be super methodical and cover everything in a really deep way, but also ensure that the right people are doing the right job. Everyone's going to bring that

particular skill set and that expertise, and then maybe hand it off to the next guy if we're having to negotiate a deal or convince someone about something or syndicate something. But all of that contributed to our vision of having a big enough firm that if we have a company that needs a large check, we can be there for that company and write that large check. In a very simplistic way, our view is to invest successfully in something,

How you invest or the structure of investment firms should in some way mirror what you're investing in. And our industry has evolved a lot. The decision we made a decade ago to become not just public investors, but public private investors is an example of that. It turned out to be a very good decision. And what Stephanie just described is a big bet that we've been making now, which is that with exploding innovation, you need a different structure.

and team, one that's larger, more sub-specialized, working together as a team, benefiting from everyone's expertise. If you looked at what you described as the potential opportunity for this explosion,

There are constraints. Maybe it's capital. Maybe it's the labor pool in terms of the people with the academic and scientific capabilities to help push these along, whether it's regulatory. Are there constraints that you think exist that really stand out? How would you balance those in terms of what could potentially slow down the explosion?

From the investment perspective, if you think about even some of the most successful hedge funds or investment firms that you're aware of, they tend to be of a certain type. Even large firms are made up of small teams where there's a lot of lone wolf behavior.

As simple as it sounds, one of the biggest challenge for investment firms is to say, hey, there's value in teamwork and teamwork of subspecialists. It's the opposite of how our industry historically has been structured. And we've been living through it because we've been trying to build exactly that. And I'll tell you, it is hard. So from an investment perspective, I think it's this human management challenge that

and I don't think everybody's going to be able to do it or want to do it. From the underlying company perspective, there's always talented entrepreneurs, leaders, managers that are extraordinary people. In technology, we know their names. As we were saying in our industry, it's structured totally differently. So you actually need hundreds of these people

And that's too many. Management talent is in short supply. And that is a challenge as you have exploding innovation. When you work with the businesses, when you make investments and they're at private stage, how much can you actually be assisting them in any type of operational thing? There's plenty of examples, perhaps more in the seed stage category of tech investments, where I think there can be an impact from investors helping them out.

Is that something that you feel like your team can also do, even if it's potentially helping with the fundraising things in the future? That is an element. Capital is required. But I'm just curious how much involvement you can have with the businesses as they go on their journeys.

There's value to having an in-house team that can support young companies across all the different functions that a startup would need. And we think there's value to having that institutional knowledge. You can move faster, you can move more efficiently.

And so that's what we have done. We do think that helps us so that when we see an opportunity, we can act fast. You don't have to wait until, let's say it takes you months to recruit a CEO for some opportunity. We can get it off the ground, get it running before we hand off the baton. So on the softer side of things, the team that I run is global. We have a few folks here in our New York headquarters. We have

a senior person that works in London and covers the UK, Europe, and the Middle East. And we have someone who's based in Singapore and Shanghai. Having boots on the ground and having the ability to deepen relationships and ties and having those ties to very senior government officials or decision makers across the landscape of companies, knowing what's happening can also really help contribute to

painting a picture of a geography and then identifying some of the gaps and some of the weaknesses and then stepping in and either helping companies or on a specific case-by-case basis. We actually have a listed fund that trades in London. There was a peer fund that their largest shareholder was an activist.

that seemed to want to be pushing for liquidation. This was like during the big biotech bear market a couple of years ago. We didn't want those assets to be liquidated. We owned a couple of those private positions and we were actually able to take in and basically absorb that business, which ended up being a win for all of those shareholders. We're also at a point in our own business that we can do very creative things, which is very cool.

So much of who we talked to on the show and my historical investment work is very much just oriented around the capital. And certainly when we talk to the private investors, there's a little bit more going on. But I think in this space, there is a lot more to be done. And the domain expertise looks so much different. I am curious abroad, how much the investing skill set in the US is

applies to investing abroad, how much difference there is, even just the opportunity set. And you clearly have a global team, but how much time you spend thinking about what's going on abroad. Obviously, there's some big businesses that have been growing very recently abroad in the public sphere. Specifically with biotech, the interesting thing about it is while there is exciting innovation outside of the States,

And I would say most importantly in broader Europe. And then China is obviously the newer but big kid on the block. Despite that innovation, the capital markets difference is so huge. It's so much deeper in the U.S. that this really is, from a public markets perspective, the U.S. industry. Now, that's not to say there are not exciting opportunities involved.

in Europe and Asia, and that's why we keep people there. But oftentimes, the most common opportunity is different. For example, we see a fair amount of opportunity in China right now, not to fund publicly traded companies or even private companies, although we do do that. But the biggest opportunity in China, we think, is to do partnerships with Chinese companies and bring assets into

Western or global businesses that will have access to capital that the Chinese company would have a very hard time getting. The innovation is there, the opportunities are different, and many things, no matter where they start, end up in America.

We can transition to talking a little bit about the market dynamics. And one theme is you still have biopharma companies showing this profitability growth, yet you have drug prices coming down. What would you point to just in terms of the dynamics driving that and what's behind it? How much of this is a secular change versus maybe just a cyclical move? If you look at the last decade,

The winners in pharma, it's a short list. It's Eli Lilly and Novo Nordisk. Lilly's up like tenfold, I think. Novo is a little bit less than that. Danish company, like sevenfold. After that, the next biggest winners are AbbVie and then Merck. Those were triples and doubles. And then the bulk of the other pharmas that you know well, like the Pfizer's, the Bristol-Myers, Novartis', Roche's, Sanofi's, have basically gone nowhere in the last decade.

Why is that? Well, the winners are obvious. It was obesity. And then there's also significant advances, big products in immunology and cancer that drove companies like Merck and AbbVie. Everyone else has suffered because of what we said at the beginning. There were product cycles that ended, patent expirations. The return on invested capital is low in our industry, and it's very hard to stay on top

even just to maintain where you are when you're losing huge products, much less grow. So that's the constant challenge that the large companies are in. This, I always find an interesting step. Look at Lilly and Novo. They're the most successful biopharma companies in the history of the industry. They combined have created now roughly a trillion in value because they are transforming the biggest health problem in Western society, which is obesity.

And for tackling that challenge, it's a trillion dollars in market value that's been created.

That is still less than things like Facebook, Google. It's like a third of a Microsoft. And by the way, it's temporary. So in 15 years, when the patents expire on Ozempic, it's going back to zero. That's the challenge that our industry faces. And I guarantee you, Facebook was there a decade before they cracked obesity, will probably be there a decade after obesity has gone generic.

Microsoft has sat on top and continued to grow for decades. Microsoft Word, PowerPoint, Excel, they're the same products that I remember using when I was a kid. Effectively, a little better, but basically the same. That's the challenge that our industry faces, the large companies. The tailwinds are innovation, which we've talked a ton about. The new headwind was the passage of the IRA last year, which basically shortened that revenue part that we talked about.

That's fixed. It shortened it for certain types of drugs, small molecules for diseases of the elderly because it impacted Medicare now have an even shorter duration before they're basically facing severe price cuts. That 15 years you laid out, it sounds like it's going to differ based on the type of drug that it is. But is that the right rule of thumb? What I'm picturing is you basically have a 15 year DCF that you have to include in the model. That's exactly right.

So the average, I think, by industry reports is 14 years. I round up to 15.

And then the IRA for small molecule drugs that are used by the elderly, it's now nine years. So it's challenging. A lot of the great companies are built off of products that last a lot longer than that. Some of these macro conditions, plus the headwinds that you laid out, really left us with this gaping hole of not enough capital to fill. So after 2020, the COVID trade

Right.

with rising rates and inflation and everything that happened in the last couple of years was not helpful for our sector. So the sector, I think at its peak, there were maybe 35, 37% of the companies trading at a below $10 billion market cap were trading at

zero enterprise value. That number is much lower, but it's still higher than historical average number. So we're in a point now where I think money is starting to float back to the space. It's starting to recognize that this innovation story is not going away. There have finally been some realizations where people have been able to exit and there's this building war chest from the Lilly Inovo that's going to be recycled back into the space. So

We're in a recovery phase right now, but I think that we're going to have a pretty powerful run ahead of us.

When I hear about the shortage of time for something like that, it's obvious the reasons in terms of you don't want to see price gouging when competition, particularly for those types of drugs. At the same time, you start to question the incentives to then create drugs like that. Do you see it stifling innovation in any way? It seems from the very high level that could be the outcome of something like that. But does that actually result or drive a difference in terms of where...

time is spent, where dollars are allocated? There's no question that it does. For example, the IRA law change that we talked about, for investment firms like ours, most firms have shifted dollars away from oncology and specifically small molecules because of the law.

Why would you invest in that when you can invest in something else that has a longer duration of revenues? When you think about the difference in five years at the tail of the product, that can be half of the NPV value of that asset. And specifically in cancer, there's extra challenges that cancer, if you think about it, they're typically introduced at the end of

as salvage therapy. And then after a product is approved, then you run the very long expensive trials to then move it up to frontline therapy where it might be most valuable for patients. But if you have nine years and clinical trials take years to conduct, you don't make those investments because they don't make sense. And that is absolutely what is happening in the industry.

It's a tragedy for society, of course, because who wouldn't want a pill to treat cancer? From an investor's perspective, fortunately, there's a lot of innovation across other technologies that are not affected by the law, and there's innovation across diseases. And so there's plenty of work to do, as Stephanie was talking about. The boom in innovation is real. So as investors, we have good opportunities and a job to do, but we are making choices because of those changes.

One of the best historical examples is for a whole bunch of reasons, which we don't have to get into, but the way drugs are paid in hospitals and things like that. Antibiotics, they're not paid for, basically. You can't get pricing power.

for them. And we've seen what the result is in the last two decades. There are no new antibiotics. So if you ever have a resistant, highly contagious strain of bacteria that's deadly, we're in a world of trouble. Financial incentives matter. Of course they matter. Our industry is no different from any other.

to attract investment dollars, especially with 10% success rates and billion dollar costs, you have to make it financially worthwhile.

I was going to make that same example, and I think that's really the tragedy. The tragedy is that the narrative that's being dealt to people is no one's going to price gouge on your cancer drug, but we don't actually know how many potential great small molecules are not going to be developed now because of this. That's the tragedy. My mind immediately goes to what is the right structure and alignment, but that would take up quite a bit of time, but I think you laid that out nicely. When

When you're looking at public businesses, is there such thing as a company with an undervalued drug? How would you go about finding that? What would make it undervalued by the market that you could then see a change and it reflected in the actual value? The way we kind of think about it is at any stage of a company's life cycle, there is upcoming events. Some may be very binary, like control readout. Some may be less binary, but still very

There's scenarios like whether a drug sells X or Y. And at each step, there's a risk reward around the next couple of steps. And there's odds. So our job is basically to calculate those things and to find points along that journey where it's the most attractive from an investment perspective. Quantitatively, that's how your healthcare investors should think of it.

If you look at our most successful investments over the life of the firm, you take away a slightly different conclusion, which is that the most successful financial investments are

are the ones where you're there early, you discover a breakthrough medicine early, like the Vexus example, right after we saw the pig data, we were there. And then you are with that journey through ups and downs, maybe at different sizes along the points to manage the downside risk. But you're there through multiple steps until that's a medicine that's in patient's hands and transforming their lives and generating a financial return.

That's what has driven our business at the end of the day long term. But it is the string of all those individual steps and investment decisions to make sure that we also are delivering what we're responsible for, which is a reasonable financial profile for our investors.

On the drug side of the equation, if we go back in time, I can remember distinctly, I want to say it was the 2015-16 timeframe when Valiant was the name. And I can remember being in conversations where if you were a fund and you didn't own Valiant, you were underperforming and those that were massively outperforming, it was such a big piece of it. And a big piece of that story was the drug acquisition and the price changes. There was a lot more to it. So I'm oversimplifying here.

But I am curious, it seems like there was an obvious fallout after that. Is that what has driven some of the regulatory changes? And what have been some of the other dynamics that have played out since that collapse and everything happened with Valiant? Our industry has a terrible PR problem. Number one, because we have that revenue phase where it does look better than other industries and everyone ignores it.

the other two phases, the beginning and the end that are so much worse than other industries. And all the failures. No one cares about those or hears about them. So when you focus just on that revenue phase, it's a tough PR thing when people start coming at you.

There's a very real reality that's a major problem in the United States specifically, which is out-of-pocket costs for drugs when you go to fill your script at the pharmacy counter are far too high. And by the way, it wasn't always that way. 30 years ago, it wasn't that way at all. The point of this is not, again, a deep conversation about industry structure and what caused this, but in very, very brief history lesson...

What happened was healthcare costs rise like everything else rise. 80% of healthcare costs are actually not driven by drugs. It's driven by hospitals, which are very expensive, and services, all the professionals that we rely on. And those are actually 80% of the cost in healthcare. And they've been rising pretty quickly over time.

And it got to the point where people are like, my insurance is too expensive. And insurance companies responded in the following way. They found that the easiest way to bend the cost curve was to focus on drugs because it's something that you have to do every month. And many drugs, if you don't fill your script, bad things don't happen that day or that month versus it's very hard to disincentivize a person to go to the hospital when they get hit by a car.

So that's what they did. They started making co-pays and out-of-pot costs at the pharmacy counter higher, and they started bending the cost curve. There are ramifications of that, which was, you can be a conspiracy theorist, maybe it's good for the insurance companies. But regardless, what happened was then people's anger is directed towards the drug companies, when really you could argue that, hey, insurance is no longer fulfilling the role that it was intended to fulfill.

And that's only, frankly, gotten worse with time. Obamacare, part of that law was that it put a cap on the profits that insurance companies can get. It's very well intended. But what ended up happening was then insurance companies started being the consolidators of everything else because they're like, then how can we generate profits and growth? Well, let's buy the hospitals and let's buy doctor's practices and let's buy the PBMs.

So that's what's been happening. There's been a consolidation of many components of the healthcare ecosystem, everything but the drug companies, which they can't buy. So now it's become an us versus them thing. Insurance companies have a very powerful way to direct anger towards drug companies, again,

via out-of-pocket costs at the pharmacy counter. So that's the state of affairs in the US healthcare system, which largely does not exist in other healthcare systems. To me, that is the biggest problem that we need to fix. Because if you were to ask me, where are you seeing some of the most tremendous advances that are making a difference, extending people's lives, et cetera, et cetera, that's coming from the drug industry.

We shouldn't be disincentivizing the most value-adding part of the ecosystem that's only 20% of the cost. Let me take a different angle on that question. How did we survive that time? So you said everybody was invested, and if you weren't, then you were underwater. We were not invested in Valiant. In fact, we were short for a good portion of that while it was going up.

I think we both got into a number of very heated discussions with investors who were sitting across the table. RTW during that time was about a tenth of the size that we are today. So we had no business going head to head with all of these people that had way more experience telling us that we were wrong.

we stuck to our belief on that and a load of other things. And that has been something very consistently throughout our business. Sometimes it's painful and it takes a while for the right to catch up with you. But in the end, it always does. The one thing I'll say about Valant is obviously it was more negative PR for our industry, but I think it's

Really especially sad because if you think about what Valiant was, it was the opposite of our industry, but somehow it's lumped in with our industry. It was started by a consultant whose concept was to not do discovery because science doesn't pay.

basically just take existing drugs and use a tax arbitrage and reduce costs. That was the business model of Valiant. It's literally the exact opposite of the stated mission of our entire industry. That's the very sad part about Valiant. It was the anti-biopharma. It's like Darth Vader, but we're

We're glad it's gone because it was truly a horrible thing. But we live to fight new battles. Before I asked, I was wondering if that was a sore point for you. I did not know the actual dynamics of being short. So it said something. We had LPs say, hey, our famous generalists are making money hand over fist going Long Valley. You guys are the health care experts. Why are you losing money on a health care name? Those were interesting times.

This is coming from me, my opinion. It was the most unbearable owner base of any stock in the history. That was an interesting one. And to your point, sad and kind of interesting in terms of the system creating something like that. And when you don't have the incentives aligned, you can make the case for, well, the R&D and the science doesn't pay. That's sometimes what can be the end result. I think you brought up a very interesting point, though, just in terms of when you think about a value chain and...

And where value is captured, you have your customer base, you have your supplier bases, but insurance versus the person actually coming up with the science or the business actually coming up with the science, getting their fair share seems reasonable. So it's a very interesting way to frame it and something that we could talk about for a very long period of time. The only other thing that I would ask that was somewhat related to value, we'll remove them from the conversation going forward, is just the M&A cycles or M&A activity in this space.

How common is it? How much does that play into your thesis when you're thinking about some of the earlier stage businesses and where they'll actually go over time? And just investing around that, the potential for M&A, both from a buyer perspective and from a seller perspective.

M&A is actually critical. It's actually built into the way the ecosystem is structured. It's necessary for success. We're a less concentrated industry, even at the top, than other industries. There are two dozen

global biopharma companies. Whereas in other industries like search or phones, there might be two players, sometimes one player. So we're actually already fragmented at the top. But as we talked about, it doesn't make any sense to replicate distribution. These large companies cannot fill their own pipelines themselves. There are limitations to how many projects large companies can take on.

So when these products go off patent, they have to replace them. And the natural way to do that is to do M&A. And for the small companies, it's the natural way to access distribution is also to be sold. It works very, very well in contrast to the insurance situation, which we talked about, which has some major misalignment issues.

This is very, very well aligned. So it brings up another policy issue that's very interesting because it is a period of time where people are saying, oh, we want to stop large pharma companies from buying small biotech companies because it suppresses competition. And we're like,

No, that's wrong. Actually, the exact opposite thing will happen because if you don't allow M&A of smaller biotech companies happen, a lot of bad things happen. Drugs get to patients slower. That's number one, most important. Two, you're going to have a thousand sales reps calling on the same doctor. That's an industry structure that is

societally completely inefficient and totally annoying. And then the investors involved don't have exits and then can't actually recycle the dollars to fund more innovation. That part we're very happy with. The key thing is we don't want to screw it up. But M&A is cyclical in nature. The big buyers...

strategically. They don't act because the sector is under pressure. So the smaller companies are cheap. They don't really care. I mean, maybe they do on some level, but not really. It's not really big picture. It has to be part of the plan. This is a super interesting conversation because it's actually a lot more philosophical to put the investor hat back on and maybe more the thrust to your question. We are actually entering the beginnings of a period of a lot of patent expirations for the large companies. So you should see more M&A and

and you're starting to because of that. So it is an M&A cycle, which tends to be bullish for the small companies. I was actually going to ask if there tends to be a correlation between patent expiries and M&A, which is interesting to your point on industry structure. Just in terms of the...

innovation that's happening with inside a business and the science that's happening versus just the operational side of things, managing risks, managing the business itself, the science and the business can be very different. It's like any business where the traders are very different than the people running the bank. And you can have these things that are the real driver and the real value, but without the right infrastructure around it, it could go poorly. How much is operational execution different?

playing into the value of these businesses separate from the scientific discoveries. We talked about how it's hard to find enough great leaders and managers and that applies to full teams.

By the time you get to the point where you're filing for the approval of drug, those files are many tens of thousands of pages long. And that's the most efficient summary of all of the work that went into in the couple of decades that preceded that achievement. You absolutely need to build teams. It's way more true on the company side than it is on the investing side. How much people are subspecialized, how each individual thing, like some of that sounds tiny,

assay development for a product to be released from a manufacturing line. That's a whole team's job. And there are people that spend a career just developing that expertise. So you need people that know how to build and manage teams of all these super uber subspecialists. When you kind of take a big step back, it's amazing that it ever happens at all. So we have a lot of respect for the people that do it and make it look easy.

I know we've gotten so far into the conversation. We've talked around GLP-1, but I haven't asked directly. Just in terms of the impact on the market, we're hearing restaurants and the food industry actually seeing declines. And you could opine on that and how much of an impact it'll have outside of your space. But to start just on the sector as a whole, the story itself, if you play just that,

it seems like it's continuing to grow. Are there second order effects that you think about as it relates to this, whether it could actually have an impact negatively on other areas of the industry?

The number one killer in the United States is still cardiovascular disease. All the early studies we've seen so far from the glyphs say you're going to get 20% to 30% benefit. So it's going to have the biggest impact on life expectancy of Americans in a very long time. That's the top line result. It's going to take time to get there. If you look at where we are today, we're plus or minus 10 million Americans.

out of over 100 million who are overweight, plus diabetics, another 20 plus million. Insurance companies are doing everything they can to slow the adoption curve. Reimbursement for obesity is still very spotty. So it's gonna take a decade, probably really until the first products go generic,

before you get to penetration levels with other mature categories. If you look at blood pressure or high cholesterol, if you have that issue, it approaches two-thirds of patients with the condition being on the right medicines. So that's where we're headed from single digit to maybe two-thirds. You could even make a theoretical argument to say it ultimately should be higher for obesity because

It's not just a number. People feel better, they look better. So there's a lot of consumer aspects to it that have nothing to do with the fact that's reducing your risk of heart attacks and strokes and other things by 30%.

It is going to be transformational, but it's going to take time. I remember that Walmart earnings call comment that freaked people out when they said people were buying less. I think what they meant was the people who are on it, the point whatever percent of people on the drug were reducing their spending by X percent. So if you apply that at population level before it's going to hit Walmart earnings, or frankly,

the things that would be most hit, diabetes companies' earnings, it's going to take a very long time. What I like to tell people is you should be a lot more worried about whether we're going into a recession or not

whether China is going to go into a recession or not or recover, those things matter a lot more over the next six months, one year, five years than what happens to glips. Glips will matter a lot in 20 years. It's not going to cause the recession in the next one, three or five years. No. And with people living and having a better quality of life while they are alive, it's

that's probably gonna promote more spending in other areas, in other industries. They'll buy more clothes, they'll do more sporting activities, they'll go on holiday more.

solve the population crisis. There's all types of impacts that could happen. This has been a fascinating conversation. I think I could go for another 90 minutes, two hours. We have different tangents that we could go on. But it's been just an incredible breakdown of the sector, your investment process. Just to close out, as you look today, it's September of 2024. When you think about the environment that we're in, how do you think about

how your time is allocated to everything that we just described. Is there something that you think is most interesting and you're spending the majority of your time on or something that you would point to that stands out above the rest?

Biotech has actually been in a bear market for the last three years. So it's the first time we've probably gone this long on a conversation before saying that. But that's very, very important to know. A lot of reasons for it we don't have to get into. But as a result, things are cheap in our space. Obviously, we believe innovation is booming. The combination of those two things should mean that there's plenty of opportunity and we see it.

So we are very active. We're excited. We're doing a lot of cool stuff. Our sector may finally be shifting from a headwind situation to hopefully a tailwind situation. And so from a short-term tactical basis as well for people looking to get into the space, it's probably a very good time to consider that.

A hundred percent. Being invested in biotech can be really stomach churning for those without a strong constitution. I think we are probably set up for, I think one of the brightest futures. I've been here for 12 years. I cannot wait. I just jump out of bed every day. I'm so excited for what the rest of this year is going to bring, for what next year is going to bring and what the next five, 10 years are going to bring.

This has been excellent. You have me excited on a few fronts, a few modalities, developments, and a lot of philosophical thinking for me to do just in terms of incentives and alignment and all the various parties that are involved in this value chain. There's so much to talk about here. Thank you very much, Rod. Thank you very much, Stephanie. Appreciate you joining us. Thanks a lot. Thanks for having us.

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