Samuel Isaly is one of the foremost health care investors in the U.S. He founded OrbiMed Advisors, a global management firm with $13 billion in assets that invests across biotech, pharmaceuticals, medical devices, digital innovations and other areas of the industry. In January 2016, Barron’s Magazine recognized him as the only U.S. mutual fund manager to beat the S&P 500 for 25 consecutive years ending Nov. 30, 2015.
In an interview Thursday, Isaly discussed the rapid changes occurring throughout the sector, both in policy and treatment. The conversation spans the Trump administration, latest health care trends, virtual reality and how drug pricing compares to cement. Isaly also parses out what investors can anticipate going forward in a period of uncertainty and how it should affect their strategy going forward.
GuruFocus: Can you sum up in a few sentences what you’re seeing in the health care industry currently and how you’re responding to it?
Samuel Isaly: In the last five years, you would say there’s never been anything like it because the pace of change in many ways has been absolutely unknown. Keep in mind, we are worldwide investors. So, for example, there’s been the emergence of emerging markets, I think changes in China and insurance systems and so on. There has been changes in the United States, insurance systems and so on. There has been, not exactly a disaster, but a lot of negative pressure in Europe. So it’s been a mixed bag in terms of environment worldwide.
There’s been a lot of – we sometimes if we talk about pharmaceuticals, we call it pharma-political change. That’s health political change. There’s been a lot of change in health systems around the world. So I’ve never seen anything like it.
Now, overlaid on that, there has been a lot of technological change. I don’t know if there’s anything actually newsworthy in my observations there, but there’s been a lot of change. It’s plus or minus five years, let’s say. If you include the initial adoption of the Affordable Care Act in the United States and some other things going on around the world. So there’s been a lot of change.
You and your readers are probably more interested in the future rather than the past, but we’re in a period of great change.
Now, there continue to be uncertainties. We’re talking health care industry currently, and how you’re responding to it. Well, number one, health care spending as a percent of the economy continues to get larger and larger. So in the United States, the health care sector is something like 17 percent of the economy. That’s just enormous. There’s a lot of pressure on people’s pockets, either directly or indirectly. I don’t know how you’re covered, but you probably have some kind of health care plan, and you have co-pays and so on, and your co-pays are going up, your premiums are going up. So it’s getting on people’s nerves. It’s also getting hard to support in any fiscal way. But it’s on everybody’s mind. So it has become central to the United States economy, it has become central to economies around the world.
I think the squeeze on people’s budgets of health care spending – either direct or indirect – I mean if it’s an insurance premium it’s kind of indirect – you don’t always see it the same way. If it’s out of pocket when you go to the pharmacy and you have to put up 40 bucks or whatever it is to get your script. So there’s visible and less visible, it’s a squeeze on every economy around the world. That’s a macro thought to keep in mind.
Fortunately, or maybe unfortunately, we are not in a very inflationary economy worldwide. So health spending has actually leveled off a little bit in the United States. In the last couple years, I think that percent is up to 8 percent or so, has not increased materially. You can check that with the Social Security numbers and so on, but you’ll see total health spending in the United States has leveled off. There’s some debate on why that’s been the case, but there’s no doubt that it is the case. So maybe we’re in 2017 getting in a place where we just can’t afford it anymore, with the pressure on utilization and prices.
Drug pricing is one of the biggest issues right now. Is that uncertainty, with nothing nailed down and Trump talking about it, creating more opportunities for you or do you have to look at how that will affect your investments on a more macro scale?
Usually we are judged by our clients on how we do relatively to someone else. And so we can be underweight and overweight and so on, which then influences whether we do better or worse than the competition. With respect to drug prices, again, it’s been an issue for many, many years. Now, typically in the United States, there’s been a political lineup. Democrats don’t like high drug prices in the short term and Republicans do. I’m adding importantly the “short term” because if prices are high or at least not pressing down, then there will be a lot of discovery undertaken.
So money in general – the economist – money flows to high returns. So if any economy or a society permits drug high prices, there will be a lot of advance.
Texas -- I don’t know precisely where you are -- but they have a college of medicine. The economy around Baylor [in Houston] is going to be terrific with high drug prices because there’s a lot of discovery undertaken.
So there’s both a short-term and a long-term distinction here. Democrats usually want low prices in the short term and Republicans want high prices both in the short term and the long term.
Now, that’s flipped upside down here, with the election of Donald Trump. Because, for whatever reason – and it could be just the nature of the man – he is much less certain to support high drug prices, even though he’s a republican. Now, think about it – be a psychologist to the mentality of Donald Trump – he is a real estate developer. What does he do when he puts up a building? He negotiates the price of concrete, right? He negotiates the price of concrete. It is the case that in the coverage of drugs out of the hospital, so-called Medicare Part P, it is the case that there’s a certain non-interference clause. That is that you or the federal government is not permitted to negotiate prices. So that’s a red flag for the bull who negotiates the price of concrete in any building that he’s ever put up. Maybe it’s not drugs, maybe it’s just telling a guy who negotiates all the time that you can’t negotiate.
So that might change? Is that what you’re saying?
No, no, no, that’s not the outcome at all. It’s now unclear. He rightly points out that the biggest customer is the federal government. If it’s the biggest input in a real estate project, he’s going to be particularly tough on it. So he’s got to make budget. Trump’s got to make budget. It’s a $100 billion Medicare spending in drugs. That’s a quarter of the drug market in the United States, or the approximate market size. so he’s a far greater threat than we earlier anticipated, in terms of wanting to negotiate prices.
The way it is done, is always important in the details. And so, we have a variety of ways to do that. One is the so-called formulary where drugs are either added or excluded. In order to get it added to the formulary you have to come up with a cheap price. That can be very damaging to the companies. So there’s been a series of positives and negatives out of the Trump campaign. Early in the nominating process, or shortly in the campaign, he said that the drug industry was a disaster, we’re going to have to go fight these companies, they’re leaving, they’re taking jobs away – they probably confused that with so-called “inversions” – but in any event, he made some negative statements.
Then, about two weeks ago, maybe it was about 10 days, he invited a dozen drug presidents of companies to the White House for a good meeting and it came out that this is an industry that he wants to have grow in terms of the economy. The other day, again, on the other side, Sean Spicer said yes, Trump wants to regulate drug prices. So this caused a bit of a whipsaw in terms of investor psychology around the sector.
So as you're seeing the uncertainty, is that causing you to lose interest in that sector, or are you still excited about it?
Well there’s another aspect, and that is that the pace of scientific advance is moving as quickly as the pace of change in general, around the world. We are now seeing a lot of innovation and in addition, we’re seeing a lot of merger and acquisition activity. Those are the two things on the positive side which don’t let us get overwhelmed by what we call pharma politics. So we’re not avoiding the sector of drugs and biotech. There are other subsectors – physical devices, insurance companies and so on – we’ll get to those.
For the everyday investor, what aspects of the ACA being repealed should people be most concerned about?
I think – and I am not a health care economist – I think it was an extra 20 million people covered, I think the bulk of those were the expansion of Medicaid. Now if you repeal and repair or repeal and replace – whatever word you want to use – the expansion of Medicaid looks like a pretty good program to me. But Trump would take it back out to the states. You’re in Texas – Texas never expanded Medicaid. It was up to the states to decide if they wanted to expand. He’s going to put the spending back to the states with so-called “block grants.” That does not necessarily reduce the number of covered people under the Medicaid program. So we have to wait and see on that.
Ok, that would knock – if it is repealed and not replaced – that would knock the bulk of the added people, the Medicaid part, off the ranks. But I think it will be replaced and I think it will be replaced by something that’s back to the states rather than the federal government.
Moving on from policy into more about treatment. How will the big trend of “value-based care” change the way you look at companies, and how will it affect their bottom lines? If they’re saving the clients money it seems like it would lose money. I don’t know how it’s also going to be profitable for them.
Well value-based care is something we have to work out. If we isolate it to pharmaceuticals for a moment. A couple of examples, with respect to reduction of cholesterol, you can take a so-called “statin” – I don’t know how all your language is on all of this yet – but you can take Lipitor and it will knock your cholesterol from 200 to 140. It is now off patent, so you can move 60 cholesterol points for a cost of 10 pennies a day. There is a newer class called PCSK9, and those are the trademarks of the two companies selling it, and that will knock your cholesterol down even more. Let’s say another 20. So you go from 200 to 140, and this will one take you down to 20. But that costs $10,000 per year. So the price per cholesterol point reduction is going up in that particular instance.
That’s getting harder and harder to substantiate. That’s one possible thing to look at – the cost per increment.
Another value-based care issue – there are some new immuno-oncology drugs. Opdivo. It’s a new way to treat cancers. It is useful in several cancers. Let’s say half a dozen. In melanoma, it is basically a cure in about 40% of the patients, who would otherwise die. So Opdivo, which costs $200,000 a year, let’s say, or at least $100,000 a year, will make 40% of the patients cured. It only cures, let’s say, 10% -- I’m making that up. But the price is the same. So if both the companies and the payers could figure out how to do it, you would pay per human life saved. So that is value-based pricing, and there are a number of hospitalizations removed, or avoided. So it is still a challenge to work out value-based pricing and value per additional benefit. I gave you the value per additional benefit in cholesterol reduction. Well right now you’re paying for it. What they’re trying to come up with is a system where you don’t pay if it doesn’t work.
I know you do private companies and public companies, but how do you value companies in health care and does it vary according to what the company does? A smaller company can come up with a new medicine, so the valuation doesn’t really matter. When does valuation come into play for you and how do you work with that?
Are you talking about private companies or public?
Well typically company size – and let’s for the moment define size as stock market value – typically company size correlates to risk. We are not going to pay as much for something that’s highly risky, and paying as much can be differentially defined because all these companies are losing money, so it’s not a matter of price-earnings ratio or price-book or something really simple. It’s more like price-to-projected-sales or projected-profit sometime in the future. But the more risk we have to take, the less we’re going to pay.
For the individual investor who isn’t well stocked with lawyers, experts and physicians, how do you look at health care stocks right now? What areas should you be interested in?
In a way it depends on where you fall on a scale of risk and return. I would suggest that over the next 10 years, you’re going to make money if you buy shares of Johnson & Johnson (NYSE:JNJ) today. If you happen to get lucky and buy shares of the correct discovery company, you’ll make 10 times as much than in Johnson & Johnson. If you buy the incorrect discovery company, you’ll lose all your money.
So for an individual investor it somewhat depends on how much risk you’re willing to take. The way individual go about it is to either compose a portfolio by themselves or to buy some kind of investment fund.
What stocks should people be interested in if the ACA is repealed? What areas will benefit?
That is not an easy answer. The repeal-and-not-replace is going to be a reduction in demand for health care. But there will probably be a replace-and-repair so the total spending doesn’t slow or doesn’t slow much. The more likely escapees are medical devices, less expensive drugs – generics – and very novel drugs which might be expensive.
With all of the changes – we just got ACA and now it might be repealed – is this stressful for health care investors or is it par for the course?
I think the Affordable Care Act has resulted in a lot more learning. It’s a costly social experiment, but I think we’ve been able to find some of the better parts of it and also some of the less attractive parts of it. We have not fully solved the need to offer insurance to everybody. So in other words guaranteed care, guaranteed coverage. Because there were not enough invincibles who signed up to balance those less invincible. So the guaranteed issuance is a problem in itself, but a lot of other problems became evident and it looks like there are solutions for them.
Medical devices – artificial intelligence, blockchain, virtual reality – are those promising, or are there any interesting companies there?
Well artificial intelligence bleeds into what’s called big data. Big data almost always says genomes or genetic sequencing. And so, take it some decades from now, beyond my lifetime and let’s say maybe yours – I suspect you’re younger than I am – every baby and every embryo is going to be sequenced. So it is possible, right now, to take from the blood of the mother. You do not need an amniocentesis anymore, you don’t need the big needle in your belly. You can take what’s called a liquid biopsy. You can take from the blood of the mother. There is circulating fetal DNA and you can sequence that DNA and you can know what the baby looks like genetically.
Now that kind of begs the question, once you know that what are you going to do about it? Let’s say you’re a female with many possible pregnancies in front of you, and it turns out your baby’s got blue eyes and you want brown. You might just end one and try the next hoping for a different eye color.
I hear all of these things, but I wonder is it just hype, is it just trying to get pageviews? It’s cool to hear someone who is smack dab in the middle of it.
It’s meaningful and not trivial. I gave you a trivial one, but you can find damaging genetic faults or differences and anticipate them, although again it begs the question, “What do you do about it?” And really if you want to avoid it, the only way to do it is to abort, which raises other questions.
Have you heard of a technology called CRISPR?
Yes, trust me. I don’t want to say the whole world is concerned about CRISPR, but it’s a very promising technology and that’s changing people’s genetic makeup in their lifetimes. So you can correct genetic faults, genetic differences, or you can add genetic differences.
There are a couple of companies racing to bring that to market.
Yes, that’s right.
The technology itself, do you think it’s viable?
It’s extremely promising. It’s an extremely promising technology.
Can you list any stocks you’re interested in right now?
I think the takeaway is that the pace of scientific advance is rapid and we want to participate there. The amount of merger and acquisition activity continues strong and we want to participate there. We do compose a custom sub-portfolio, I call it, of companies that we expect to be taken over or are the most likely to be taken over. We call it our mergers and acquisitions basket. We do not publish who’s included in that.
Orbimed invests in public, private and startup companies, but some of its public holdings can be seen in a portfolio here, where the top stocks are Biogen (NASDAQ:BIIB), Boston Scientific (NYSE:BSX) and Amgen (NASDAQ:AMGN).