Editor's note: Jim Gale is the founder and manager of the Life Sciences Opportunities private equity fund at LOF Partners, the life sciences investment arm of
Sanders Morris Harris Group
( SMHG). Gale invests in later-stage biotechnology companies.
He sat down for an interview with staff reporter Althea Chang on Jan. 12. Following are some of the highlights of their discussion. (Some of Gale's comments have been edited for length or style.)
TheStreet.com: What do you see for the biotech industry overall in the near future?
The problem right now for the biotech industry in general is that the molecules or the proteins that the industry's looking to try to get have some very ambitious indications and labels, and it's very difficult for some of these drugs to meet their
clinical trial endpoints.
In 2005 we saw one of the lowest levels of
drug approvals in recent history. And I think that's indicative of the fact that some of these indications that people are going for are very, very ambitious. When these drugs were put into the clinic, five to seven years ago, less was known about mechanism of action, what causes the disease and how the drug would interact inside the body. So as they've come through late-stage clinical trials, I think the lack of understanding of these disease processes are starting to show up and are becoming magnified. That's why we're seeing a lot of failures.
As a result, the public market seems to be quite skeptical about a lot of the press releases about interim development of these drugs because they've seen so many later-stage failures.
The market is being extraordinarily discriminating about what they're prepared to invest in. Unless we see some of the smaller guys, other than
( DNA), who's driving a lot of this market right now on the positive side, I think the biotech market is going to continue to tread water.
Of the public companies you're invested in, which do you think is the most promising?
In some respects,
a maker of needle-free drug delivery systems. If you could deliver a drug without sticking yourself with a needle, in other words through what's effectively a high-stream jet that goes through your skin, that would be favorable because a lot of people who self-medicate, insulin-users even, who've done it for a large part of their lives, still have a problem sticking themselves with needles. So needle-free devices on the surface would seem to make a lot of sense.
The stock was beaten down a little bit in the fourth quarter because
has a drug called Fuzeon, which is a very important HIV drug, and they applied to use the Bioject needle-free device in approval. The FDA came back and gave them an approvable letter, saying they needed to complete another trial before the agency would act.
I believe Roche is going to take this thing to completion. So while you have, let's say, a nine-month delay, it doesn't affect the ultimate fundamentals of what's happening. In the industry, there's a rate of adoption for needle-free devices. For a long time, people were very skeptical, but now you start to see a number of companies taking it on, so that one has a high degree of leverage if people are patient.
( QSC), has gone through a strategic change. With that one, it's hard to say whether management will be successful or not. A new management team that came in earlier last year, refocused the portfolio around
central nervous system diseases, building up the sales force and doing a much better job in promoting the existing product. If they can make an acquisition or in-license another CNS drug, the operating leverage, meaning the revenue and the gross profits, will drop almost directly to the bottom line. That could create quite a change in the earnings if they're successful.
Are there any public companies that you're considering investing in?
We've been watching the specialty-pharmaceuticals sector because valuations have been coming down. We were looking to see, opportunistically, whether there are some financial opportunities to get involved in there. I don't know that I would necessarily put out specific stock recommendations.
What kind of specialty pharmaceuticals?
Dermatology and gastroenterology. These are narrower fields, and there haven't been a lot of breakthrough technologies, so there's not a lot of risk of something that's going to displace these companies. They're doing things better with drug delivery.
There aren't a lot of undervalued situations that really drop out. The only reason I mention specialty pharmaceuticals is that there's been a decline in share price in some of these stocks recently, and they're starting to become more attractive.
Do you think most biotechs are overvalued?
The trouble with the biotechs is that it's very difficult to interpret whether they have anything or not. It's almost like betting. With these later-stage drugs, there are a lot of them, and it's difficult to get a sense of where they are, and if they're going to succeed or not, like in the cancer drugs.
The problem is that the cancer tumor in your phase II
clinical trial may react initially, but it may still spread and may be sprouting up all over the place so the drug itself isn't going to meet the primary endpoint. This is the problem right now with biotech when we talk about information flow. Phase II data are not indicative of what you're going to see in long-term product trials in time-to-progression and survival time.
The area of promise, I believe, is pharmacogenomics, which is identifying biomarkers or tests that predict the efficacy of a drug in a specific population. If we do that and we find those biomarkers, then I think we'll see smaller market sizes unfortunately, but you're going to get a better outcome in terms of R&D.
Why do you stay away from medical device companies?
For business reasons, because the rate of adoption is very slow. When Viagra was launched, it became a billion dollar drug overnight. Why? Because of unmet medical need. People wanted it. When you bring out another stent, there are already some entrenched players in that market. You may have an improved stent, but will doctors adopt that as quickly as a new drug? The answer is generally no.
What the life sciences industry likes is that you don't have to go thorough lengthy clinical trials, it's a shorter time to market usually. The problem with that is the rate of adoption is often times slow. Unless there's some compelling reason for doctors to spend the time to learn how to change their practice, they're going to adopt it slowly, which means you have a bigger sales force, your margins aren't as attractive as pharmaceuticals and so it takes a long time to plod along.
Do you think individual investors who are interested in biotech should focus on stocks, ETFs or sector funds?
I believe in portfolio theory. Peter Lynch used to say, invest in stocks in which you have personal involvement. I guess in applying that theory, if I was taking a migraine drug and it really significantly improved my condition, I'd be interested in shares of the company that produced it. The problem is, how do individuals know whether they're fairly valued or not? That's why I think buying an index or a sector fund
is better, but you have to pick carefully and find the right managers and look at their track records.
Your fund has an average rate of return per year of about 30%. What would you attribute that success to?
Luck in large part. The management teams we've been affiliated with have been very, very good and executed a plan. I think the skill part is that we invested with correct valuations. And with a good management team executing the business plan, the rest of it sort of took care of itself.
How do you identify commercial possibilities?
Generally you look at products, look at distinctive capabilities and make a commercial determination. You can call customers and ask, "What do you think of these guys in terms of responsiveness or quality?" We can look at FDA inspection reports, things of that sort besides looking at markets and intangible things. We look at various trends within the industry and say, where are the pockets of opportunity?