Sitting in the offices of investment banking boutique Daniel Stewart Securities (LON:DAN) , Vadim Alexandre presents a bullish case for the prospects for his sector during 2011. As one of the City’s top healthcare analysts, earlier this year his impressive stock-picking record helped catapult the firm to the top of Hemscott’s broker rankings in the sector by number of clients. That feat was all the more impressive given the tortuous time encountered by many London-listed healthcare companies during the economic downturn. Nevertheless, Alexandre points to increasing evidence that investors are once again warming to healthcare and that 2011 could mark a return to more optimistic market conditions.
Montreal-born Alexandre joined Daniel Stewart & Co in January 2007 at a time when the firm was moving from a generalist model of research to a specialist model, with a particular focus on AIM companies. He worked in the pharmaceutical sector, both on the research, marketing and finance sides before moving into industry research. The firm itself acts as a broker or nominated adviser to around 50 clients, the majority of which are AIM companies, with a peppering of Plus and Main Market quoted businesses.
Vadim, what are your views on AIM and the way the market has performed over the course of the last year?
AIM is a very interesting market. It has had a tough time in the downturn but that is no surprise, it was the high risk investor that went first, so when you have a major downturn a flight to quality does not come as a surprise to people, but I think it has actually faired well. A lot of people have spoken negatively about AIM but I think, given the severity of the downturn, it has done quite well and companies have still managed to raise money. A classic example is Reneuron Group (LON:RENE) , which is a company that I cover. We did a fundraising for them in March 2009, at probably the worst time in a very long time to raise money, and we still managed to raise money for them. So AIM is still a very functioning market and now, more than ever, I think it is really bouncing back aggressively.
Were there any surprises or was it just the macro economic factors that threw the mix slightly?
I think there are always winners, it is not easy to find them but there are a few that come through regardless of the macro environment. I’ll give you an example, Asterand (LON:ATD) is a company that outperformed during the financial crisis and they were the top performing stock on the LSE in 2008. Granted they ran into some difficulty times afterwards and things are on the mend now, but in that single year I think their stock went from something like 7p to a peak of 28p, so that’s fantastic return. Give or take six months, from their trough in 2007 to a peak in early 2009 it was a five times return and that was a horrendous time in the macro context.
But this is our job, this is what we are supposed to be looking for – the small diamonds in the rough. As far as the whole market is concerned, and especially on the biotech side, firms faced capital constraints and that is a difficult thing. But I still think, as a result, you’ve had a clearing of the decks at some level because some biotech firms had to go, whether it was to be restructured, be sold to larger firms that could develop those assets further, or in some worst case scenarios, go into administration. If there is a light at the end of the tunnel in any downturn it is that the quality companies that remain are stronger. I think we’re seeing better markets and I think some companies, those that have survived, are now in a strong position.
What was your reading of the sentiment among investors during 2010?
It has definitely improved, specifically over the last quarter. There have been many false starts since March 2009, there have been periods when the markets have opened up but then shut back down on the basis of some global headline that was serious but shouldn’t technically have shut markets – fear of a double dip recession in the US or fear of a major European debt crisis. More recently, with the bail out of Ireland and potential contagion all the way to Italy, we have nevertheless seen markets plough their way through without shutting, so that’s a good example of how it is different. These are major macro events that in the last three years have impacted the markets and effectively shut markets, whereas today they are not shutting markets.
How does this relate to healthcare or biotech? We are probably in the most volatile area where markets would shut first. Even within the small cap arena, it is these high risk plays and it is all to do with risk aversion. First, there would be a flight to quality out of high risk biotech plays and into more asset backed plays and then, after that, if there is a further flight to quality, it is out of small caps as a whole and into larger caps. I have to say that you do still feel it but not too much, not anywhere as close to how it was felt say a year ago, or even in the first half of 2010.
So in terms of the companies you cover, are there specific parts of the healthcare sector that you focus on?
I focus predominantly on asset backed plays, cash generative or at least revenue generating healthcare companies. The overarching theme is healthcare but it’s a broad sector and there are very different companies all the way from healthcare services, which I would say are relatively simple to understand to a generalist investor, all the way to pure play biotech companies, which may have one product that is going through pre-clinical trials and is strictly cash burning. So one is revenue generating and profitable and one is cash burning and blue sky opportunity in five years, 10 years’ time.
We cover the spectrum but we prefer to focus more on healthcare equipment and services companies because they are interesting companies as a whole and I think there is money to be made. I think they have taken a hit in terms of valuation during the downturn when they shouldn’t have, largely as a result of the perception that this is a risky sector. I don’t cover other asset backed companies, such as care homes, which is another interesting sector but is more of a real estate play, or at least has strong real estate components to it.
That real estate element is why care homes are a particular source of affection for private equity firms, isn’t it?
Exactly, they are very cash generative and fit well into the sector’s prognosis, which is ageing population, developing nations growing more affluent, so demanding better and higher quality care. These are major structural themes within healthcare that everyone should be piggy backing on because it is a well known fact that, to some extent, in 20 years time the population will be skewed towards the elderly. So inevitably, at some level, the wind is in the sails of all healthcare companies – but always considering that spectrum of risk. If you’re a small biotech company and you can’t get to 20 years from now because you are burning too much cash and you can’t raise the capital, what use is that, right? That’s why these care homes are so loved by private equity, because there is a nice solid asset underneath it all.
So among the companies that you cover, which have been the stars?
In healthcare equipment and services, one company in particular is a case in point to explain exactly why that side of healthcare has been more interesting to me. The company is called Immunodiagnostic Systems Hldgs (LON:IDH) and we picked up coverage of it about two years ago. It is a diagnostics firm and one of the segments that we really like within healthcare is diagnostics. What I like the most about it, and IDS has shown this, is that you have all the IP protection and all of the patented monopoly protection –because when you develop a good product you effectively have the monopoly on it, unless someone else pays the high sums of developing a similar product. I think they will face some competition eventually but they’ve done very well with their Vitamin D test. They do other tests but that’s their breadwinner, and Vitamin D testing has just shot through the roof over the period, it has become a biomarker of many different types of diseases and the roster is growing.
I think Vitamin D testing is part of a trend and that trend may subside eventually but I don’t think it will happen soon. What IDS has benefited from is that they were in the right market at the right time with the best possible test. It’s up almost from a low of 120p, now pushing £10, so it’s a fantastic story, a fantastic return and a perfect example of a success story in the broader healthcare sector. You just have to identify one or two of these a year and you have made some good returns for investors.
Broadly speaking, I like diagnostics because they are high margin businesses with similar aspects to the pharma industry but with much less risk. Granted, the monopoly control isn’t as long and isn’t as strong but it doesn’t take as much money to develop a test as it does developing a drug, however you can make some very good returns in a very short span of time and IDS is a case in point.
There is a peer in the market, Axis-shield (LON:ASD) , which is not in Vitamin D testing but is a similar sized company, actually larger in terms of revenues, but it is having difficulty. Axis Shield hasn’t really performed in recent times and if your share price isn’t performing for years and years and years you have to start to ask questions about what is going on, should you be shedding businesses, should you be spinning out businesses, something is not working, something has to be fixed. So to some extent a sustained period of things not working, I think, is not acceptable.
Another of your companies is Cryo-Save Group (LON:CRYO) , what potential do you see there?
Yes, again, it is still within healthcare equipment and services sector, and specialises in cryo-preservation of umbilical cord blood. Umbilical cord blood is rich in stem cells, specifically haematopoietic stem cells, which are blood based stem cells that generate both white, red and platelet blood cells. There is still a lot of controversy around storing this because the debate is whether the health economics stack up, and that means that for what you’re paying are you actually getting a benefit relative to the risk of you contracting a blood based disease. Cryo-Save claims, through some meta-analysis, that 1 in 400 people will use these cells. I don’t know that for fact but nevertheless there’s a market and Cryo-Save is making real profits out of this. They’ve stored over 130,000 samples to date, their larger peers in the US have stored far more, and it is gaining traction. The US market penetration is about 3-4% of all live births storing their umbilical cord blood. In Europe it’s about 1%, so there is still a lot of market to go after in Europe. We are house broker to Cryo-Save in London and when we took them on they were roughly one fifth of their value today. Now that’s levelled off over the last year but the year prior to that it went up about 500% because the company has good assets, they’re almost a single distribution channel for Europe, they’re the largest player in Europe with about 50% of the market.
Another company, ReNeuron, is developing a stem cell based therapeutic targeting stroke related disability, where there is an unmet need and there are no other treatments that could even remotely work. Once you have a stroke it leads to brain damage and while the brain can recover a little bit it then stabilises and whatever damage has resulted after that stabilisation is permanent. So it is almost inconceivable that without some kind of regeneration of that area of the brain that you can have return of those functions. Often stroke related disabilities are associated with speech impairment and mobility, so that’s a major reduction in quality of life, so any kind of improvement on that is almost a revolution. Now I don’t want to speak too strongly about it because we just don’t know how successful it will be, but it gives you an idea of what the potential for regenerative medicine is and that’s why I’m interested in that space.
How challenging has it been to raise money for these types of companies?
It is always a hard sell in the high risk areas. Biotech companies have given the whole sector a bit of a negative reputation, even though it doesn’t take very long for investors to recognise that a services company has nothing to do with biotech, but inevitably there is still this negative stigma in times of massive risk aversion. Ultimately it’s just a question of getting the information out to investors and making them understand the difference between the risk/return of different companies operating in different sectors. I’ll give you an example; ReNeuron is a high risk player that’s a perfect example of high risk, high reward. Cryo-Save, which is a profitable services based company, is a completely different company in the same small niche of stem cell sciences. So the question there is to just identify the major differences between these companies.
What is your perception of the importance of private investors in the fortunes of these companies?
I think private investors are always important. Liquidity is mostly driven by private clients so they’re very important, they’re very important to the companies and very important to the proper functioning of the markets. Institutional investors, when they come in and take 5% of a company, cannot easily get in and out or change their holding, so they’re almost like dormant investors. In general, they are in for a period of time so the price on the market is not as much driven by trading by institutional investors, especially as you go down the market cap ladder. The smaller the stock the less liquid there is and the more the private clients have a sway on the price. The institutions are more like VC blocks, they just sit there and cannot easily augment or reduce their position within economic reason, meaning that if you were to start exiting a company as an institution where you own 5%, you exit one tenth of it and you’ve destroyed the value in the 90% that you’re still holding, so there is no economic rationale to go out in the market.
So yes, the private clients are extremely important because they’re the ones that are actually setting the price in the market and that, to me, is the market mechanism for small caps. As you start to move up the market and you see more and more liquidity it becomes a different game; institutions are trading in and out of stocks every day, changing their positions. Liquidity is a difficult thing to achieve and it’s rare, it’s more an exception than a rule. I would say private clients are the ones where the liquidity begins for these small cap stocks. It starts in the private client arena and then as that expands and as the company gets bigger, it starts to become mixed with institutions and then once the company is properly liquid it then becomes the bulk of institution trading.
Finally, what are you expecting to see from the market over the course of the next year?
I think it’s impossible to say but I think the markets have reopened for good although there may be a few blips along the way. The proof to me was with this whole Irish bail out - that could have shut the markets and it didn’t, they bounced back pretty quickly. I don’t want to overstate the macro influences but they do inevitably impact healthcare because they impact the whole of the market, especially in the small cap arena because of those flight to quality issues.
We seem to be past that so, if anything, 2011 might be a very good year. The real litmus test will be when IPOs start flying off the shelf again and that will be a proper market, it’ll be interesting when those days come and I hope it happens in 2011. I think the risk aversion has reduced significantly and that is what we need, that’s the kind of environment we need to start getting IPOs lined up – there is a pent up need for capital from privately listed firms. A lot of them have remained privately listed and have gone for private placings; that could continue and should continue but some of them are ready for IPO and I think the investor appetite is starting to return. It won’t go from a standstill to 2007 levels but I think that once it happens it will be the trigger for showing that the markets are properly back in business and useful – but there is still a lot of debate over that.
In terms of healthcare, how does that impact in our sector? I still think you’ll continue to see risk aversion but on a one-by-one basis you’ll see more companies, riskier and riskier companies, raising more and more capital. There have been a few success stories in terms of raising capital – Phytopharm Plc (LON:PYM) , Is Pharma (LON:ISPH) , Proximagen Group (LON:PRX) – and you will see more and more.
Thank you for your time.
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