Healthcare Investing,
the Pharma/Biotech Industry
and Some Other Observations Along
the Way
(Oh, the Places You’ll Go!)
Harsha Murthy
(Duke 1981)
Presentation to Duke in New YorkFinancial Markets and Institutions
Program
March 19, 2015
©2015 Harsha Murthy
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:
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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?
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I’ve Been Where You Are:
Bright College DaysTo Days Free of Strife
Soon We’ll Be Sliding Down the Razor Blade of Life!
Note: With apologies to Tom Lehrer, Bright College Days (1959)
It Was Not That Long Ago When
I Sat Where You Are
YOUR SPEAKER
THEN:
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YOUR SPEAKER
NOW:
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What We’ll Cover Today:
Who I Am Through What I Have Done
II.
What Are the Sectors of the Healthcare
Investment Business and Why Invest?
III. Investment Cycles/Time Horizon
IV. Pharma’s Longer Time Horizon
V.
Some General Points about the
Healthcare Industry and Healthcare
Investing
VI. Some Thoughts about Learning and
Career Planning
VII. Recap/Questions and Answers
I.
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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, Stanford
Confidential
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0 10
My Duke Experience – Then
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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
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 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
The Healthcare Business is Truly a “Cradle to Grave” Enterprise
that Affects Everyone
Source: US Center for Medicare
and Medicaid Services (2014)
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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
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– 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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My Investing Focus:
• 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
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III. What is Investment Time Horizon?
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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
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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?
*Source: Dalbar’s Quantitative Analysis of Investor Behavior (2005)
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Volatility/Time Horizon –Time Does Not Erase All
Wounds
•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
= $$$
Investment Decisions Required All Along the Way
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What are the Key Investment Decisions?
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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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What Makes Pharma/Biotech Investing Different?
Multiple Investment Decisions Over Time Coupled with Large and Multiple Risk Factors
(high Beta)
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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)
Long-Time Horizon from Initial Investment to Payday/Return
- Uncertainty in DCF Valuation
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Pharma Companies have
Revenue-Generating Products on the Market (and Sales Teams)
Whereas Biotechs are Usually Non-Revenue, R&D-Focused Companies
Traditional “Big Pharmas”:
Biotechs:
“Convergence”
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Suggested Implications:
• 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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So What Should We Do?
Are We Lemmings?
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 versus Generic Drugs
• 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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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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Prescription Pharmaceuticals for Unmet
Medical Needs Remain Expensive
The World’s Most Expensive
Drugs
Source: Pharmaceutical Commerce and Fierce Biotech (2009)
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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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The Trend toward Commoditization
and Convergence
 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”); and
3) The manufacturers allocate more of the purchase price they receive
to pharmacies; and
4) The business model is based on re-engineering, lowering cost-ofgoods and breaking patents
 Branded drugs are high margin products
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Both branded and generic drugs can obtain approval to be sold “OTC”over the counter
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Bottom Line: There is a place in the world for both branded and
generic products.
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There is also CONVERGENCE between branded and generic
companies (i.e., virtually every branded company owns a generic
entity and generic companies want brands)
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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 Growth
Big 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 StartUps; 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
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Circulatory conditions, such as heart attacks and high
blood pressure, are the largest category of spending
Total expenditures in $ billions by disease category, 2010
Note: These are largely diseases of aging and affluence
Circulatory
$234
Ill-defined conditions
$207
Musculoskeletal
$170
Respiratory
$144
Endocrine
$126
Nervous system
$120
Cancers and tumors
$116
Genitourinary
$111
Injury and poisoning
$110
Digestive
$102
Mental illness
$79
Infectious diseases
$58
Dermatological
$38
Pregnancy and childbirth
$38
Other
$70
$-
$50
$100
$150
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.
$200
$250
Why Should We Care?
• 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.
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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 People
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The Very Things that Make Our Jobs Fun Also Make Them
Challenging!
Why I Hate My Job?
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What Should We Learn?
• 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
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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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What is Finance?
• 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
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Some Observations From an “Old
Timer” (i.e., Yours Truly)
• 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
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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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QUESTIONS?
(and, if you are lucky, some meaningful
answers!)
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Thank You Very Much.
Mr. Harsha Murthy
Email: hmurthy@mindspring.com
Phone: 917-882-5118
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