Understanding Biopharms: Bullworthy Sits Down with Tom Chesterman of Bionovo, Inc.

I’ve introduced many small strategies and tips throughout all of my Bullworthy articles, but I have to say the most relevant advice I’ve offered first-time investors to date has to be “know your company”. Essentially, what that means is to ask questions about what a company does and then decide whether or not you (a) understand it, and (b) want to invest in it.

Apple makes personal computers and mobile communications devices that are on the leading edge of invasive technology. Valero Energy is a major oil refining and marketing group that drills, processes, and sells gas to drivers all around the continent. And Coach makes, well, purses.

But there are many companies who operate in complex, obscure, and hard-to-understand industries that could potentially make shareholders very rich in the long-term…if that shareholder was able to understand what the hell is going on behind the scenes. This article’s case-in-point: biopharmaceuticals and drug development companies are difficult to understand, so I brought in some help to explain it all to us first-time investors.

Biopharmaceutical companies come in all shapes and sizes since gaining massive investor appeal in the 1980s when scientists and doctors began to discover that medical drugs could be produced by deriving proteins and synthesized DNA from other sources rather than a purely biological source. The first of such drugs was a blockbuster hit – biosynthetic insulin called Humulin, developed by a drug development company called Genentech and licensed to Eli Lilly, one of the largest drug manufacturers in the world. If you were a shareholder early enough in Genentech, I promise you were rewarded handsomely for your loyalty.

In 1985, the first year of sales for Genentech, the company logged $5.2 million in revenue. In 1986, the company logged an astounding $43.6 million and from there, forget about it. Check out this timeline:

What about the stock price? That record is quite impressive too, in fact, climbing from $15.00 a share in 1988 to over $90.00 in ten years time – a six-fold increase by 1999. Another interesting point is the way in which the stock price of a biopharmaceutical or drug development company reacts to macroeconomic movements or turbulence. During the financial crisis of September 2008, the company’s stock price was off only 11% or so, from an average of $90.00 a share to $80.00 a share during those panicked months. Compare those minimal losses with massive worldwide stock market average declines of 60-70% until the bottom of the Dow Jones Industrial Average Index finally brought the American economy to its bitter lows in March 2009.

I suspect the reason has to do with the nature of the business. These companies produce products, drugs to be exact, that save people’s lives. The biggest hurdles for these drug developers are actually quite simple to understand: investable capital to pay for expensive drug trials and overhead operations and landing Federal Drug Administration approval and clearance. Its how the drugs actually work that’s intensely confusing (eager to understand it all? Be prepared to enroll in medical school then – that’s about the only way to truly comprehend everything you’ll need to know to be an expert on any given biopharm company). If these companies can gain that FDA approval, then the next step is to land a partnership with a drug manufacturer because companies like Genentech and Bionovo are not in the business of actually marketing and selling the drugs; they simply discover the benefits and sell the rights to the discovery, profiting tremendously off the back-end sales.

Unfortunately for individual retail investors like you and I (not to mention first-time investors with little in any experience in researching these companies) biopharm and drug development companies are much, much more complicated to analyze in terms of share price valuation.

So let’s keep it simple for this articles sake: an inventor discovers a DNA or protein strand that can help treat particular types of cancers or diseases. The firm the inventor works for then patents, pays for, and tests their discoveries in controlled government experiments; if FDA approval and clearance is earned, they then partner up with large drug manufacturers and everyone involved (including shareholders of both partners) becomes instantly wealthy.

Of course, for most of these companies (and there are dozens in the U.S. and hundred in the world) the entire process from A-Z is like trying to wash a car in a sandstorm. The FDA trials alone can take anywhere from 3-5 years and cost millions of dollars. Sometimes those trials don’t include human testing, which can cost additional hundreds of millions but is almost always necessary because no drug partner would ever agree to manufacturer the drug without that kind of insurance and the same goes for the angel investors. The day-to-day operations are expensive, complicated, and full of setbacks that threaten to eliminate the existence of an entire firm and all of its work

I wanted to know more. I got on the phone with Thomas Chesterman, the chief operating officer of the early-stage drug development company Bionovo, Inc. Bionovo currently has 6 developing drugs in its products pipeline, one of which is finally entering Stage III clinical trial, sort of like the equivalent of a baseball player getting stuck on third base. He says most drugs available on the market today to treat female menopausal symptoms are based on a foundation that has become irrelevant and outdated– by using chemistry instead of biochemistry – and essentially, biopharmaceutical based therapeutics are much more effective these days.

Tom gave me a timeline of how biochemistry and biopharmaceuticals have come about in the women’s health niche the company focuses on. Currently, women’s postmenopausal hormone therapies are effective but come with substantial side effects that include cancer and disease, recently causing the FDA to issue black box warnings. The founder of what would eventually become Bionovo discovered a series of estrogen receptors (aptly named “beta” and “alpha”) were causing these abnormalities when activated by these drugs that flood the market. Menerba, the company’s first product in the pipeline, could become the remedy since the drug is selective in which estrogen receptors it activates, thus eliminating those newly discovered inherent risks.

Tom and I talked at length about the evolution drug development companies take as society, consumers, and the government begins to discover the dangers and side effects of therapies that were developed years ago are actually much more dangerous than the new treatments and discoveries we’re making now as technology improves. Essentially, as Tom says, “most of our competitors are putting the same salt in different salt shakers”.

If you’re looking at drug development companies to buy stock in, make sure that company meets this basic criterion:

Take a deep look at the company’s pipeline.

Are there many different products in the making, or is there just one or two? Remember, with these small start-ups one product can make or break the entire company. Bionovo has three different drugs in or entering Phase trials with the FDA. There are also three additional discoveries the company has recently made that will sustain the long-term growth of the company. Remember, these drugs may take years and years of investment and incubation before even getting FDA approval, much less actually coming to consumer markets. Make sure those drugs in the pipeline are spaced out in equal intervals of time so that the company your looking at is not wholly dependent on one drug not being ready for sale for an unreasonably long time in the future (“It’s coming along great!” I can hear some clueless CEO trying to convince shareholders during a meeting, “Only twelve more years to go!”).

Make sure the company is actually meeting a high-demand need.

A company that promises to cure athlete’s feet is probably not one you should be betting the farm on. Bionovo has been in development of a topical and orally-administered drug that has promising breast cancer treatment capabilities that so far the company has indicated as being a safer, more accurate, and more efficient treatment when compared with traditional therapeutics including chemotherapy.

Make sure the right team is being the company.

Having experienced and knowledgeable officers in the executive ranks and a powerful and deeply-connected board of directors is much more important than many investors realize. I call it “insider confidence” and I value it. When I buy a stock, I want to know that people who run the company have enjoyed success and they have an interest in the success. Insider confidence I believe is particularly essential in biopharmaceutical companies where cash is tight, the odds against success are high, and smart, dynamic leaders need to be steering the wheel.

For questions, comments, or concerns, contact me at Tom@bullworthy.com. To suggest a CEO or company you would like to see me interview, drop the suggestion in a comment below.

DISCLAIMER: I have not been compensated in any way, shape, or form by Bionovo, Tom Chesterman, or any of their affiliates or third-parties.