Words on Investing in Healthcare

Tim Rocks

Hello and welcome to Words on Wealth. I’m Tim Rocks, Chief Investment Officer at Evans & Partners. And with me today, I have Dr. David Nyagam, ⁓ who is the head of our biotech and broader healthcare research team. ⁓ As a company, we’ve been thinking a lot more about how to invest in biotech and medtech, partly because we think it’s a good opportunity for Australian investors and it’s underappreciated how interesting these those Australian sectors are. We also want to think a lot about how we invest in them, how we put them in portfolios and how to think about these stocks. So Dr. David is going to help us on some of those things today. So welcome, very welcome, Dr. David. And thanks very much for your time.

David Nayagam
Tim, nice to be on the show.

Tim Rocks 
Now, let’s perhaps just start by talking about the Australian biotech and medtech kind of system. Do you want to give us a brief overview and maybe compare it to the US and sort of European equivalence?

David Nayagam
Yeah, that’s a good place to start. I think, I mean, Australia, you know, it’s pretty well understood that we punch above our weight scientifically. We have a lot of world-class translational research organizations here in Australia. We’ve got great institutions, universities, ⁓ basic sciences is performed at a very high level and there is good translation here. We’ve probably also heard here in Australia about the Valley of Death. And, you know, that obviously that capital ⁓ intensity that needs just required to bring some of these innovations through to the market. And really the small domestic healthcare market is in Australia not large enough to support the innovations in a commercial sense. So really the companies that are coming out of Australia need to have a global ambition from day one. And while the ASX can support companies once they’re listed, the early stage risk is still ⁓ quite significant here compared to the US where there’s more capital abundance and you see later IPO’s more angel investments at an earlier stage. And Europe, which I guess is a bit different again, you have a bit more grant heavy, a bit slower commercialization. So I think all in all, what we’re seeing here in Australia is a sector that’s not short on science, but it’s perhaps a little short on time, a little bit short on capital discipline and tolerance for the longer evidence cycles that are required and the patients that’s required to bring some of these technologies from the bench to the bedside.

Tim Rocks 
Okay, that’s really interesting. Okay, so the Australian companies tend to be earlier in their lifestyle, their life cycle. And so then how do you think about drivers of long term value then for these types of companies compared with maybe a more general company and, and perhaps a distinction between biotech and medtech from that perspective?

David Nayagam 
Yeah, I think the long-term value at the end of the day, and you’re right, there is a distinction between biotech and medtech. Biotech is obviously predominantly biology risk dominant, whereas medtech tends to be more around execution, reimbursement, adoption frameworks. ⁓ In biotech, as it comes down to it, it’s really about clinical data. ⁓ Clinical data is what matters, but not all data is equal. And so you have mechanistic validations of the drug, so it’s a drug and its efficacy incremental benefits. Obviously, ⁓ you need to have reproducibility, you need to have statistical significance. We talk about P values, that’s often the headline, but more than that, you need a regulatory pathway and you clarity around how to move from what is raw efficacy through to commercial reality. And that requires an understanding of reimbursement around competitive dynamics, around pricing. ⁓ And these are the things in the long-term that actually create value. ⁓ Underpinning all of that, of course, in biotech and medtech, for that matter, is safety. If you don’t have a safe product, ⁓ then you’ve really got nothing. That’s the number one, do no harm. ⁓ then value is then created at various inflection points as you work through that de-risking of those things that we just talked about. ⁓ And of course, in order to do that, you need to have cash. Cash buys you time, ⁓ time buys you data. And if you’re running out of time, then that’s gonna lead to a ⁓ dilutionary event. And of course, that’s a good way for ⁓ investors to lose money on biotech is if there’s too many dilutionary events from the time that they’ve invested to the time that it’s realizing the value ⁓ By contrast, med tech, I guess, isn’t so much about does it work? It’s usually at the point where when people are investing, it’s well understood. It’s more about will clinicians adopt it and will hospitals pay for it? And in that sense, Australia has really got some advantages. We’ve got some deep engineering. We’ve got really good clinical trial capability. And there’s probably a faster time to market versus drugs. ⁓ So that’s maybe a little bit of a contrast with biotech and medtech. And the real questions I think that people think about in medtech is, is there a clinical workflow problem? ⁓ Does it change behavior? Or is it just something that sounds interesting? ⁓ And who’s going to pay for it? And then ultimately, how do you scale it? So these are the things that I think people are looking at when they’re thinking about those investments.

Tim Rocks 
Yeah, yeah. And then as individual investors, when we’re investing some of these things, I think it’s very easy to fall in love with the narrative behind a stock that’s going to be a new cure for a particular type of cancer and the like. But I’m thinking about that’s probably a common mistake that people make that in many ways, lot of these, investing in these companies is a bit of a numbers game. You should be investing in 10 of them rather than one of them. Is that a big mistake that people make?

David Nayagam 
Yeah, think definitely there is, unless you have some very specific insights or knowledge about a particular opportunity, I think ⁓ it’s a risky area to take one-off shots. It’s definitely an area where portfolio theory and diversification can pay off and you can get some very good returns from doing that. I think, yeah, some of the mistakes that people make is treating some of these names and these companies as if they’re binary outcomes ⁓ rather than ⁓ actually probabilistically modeling the risk. mean, obviously there is an element of, there is a binary nature to some of these outcomes, but it’s not simply a toss of the coin. is ways to increase your probabilities of success and to model that correctly. to give yourself an edge, ⁓ you know, if you understand the underlying science, understand the regulatory path and what the regulators are looking for. And then of course, you know, you’ve got to make sure you don’t confuse things like, there’s a lot of buzzwords you’ll hear, first in class, best in class, but really what’s ultimately important is whether it’s statistically significant and it has clinical relevance ⁓ and whether it’s something that ⁓ you know, the doctors are going to end up using to treat their patients. At the end of the day, that’s what’s going to be important. ⁓ You know, think biotech losses don’t necessarily come from bad science. They come from a mismatch of science ⁓ and, sorry, a mismatch of expectations, you know, really they come from not understanding the risks and the journeys that you’re on.

Tim Rocks 
Yeah, yeah. And so in your research, how do you think about the biotech and medtech space?

David Nayagam 
Yep, so we basically try to take a combination approach. First of all, using the frameworks that I guess most analysts on the sell side and probably a lot on the buy side would use as well, which are the risk adjusted net present value models, we probability weight scenarios, we look at adoption curves, we look at peak sales, some of that is a bit of fantasy, but you have to start somewhere ⁓ We try to concentrate more on valuation ranges more than on point targets, because a lot of these companies, although we have to put a point target in our report, they’re a long way from revenue. And so I think that the assumptions that you make, the levers that you can pull can really create a lot ⁓ of spread in the potential outcomes in terms of evaluation. So I think that it’s more in some senses around the qualitative story. It’s about asking uncomfortable questions. What would make this fail? Who will use the drug? Who will lose if it works? And then speaking to KOLs is really what underpins a lot of what we do here. I guess I’ve been lucky to have had a couple of decades working with some really experienced and talented industry experts. I’ve had some great mentors some great colleagues, surgeons, scientists, engineers, clinicians, and I really listen a lot to them, to their advice. One of my mentors once told me, always listen to the clinicians because they know their patients. They’re usually pretty pragmatic. And at the end of the day, what we’re trying to create here at EMP in our franchise is a sort of a win-win-win sort of virtuous cycle that’s based on a patient-centric view. So if we have better patient outcomes and that’s really what we look for that underpins our research, then that leads of course to clinical uptake. Doctors will like it. Companies will profit. And then of course investors win. And that’s what we’re here for in our role is to make money for investors. So I think that that’s kind of how we see it and how we try to approach it. And we don’t always get it right. Sometimes I think like all analysts, we get it wrong, ⁓ still learning ⁓ You know, you can be overconfident sometimes in timelines. You can anchor a little bit too much sometimes to management guidance. That’s obviously an easy trap to fall into. ⁓ And you can underestimate, you know, reimbursement drag on new products that are approved. So there’s lots of things that you kind of learn through experience, but, you know, we’re trying to put all the pieces together as we get further into it.

Tim Rocks 
Yeah, yeah, no, that’s interesting. So when you look at the current suite of companies on the Aussie market, what do you think is worth watching?

David Nayagam
There’s a few themes, I guess, that have been emerging ⁓ over time, ⁓ certainly as we’ve been watching it in the last half a decade or so in this role. But there seems to be more of a shift from the science stories to execution stories. ⁓ We’re definitely seeing devices and diagnostics gaining favor versus some of the longer cycle therapeutics. There’s more and more evidence around the importance of real world ⁓ utilization. ⁓ Pragmatic trial designs are definitely becoming more interesting now. We’re seeing people working with regulators. We’ve obviously seen a lot of change going on in the US at the FDA level around regulation on trials and ⁓ people are trying to work with regulators to come up with different designs, adaptive designs. I think we’re seeing interest in companies with more near-term revenue visibility versus some of the longer-term phase sort of three programs that were popular when I first started in this role. ⁓ At least there was a couple of them when I first started. And there’s been a couple of fairly ⁓ well-publicized failures as well, which shifts people’s appetites. I think the market is kind of moving from, it purely interesting to how do we get paid for this? ⁓ And that certainly is echoing that theme around the med tech, as we talked about earlier, there’s that sort of shift towards minimally invasive procedures, things that have outpatient settings, things that can save hospitals money. ⁓ And again, there’s that trend really that if you can bring something out that it brings economic as well as clinical benefit, then you can certainly outperform in the med tech space. So that’s what we’re seeing a lot of companies shifting towards those propositions ⁓ in the last year or so.

Tim Rocks 
Yeah, yeah. And then so I guess the next question is, is when you’re looking at these companies, it’s easy to see the kind of the blue sky in terms of revenue. But I think your view is a better way to invest in these companies is think about sort the risk profile and how that’s changing. Is that right?

David Nayagam 
Yeah, mean, that’s, as we sort of alluded to at the start, that’s the way the value kind of increases in these companies. It’s not often a gradual increase, but it’s more like a step-wise increase as you meet catalysts. And milestones and catalysts are not necessarily the same thing, but as you take out the risk, ⁓ and the standard path for a biotech is just sort of your phase one, your phase two, your phase three. And at each of those phases, risk comes out and that increases the value. And it’s ⁓ sort of almost in quanta that you see that occur. ⁓ And I think that understanding the risks and understanding how to de-risk a company is really at the heart of investing in biotech and medtech. ⁓ But it’s understanding that scientific risk and investment risk are not necessarily the same thing. so, obviously you need good science, At end of the day, think if you have even modest science, but a clear economic framework and a clear path to market, then that will often trump some of the fanciest, newest, cutting edge science. ⁓ when you’re looking at it, often in the biotech world, you talk about the four risk model, which is the four risks being biology. Does the science make sense? it work? Does the mechanism work? ⁓ Execution, which is more about the company management. Can they run the trials? Can they manufacture? Can they source products as a supply chain? All of that sort of things. ⁓ Capital, of course, very important ⁓ as what we do here. Can they survive long enough? Can they raise capital? What is the source of capital for them? ⁓ And then competition and reimbursement. Will anyone pay for it? And ⁓ will it be able to be positioned accordingly in the market in the commercial sense. I actually have added a fifth ⁓ dot point to that, which is clinical uptake. ⁓ think that sort of fits in a little bit with competition to some extent and a little bit with execution, but also it requires biology and to some extent it requires capital. So it of, it kind of encompasses everything. And, that’s, think, ⁓ you know, I like to start there, you know, is that something that this is a drug or a device that doctors will want to use. if that’s, and again, it goes back to that advice from my mentor all those years ago, but is that something that will then drive the rest of the business forward? Because if there’s that pull from the clinical end, as much as there is a push from the company end and from the scientists and who are developing the drug or the device, but if there’s a pull from the clinicians, they say, we need this, we want this from our patients, then that really helps to catapult these things further forward. I think most investors, when they look at that for risk model, probably just focus on number one, does the biology make sense? I think probably more the professional investors and the institutional investors will focus very heavily on three and four, just can I have enough capital and do they have the reimbursement and strategy right? ⁓ And I think ⁓ ultimately, The people who really do well in this will focus on everything. ⁓ So I think that’s, yeah, does that help? Does that answer that question? ⁓

Tim Rocks 
Yeah, yeah, no, it does. think that’s interesting. actually it’s sort of related to the next question, which is always kind of intrigued me. Like if you look at the stock market behavior of biotech companies as a group over time, they’re famously just big, big boom, bust cycles. And I was wondering if you had a perspective of… Is that because there are waves of innovation or is it simply that there’s waves of, I don’t know, liquidity and speculation in markets?

David Nayagam
Yeah, definitely there’s times when big, large pharma, but large medtech, strategics have excess balance sheet capital ⁓ and that can drive ⁓ &A waves, which can then drive more investment in those areas. And so you do see that a lot of that’s driven by patent cycles. Some of it’s driven by new technologies. mean, we’re going through an interesting period right now with first of all, the GLP-1 drugs and also the AI contributing to really big cyclical themes that we’re seeing at the moment. I think there’s got to be a balance between that overfunding, which then creates complacency, as well as scarcity in the market, which then forces focus and forces some neat innovations. ⁓ Ultimately, think there are some, obviously the larger companies have written out many of these waves and the smaller companies, some of them will boom and some of them will bust depending on the cycles. But I think if you look at it just across time, if you try to pick out the common traits that survivors tend to share, it’d be things like focusing on narrow indications in the first instance rather than trying to everything to everyone you know, unless there’s a really good reason to do that where there’s a, when it’s a particular drug class, that’s because it’s very hot and you need to kind of scoop up as much of the value before other players do, you know, in which case maybe there is a need to go broadly more rapidly. But I think the other things that companies that do well tend to do correctly is to kill programs early. ⁓ You you’ve got to be willing to pose that killer experiment that, you know, the hypothesis that will kill your program and then kill it. If you’re not seeing the results that you need to see early on, don’t keep throwing, you know, ⁓ good money after bad. ⁓ It’s the sort of the sum cost fallacy that often gets some of these companies. You know, you need to play into strong regulatory strategies, you know, that again, we’re seeing a really interesting period right now both from the regulators and from payers, a lot of that’s driven by what’s going on in the United States, but being able to navigate those, at the moment, quite ⁓ uncertain times, that’s something that companies have to be able to be agile and be able to do that well. ⁓ So yeah, you can certainly learn a lot from the past, but I think we are entering some uncharted waters as well with the… emergence of some of these new blockbuster drug classes and of course AI which is changing a lot.

Tim Rocks 
Yeah, yeah. Yeah, it does feel like we’re an interesting spot because we appear to be ⁓ ending a shall we say very long winter for the biotech sector. and that’s early evidence of that has changed in terms of stock market behavior kind of in the last couple of months. But also, there are these these kind of factors that seem to suggest that we might be at a early phase of innovation with AI and some of these other drugs.

David Nayagam 
Yeah, there’s a bunch of sort of indexes that you can sort of look at for biotech, ⁓ you know, and there’s some that will sort of show you over time interest in the sector. And we’ve sort of been going through a period where that’s been the case. So I think it’s, we’ve been in an upward trend at the moment, which is nice, as you say, after a long, harsh nuclear winter. And there’s been some, you know, obviously some deals in the space with E &P has obviously been contributing to some of that activity as well ⁓ in recent times. And hopefully we’ll continue to help companies in the space and continue to, you know, drive the sector forward ⁓ from our vantage point here as well.

Tim Rocks 
Yeah, yeah. And so when you talk to CEOs and founders, what’s your advice to them?

David Nayagam 
Well, I mean, obviously try to not preach. They know their space very well. They know what they’re doing. So actually, I’m very much, you know, it’s a two way conversation. I’m trying to listen very carefully to them, trying to listen and learn. But also, you know, given that we have spoken to a lot of CEOs now and seen, you know, lot of companies and some that have gone well and others that haven’t gone as well, you know, it’s you can start to again pick out some of the trends. think that, you know, the one thing that I’ve noticed that a lot of the good CEOs tend to do is optimizing not for share price, but optimizing for option value. So optimizing for the ability to take a drug forward themselves as a company or to partner that drug and have it potentially execute a deal or even an acquisition. And that’s something that I think doesn’t necessarily bring short-term market gain and much stock price rewards, but it is something that drives longer-term value. so think CEOs that have that big picture focus rather than necessarily trying to just have short-term impacts on stock price, I think are the ones that tend to have the better outcomes. Of course, I think credibility is very important and this is a trust game for investors. ⁓ Our clients that we speak to are definitely looking at CEOs and trying to assess them, engage them on, can we trust you? Can we trust what your management team is going to bring in terms of the execution risk? And I think that credibility compounds ⁓ in the minds of investors a lot faster than excitement and buzzwords and catchphrases. So I think that there’s certainly an element to that in terms of good CEOs really under promise. They explain trade-offs well. They’re more transparent. They talk openly about uncertainty. I think these are all things that we can aspire to if we were ever going to be a biotech CEO.

Tim Rocks 
Right, yeah, well, good luck with that. ⁓ And so perhaps just finally, coming back to the excellent research that you’re kind of putting out. ⁓ So how should our kind of clients best use that and perhaps best use it in their investments?

David Nayagam 
Yeah, I mean, guess, thank you, first of all, we’re trying to put out research that really tackles, of course, the scientific and clinical aspects at a bit of depth, because that’s the background I suppose I bring to the table. Obviously, we need to bring the commercial elements to it too, and the financial elements, and we’ve got a good team, we’ve been building up the team. You know, Tom has been working very closely with us on the modeling aspect on the biotech franchise. Of course, Sasha leading the large cap healthcare and Paul working with Sasha on the largest names has been great additions to the team. And together we’re trying to build a franchise that really does ⁓ add value to the investors in terms of the research notes that we put out. But at the end of the day, the research is just a tool. It’s not a conclusion. We’re going to be wrong a lot. And biotech is definitely one which has got unexpected elements, both in the sense of, know, we are dealing with biology. So, you know, it is still very much unknowns that we’re dealing with, especially when you’re translating from animal models or cell culture models into humans. We’re dealing with real world people, you know, with demands from clinicians and patients, and of course, changing regulatory landscapes. There’s a lot of uncertainty that we’re dealing with, and so we will get it wrong. But we are trying to ⁓ use our research to understand assumptions and help investors to stress test their own views. ⁓ I think maybe often the risk sections of our notes can be very valuable. I think, as I said before, the qualitative feedback from clinicians and experts is probably certainly in the smaller cap space, more useful than the target price. And the recommendation, obviously, you’ve got to bring your own lens to it and see how it fits into your own risk tolerances and your own portfolio. As we said, it’s this portfolio game. You probably don’t want to just have one biotech name in your portfolio unless you have some real particular insights or understanding about that technology or the team or the competitive landscape that gives you an edge, I’d say use our research as a tool to help build a portfolio.

Tim Rocks 
Yeah, I think that’s very sound advice. We should end it there, but just ⁓ thank you very much, Dr. David. That’s really interesting stuff. I mean, as a group, we always look forward to your next notes and what you manage to find in the depths of the biotech universe. It’s always very interesting to read. So really appreciate your research and your time today.

David Nayagam 
Thanks very much Tim and thanks to E&P. It’s been a journey over the last few years. Everyone here has been so supportive of it. It’s a real team effort from research, sales, corporate access, the corporate advisory team, which everyone pulls together. it’s really nice place to work. Thanks very much for having me.

Tim Rocks 
Right, thanks and bye all.