2nd March 2015
Neil Woodford, manager of the CF Woodford Equity Income fund and veteran pharmaceutical company investor outlines why he believes the UK’s science sector is in rude health…
I have been an investor in the pharmaceutical industry for most of my career and have for a long time been fascinated by the opportunity for innovation in this sector to not only benefit society but, in turn, deliver great returns to shareholders.
Pharmaceutical businesses can be difficult to value and this has resulted in some extreme valuation anomalies over the years.
Assessing the value of a portfolio of on-market drugs should be reasonably straightforward and is based on calculating the discounted cash flow of a company’s on-market drug portfolio. Important variables that influence this number are the length of drug patents, changes to the size of addressable markets, influences on price and the likely path of market shares once competition is introduced. The value of those cash flows can be, and therefore is, disputed.
What has caused analysts more difficulty over the years, however, is putting a value on the pipeline of drugs in development. This involves making assumptions about issues which are very challenging to model but which have a huge bearing on future value outcomes.
Assessing the probability of a drug successfully completing clinical trials is fraught with difficulty, as is forecasting the trajectory of growth once it has been approved, and the ultimate scale of the opportunity it is able to address.
This process, ironically, involves more art than science, and I prefer to make a cruder judgement about what is, or indeed is not, priced in to share prices.
Over the years, the market has at times made it easier to do this by placing the sector and the shares within it on extreme valuations.
By way of example, I was an investor in Glaxo Wellcome and SmithKline Beecham through most of the 1990s, prior to their merger into one entity. Valuations were modest for most of the decade, despite a prolific period of drug discovery. The pace of new drug development was impressive and steadily increasing through most of the 1990s, as were valuations in the sector.
Ultimately, towards the end of the decade, valuations became too stretched for my liking and I sold these positions as the market became more and more excited about the pace of scientific development and the great promise that it held for the sector. Some of the euphoria revolved around the mapping of the human genome and what it would mean for the process of drug discovery.
What followed, however, in the first decade of the new millennium, was a slump in research productivity. The number of new drugs being approved by authorities such as the FDA collapsed, as did the valuations of pharmaceutical company shares. In the space of less than 10 years, the perception of these businesses changed dramatically. The market moved from viewing research & development as an investment expected to deliver an attractive return, to viewing it as an expense, detracting from shareholder returns.
This led to a great opportunity, in my view, and one which is still unfolding. The process of scientific discovery did not come to an end – far from it. The plunge in R&D productivity is now reversing, with the number of new drugs being approved by the FDA in 2014 being the second highest on record, behind 1996. Increasingly, innovation in the pharmaceutical industry is being driven by what was learnt and then built on fifteen years ago with the decoding of the human genome. The market was right to be excited by this important and exciting scientific breakthrough – it was just wrong on the timing.
The pharmaceuticals sector is no longer as cheap as it was but it still looks very attractive in my view, capable of delivering very attractive long-term returns. But the opportunity does not exist only amongst large, mature companies such as AstraZeneca and GlaxoSmithKline. We are also very excited by the long-term potential in smaller, earlier-stage UK pharma businesses.
Companies such as Cell Medica, Circassia, 4D Pharma, ReNeuron, Stratified Medical, Oxford Pharmascience and many others like them, are at the cutting edge in their respective fields. Meanwhile, companies that enable analysts and technicians to read and understand genetic information more quickly, insightfully and at lower cost, such as Oxford Nanopore and Genomics Ltd, are also well-placed to disrupt this burgeoning industry.
It has taken a long time to fully understand and harness the potential of genomics, personalised medicine and the greater insights that scientific breakthroughs give into the nature of disease. But the pharma industry is now starting to do so with profound and positive implications for investors and patients alike. British science is, in my view, in great shape.