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Presentation to Duke in New York-Financial Markets and Institutions
Program
©2015 Harsha Murthy
Healthcare Investing, the Pharma/Biotech Industry and Some Other Observations
Along the Way(Oh, the Places You’ll Go!)
Harsha Murthy(Duke 1981)
March 19, 2015
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Introduction:• A Real Pleasure to Be with You• I Met Several of You at the Spring 2015
Semester Kickoff Reception on January 8, 2015 at BlackRock
• Third Time I Have Spoken to a Duke Financial Markets and Institutions Class
• Thank You to Professors George Tauchen and Emma Rasiel for Inviting Me to Speak with You
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Some Requests:• Let’s Have a Conversation Today• If You Don’t Understand Something
I’ve Said, Please Stop and Ask Me When the Question Occurs During Our Talk
• My Talk is Based on My Experiences; Your Experiences and Views May Be Different – That’s OK
• I Am Available After Class If You Want to Follow-up Later
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Questions To Get Us Started:
• How Many of You Know What Private Equity Is?• How Many of You Know What Venture Capital Is?• How Many of You Know What a Branded Drug Is?• How Many of You Know What a Generic Drug Is?• How Many of You Know What Pharma/Biotech Is?• How Many of You Know What Investment
Banking Is?• How Many of You Buy Prescription Drugs?• How Many of You Simply Want to Be Rich
Investment/PE Bankers Taking Drugs?
No, You Don’t Need to Answer That!
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Now, I Read Lots of Children’s Books
Lots of Simple But Powerful Lessons – How Do We Understand Ourselves and Our World?
I’ve Been Where You Are:Bright College Days-To Days Free of Strife
Note: With apologies to Tom Lehrer, Bright College Days (1959)
Soon We’ll Be Sliding Down the Razor Blade of Life!
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It Was Not That Long Ago When I Sat Where You Are
YOUR SPEAKER THEN:
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YOUR SPEAKERNOW:
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What We’ll Cover Today:I. Who I Am Through What I Have DoneII. What Are the Sectors of the Healthcare
Investment Business and Why Invest?III. Investment Cycles/Time HorizonIV. Pharma’s Longer Time HorizonV. Some General Points about the Healthcare
Industry and Healthcare InvestingVI. Some Thoughts about Learning and Career
PlanningVII. Recap/Questions and Answers
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I. Who I Am Through What I Have Done• Managing Partner, Consummate Capital LLC
• Founder and Managing Partner, Konanda Pharma Partners – pharma private equity fund
• Executive Vice President & Corporate Head– Business Development and Corporate Strategy, King Pharmaceuticals (NYSE S&P 500 specialty pharma company; acquired by Pfizer in 2011))
• Vice President – Administration and Business Strategy, Eyetech Pharmaceuticals (one of most successful biotechs in history; taken public in 2004; acquired by OSI Pharmaceuticals in 2005)
• Principal, kRoad Ventures – Alternative energy venture capital fund
• Managing Director, GE Capital - international equity and infrastructure group
• Board Service:• Chairman of Board and Director, Validus
Pharmaceuticals (CNS company)• Director, Fontus Pharmaceuticals (hospital care
company)• Director, MedDEV, Inc. (CNS biotech)• Director, Electrolux Corporation• Director, TenduTV Digital Media
• Guest Lecturer: Univ. Southern California Business School; Columbia Business School; Yale; Princeton, Harvard, University of Richmond
• Education – Duke, StanfordConfidential 1
010
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My Duke Experience – Then
• Not a Science Major – Poli Sci/Econ/English• A.B. Duke Scholar• Phi Beta Kappa• Managing Editor, Editorial Page Editor,
Columnist and Reporter at Duke Chronicle• 1981 Student Commencement Speaker• Singer and Officer in Duke Chorale• President of House CC Dormitory • Social Member of Kappa Alpha Fraternity
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My Duke “Life” - Now• Chair, Duke Library Board• Member, Innovation & Entrepreneurship
Task Force• Member, Duke Financial Partners (NY)• Active in Duke Alumni Association • Donor and Capital Campaign Leader• Back on Campus At Least 4 Times Per Year• Basketball Fan; Friend of Many “Dukies”
Just Because You Graduate Does Not Mean Your Active Connection to Duke Needs to
End
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II. What Are the Sectors of Healthcare Investing?
• Pharmaceuticals/Biotech – Drug Development and Marketing
• Medical Devices – e.g., implants, blood counters, etc.• Hospitals and Health Systems • Physician Practice Groups/Hospital-based Specialists• Ambulatory Surgery Center Chains• Healthcare Information Technology (IT)• Out-patient care in Nursing Homes and Hospices• Rehabilitation and Addiction Centers• Physical Therapy Centers and In-Home PT• Imaging Centers• Dental practice management• Insurance companies• Pharmacy Benefit Managers (“PBMs”) – e.g., Medco,
Caremark, Express Scripts• Overseas Markets
Healthcare is a Broad Category that Encompasses a Number of Different Activities, Services and Business Models
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Healthcare Is a Huge Part of Our Lives and Economy
• US National Healthcare Expenditure (defined as sum of public and private expenditures) grew to $2.9 trillion in 2013 or 17.4% of Gross Domestic Product and will be 19.3% of GDP by 2023
• Spending Growth is Average 5.7% Per Year through 2023
• Prescription Drug Spending Growing 5.4% Per Year for 2016-2019 and to 6.0 % Per Year for 2020-2023
Source: US Center for Medicare and Medicaid Services (2014)
The Healthcare Business is Truly a “Cradle to Grave” Enterprise that Affects Everyone
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US Healthcare Costs Per Capita(Both Public and Private) Are
Much Higher Than in Other Developed Countries
Source: World Health Organization/World Bank (2014)
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Why Invest in Healthcare?
• A worldwide “growth industry” – double-digit CAGR• Everyone wants a “piece of the large pie”• In the US, drug makers and innovators set prices • Average operating profit margins are high relative
to other industries (ranging from 42% at Pfizer to 5.6% for generic drug companies)
• “Intermediation”: The person who is the end user is NOT necessarily the payer who bears the cost of the product and judges quality– Not just in the US but worldwide– Consider consequences on market price transparency– Consider the same issue as it applies to financial
intermediaries in the capital markets (e.g., spreads, security)
Sources: Bain 2020 Report (2015); GlobalData/BBC Nov. 2014
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What is Fueling the Healthcare Investment Boom?
• Lots of cash on sidelines following 2008-2013 recession
• Equity markets are “frothy”• Debt remains cheap (low interest
rates) • Asset values are low- still cheaper
to buy than build• High Risk-High Return Game
Source: GlobalData/BBC Nov. 2014
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• Private equity with some venture capital advisory• “Legacy” branded products that still serve
important medical needs• Most pharma companies make their money from
fewer than five drugs but have portfolios of hundreds of drugs
• They do not actively manage their portfolios• My investments “milk” cashflow and brand equity• “Buy-build-and sell” model of private equity• Create value by building infrastructure
My Investing Focus:
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III. What is Investment Time Horizon? • What is the average holding
period for investments?– Average individual investor
holds mutual funds only 2 years*
– Stocks may appreciate 12% over 20 years, but average investor only realizes 4% (implication is that hold period is at least 1/3 or more lower)
– Institutional Investors: Long-term means “5-7 years”
– Volatility means shorter hold times
• Note: Finance theory traditionally suggests that the younger you are, the longer your time horizon and therefore you will hold longer and realize higher gains and mitigate risk
• What About You?19
*Source: Dalbar’s Quantitative Analysis of Investor Behavior (2005)
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Volatility/Time Horizon –Time Does Not Erase All Wounds
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• Over one year, there can be huge swings in gains and losses• Over five years, the variation is tighter but still gains and losses are present• Source: Barclays Asset Management (March 2010)
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IV. Longer Investment Time Horizon:The Pharma Industry Development Period
and Investment Cycle Takes 8-15 Years
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Investment Decisions Required All Along the Way
= $$$
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What are the Key Investment Decisions?
• TARGET: What disease state/clinical target to pursue?• DRUG CANDIDATE: Which drug candidate has the most promising mechanism of action?• WHERE: Will we spend the money to develop it in-house or acquire the rights from someone
else (e.g., University, NIH, etc.)• INTELLECTUAL PROPERTY: If something is promising, how do we protect the intellectual
property? Patent?• PRE-CLINICAL WORK: Who will do the pre-clinical (animal and other studies)?• CLINICAL TRIALS: If we find the right candidate and we get it accepted by the FDA under a
new investigational drug application (IND), how extensive will the clinical trials be?• COSTS OF TRIALS: How much do we have to pay physicians/investigators to be part of our
clinical study and how much will it cost us to make clinical supply of the drug?• KEY OPINION LEADERS: Which scientific advisors and “key opinion leaders” do we need to
back our drug?• PRICE NEGOTIATIONS: What price can we get for the product and how do we negotiate that
price with federal regulators? Will the price be different overseas? Which wholesalers will carry it and what’s their deal?
• MARKETING: What do we have to spend on the marketing campaign to get doctors to prescribe our product?
• SALES FORCE: Will we hire our own sales force or outsource?• SUPPLY: What do we need to spend to scale up manufacturing to meet the commercial
demand?• ANYTHING OR ANYONE ELSE: Do we have to do any post-approval marketing or safety
studies?
What If Something Goes Wrong and We Have to Start Over, or Worse,We Have to Kill the Program?
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Scientific and Regulatory Risk 1 in 10 drug candidates actually makes it through clinical trials
and FDA approval FDA approves fewer drugs because of safety concerns
Large Capital Outlays to Develop Drug The oft-cited number was $1 billion to develop in 2003 ($2 billion
in 2011 dollars) – Tufts Center for Study of Drug Development $59 million and a median cost that's $43 million. In 2011 dollars,
that's a $75 million average ($59 million in 2003 dollars) and a $55 million ($43 million in 2003 dollars) median. - Light and Warburton, BioSocieties (March 2011)
Patent Risk/Generic Competition Shortened time to capture monopoly profits (i.e., exclusivity)
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Long-Time Horizon from Initial Investment to Payday/Return- Uncertainty in DCF Valuation
Multiple Investment Decisions Over Time Coupled with Large and Multiple Risk Factors (high Beta)
What Makes Pharma/Biotech Investing Different?
Pharma Companies have Revenue-Generating Products on the Market (and Sales Teams) Whereas Biotechs are Usually Non-
Revenue, R&D-Focused Companies
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Biotechs:
“Convergence”
Traditional “Big Pharmas”:
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• Pharma companies need to change their business model – bloated commercial structures
• There needs to be a focus on “good science”- whether internally or externally produced
• How do we fund investment and innovation – either privately or publicly?
• Investors need to look for value, both underpriced assets and the new growth areas (e.g., new markets like Third World, Japan; generics, biosimilars, diagnostics, devices, personalized medicines, new therapeutic categories)
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Suggested Implications:
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So What Should We Do?Are We Lemmings?
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You Will Be Asked in Your Finance Career to Evaluate Risks and Trends – How Will You
Evaluate an Investment?
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V. Some General Points about the Pharma/Biotech Industry:
• Branded drugs are “new chemical entities” or older products that have definable characteristics of potency, safety, etc. and have gone through extensive testing (animal and human)– “The brand is a promise”
• Generic drugs are have the same active pharmaceutical ingredient as the branded reference drug but the variation in API can be 80-120% of the reference standard– Difference in effect and bioavailability
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Branded versus Generic Drugs
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This Year’s “Poster Child” is . . .
2014’s Expensive Pharmaceutical: Sovaldi for Hepatitis C Sold by Gilead Grossed $10.28 Billion in 2014 ($84,000 /Cost of Treatment)
Source: WSJ, March 10, 2015
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Sovaldi is Not the Most Expensive Prescription Drug
Harvoni is successor drug to Sovaldi – Nov. 2014
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Individual Dosage Costs Add Up Over Time with Chronic Disease
Source Date: June 2014
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The World’s Most Expensive Drugs
Source: Pharmaceutical Commerce and Fierce Biotech (2009)
Prescription Pharmaceuticals for Unmet
Medical Needs Remain Expensive
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So Why We Would Ever Use Branded Drugs?
• Because these drugs can be life-saving or life-sustaining
• Because some therapeutic conditions (such as CNS disorders, chronic conditions like heart and kidney disease) require specific formulations of API
• Because the brand delivers a safety or desirable side effect profile
• Because the brand makes a promise of quality, safety and reliability
• Because it is the price of innovation (?)
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Generic drugs cost less because: 1) Someone else has done the R&D and obtained the initial
regulatory approval; 2) They are commoditized (“low margin, high volume”); and3) The manufacturers allocate more of the purchase price
they receive to pharmacies; and 4) The business model is based on re-engineering, lowering
cost-of-goods and breaking patents Branded drugs are high margin products• Both branded and generic drugs can obtain approval to be
sold “OTC”- over the counter
Bottom Line: There is a place in the world for both branded and generic products.
There is also CONVERGENCE between branded and generic companies (i.e., virtually every branded company owns a generic entity and generic companies want brands)
The Trend toward Commoditization and Convergence
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2015 Healthcare Investing:
• At the January 2015 JPMorgan Healthcare Conference, all the Big Pharma CEOs talked about the “proper allocation of capital,” “tax inversion strategies,” big deals
• What does that mean?• Answer: Who do we acquire? How much do
we pay out in dividends or in stock repurchases?
• Why? No Real EPS GrowthBig Pharma Is Sitting on Piles of Cash But
Does Not Know Where or How to Deploy it in R&D
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Big Pharma - What We Will Continue to See in 2015:
• M&A Activity Will Increase Because Equity Markets are Frothy, Asset Values are Down and Cheaper to Buy than Build
• Pharma Companies Have Looked into the Abyss Off the Patent Cliff and Decided They Are Not Falling In
• High Dividend Payouts• R&D Expense Cutting Will Continue as
Wall Street Gives No Credit to Pipeline
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2015 Biotech – Some Things to Look For
• There Will Still Be A Cash Crunch for Start-Ups; Many Companies Will Die on the Vine for Lack of VC Funding
• Some Lucky Companies, Particularly in Acute Care Areas (Like Cancer and Hepatitis and Orphan Diseases, Will Be Bought Out at Huge Premiums
• “Outrageous” Valuations in the Billions• Mergers and Job Losses Due to Consolidations• Lots of Interest in Digital Health Tech(“Apps”)
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What We Did Not Get to Cover Today:
• “How a Drug Gets from Maker to Your Local Pharmacy”
• Supply Chain and Distribution• Biologics, Vaccines, etc.• Differences Between Discounted Cash Flow,
Monte Carlo Simulation and Other Valuations• Intellectual Property
Issues/Exclusivity/Monopoly• Public Health – Allocation between First
World and Third World
Source: Bureau of Economic Analysis Health Care Satellite Account (Blended Account)Note: Expenditures on nursing home and dental care are not included in health services spending by disease.
Circulatory conditions, such as heart attacks and high blood pressure, are the
largest category of spendingTotal expenditures in $ billions by disease category, 2010
Other
Pregnancy and childbirth
Dermatological
Infectious diseases
Mental illness
Digestive
Injury and poisoning
Genitourinary
Cancers and tumors
Nervous system
Endocrine
Respiratory
Musculoskeletal
Ill-defined conditions
Circulatory
$- $50 $100 $150 $200 $250
$70
$38
$38
$58
$79
$102
$110
$111
$116
$120
$126
$144
$170
$207
$234 Note: These are largely diseases of aging and affluence
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• We Are Growing Older (Even You!)• You in One Way or Another Will Pay For It• More and More Financial Resources
(Including at Investment and Commercial Banks and Investment Houses) Will Be Focused on Healthcare
• Privacy• Sustainability• Social and Industrial Policy – Innovation,
Health Care, etc.
Why Should We Care?
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VI. Learning and Career Planning:Why I Love My Job . . .
• Complexity• Science and
economics• Entrepreneurial• Innovative and
Creative• Team Building – Grow
and Exit• Outcomes and Focus
on People – “Doing Good”
• Smart People40Why I Hate My Job? 40
The Very Things that Make Our Jobs Fun Also Make Them Challenging!
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• Understand How Things “Work”- Learn the “nuts and bolts” of how your companies or clients actually make their money and get things done – The best advisors (including investment bankers) that I have worked with know how things operate
• Learn Basic Skills – How to Communicate Orally and in Writing
• How to Work as a Team with People –Both Leader and Follower
• Develop Judgment - How Do We Assess the Forces in an Industry?
• What is Your Individual Value Proposition/Brand?
People Are Going to Pay You for Your Mind and Leadership:How You Think, What You Can Produce and Make Happen
What Should We Learn?
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Frank Bruni’s New Book Has an Important Message:
• “Where You Go is Not Who You Will Be”• Even Though Bruni was Talking about
Colleges, Same Applies to Your First Job• What Makes You Successful is What You Do
With the Opportunities You Have and Make• Bruni’s Message: Use College to Diversify
and Try Different Things• Portfolio Theory: Just Like You Diversify Your
Investment Portfolio, Diversify Your Personal Portfolio of Skills, Experiences and People
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• Value Creation and Exchange: Someone is giving you something now and if you cannot give them something of equal work then you must compensate them for the risk
• Don’t get too hung up on spreadsheets• We shouldn’t “fall in love” with
financial engineering• “Models are only as good as their
assumptions”• Learn to ask the right questions
What is Finance?
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• People and Experiences Will Become More Important to You Over Time
• Don’t Take a Job JUST for the Money• Don’t See the World or Your Career in “Black
and White” – We Don’t Live in an “OR” World but in an “AND” World
• You are at a Great School that Allows You to Try and Pursue Many Things
• Make Your Fair Share of Mistakes and Failures• Remember Your Fellow Students and Alumni as
Great Resources – “We are Family” – A Network
Some Observations From an “Old Timer” (i.e., Yours Truly)
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“A River Runs Through It”:You Don’t Know Where Your Canoe is Going to End
Up When You Start Out
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VII. Recap: What We Talked About
Today: VALUE• How Do We Find Value in Industries
(in this case, pharma/biotech) over the Short-and Long Term? What is our Time Horizon?
• How Do We Find Value in What We Can Bring to the Table?
• How Do We Find Value in Our Educational and Professional Experience?
• What Values Do We Want To Project – As Individuals, as a School, as a Nation?
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(and, if you are lucky, some meaningful answers!)
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QUESTIONS?
