Friday, October 2, 2009

Ducks in sewerage treatment works, drug resistance, dumb luck and investing

The day the swine flu story broke in the global press I wrote up for the blog a possible influenza hedge.  It was a stock I thought would make money – but I did not really want to win big on.  It would be nice to profit – but not because of mass influenza deaths.

Biota Holdings is an Australian small-molecule drug development company whose core asset is that they own a 7 percent royalty on all sales of Relenza.  Relenza is a distant number two influenza antiviral drug.  As explained in the original post the drug is taken through a “turbo-inhaler” which is less marketable than a tablet – but more marketable than an injection.  The difficulties taking Relenza meant that Tamiflu dominated the market. 

The story I posted was nuanced and accurate.  It was only possible to write that story because I had followed Biota before the Swine Flu outbreak and had been considering purchasing the stock anyway.  Swine Flu forced the decision.

In our quarterly client letter I wrote a follow up story which I think deserves a wider circulation. 

Firstly our clients were really lucky.  Whereas personally I purchased the stock the day the swine flu outbreak happened our clients purchased a few weeks later.  Why?  Because we could not purchase the stock for them until we received our Australian Financial Services License.  The following graph shows the advantage that they received:




The lower purchase price (dumb luck) meant the clients purchased more.  The very strong Australian dollar has meant that our US based clients have well over doubled their money. 

The luck continues

Tamiflu drug resistance (something alluded to in the original post) turned out to be the critical ingredient in the story.  It has both policy and investing implications.

In Japan, where Tamiflu is widely prescribed, the active compound (oseltamivir carboxylate) is excreted by the body (in urine) or is activated by the biological processes at the sewerage treatment works itself.  Water at and downstream from the sewerage treatment works is high in oseltamivir carboxylate.  That is really bad news because birds (especially ducks) like to bathe in the nutrient rich waters.  Those ducks are the hosts in which new influenza viruses breed – and because the water is rich in antivirals the Japanese are breeding new strains of Tamiflu resistant influenza.  This is not good news because the US government and other drug stockpiles are heavily weighted to Tamiflu – and there is a reasonable chance that the next global flu epidemic will be Tamiflu resistant.

Whilst that is not good news for the world – it is wonderful news for Relenza sales and hence our clients’ position in Biota.  And it is nothing that we anticipated.  If you told me my blog would wind up being about ducks in Japanese sewerage works I would have laughed.  From the perspective of our clients it is plain luck – but that will not stop us profiting from it.

Luck is pervasive in the investing game.  We did not figure on Tamiflu being a serious environmental pollutant.  It was just as likely that Relenza would be a pollutant.  Then, rather than showing profits we would be explaining losses to our clients.  A story about ducks in sewerage treatment works causing us losses would not sound plausible (even if true). 

Anyone with good investing results who does not admit to a dose of luck is lying.  The world is a complex place – and I would never have guessed that ducks in Japanese sewers had anything to do with our portfolio. 


BirdFlu5Bagger said...

Fascinating story.

I hope your clients appreciate your candor. Certainly the patron saint of portfolio managers must.

Why the media who covers specialty pharma hasn't picked up on Biota yet is beyond me. I suppose it's because no one has explained it to them. The same applies to the SELL side analysts who cover this space.

Bravo to you, John, and your clients as well. I have a similar semi "dumb luck" story which relates to bird flu, chickens, soymeal prices, and eggs to tell you sometime. There's even a short squeeze angle to it.

CNBC didn't catch on until the issuer was 6% below its multi year high. As expected the CNBC hype was at market top. The premature CBS MarketWatch and Barrons trash talk (semi ghost written by a sour grapes hedge fund manager who didn't hop on board 1.5 years before at the bottom) was what fueled the "Mother of all Short Squeezes."

Too bad Biota doesn't list on the LSE or NYSE.

Anonymous said...

A couple years ago, when's columnist Matt Schifrin called, in pre interviews about an online contest i had won that year, one in which my 12 month buy and hold selections returned 87.4% for the year, retuning more than every single domestic mut fund during the same time period, when Matt asked me how i managed to "beat" everyone in the contest, as well as every mutual fund, my answer was the same as yours, John. I told him, i was lucky.

Matt said he would not print that.

Your blog muse today, John, is one great entry.

On 'ya!


-Bob Dobb

Anonymous said...

"and I would never have guessed that ducks in Japanese sewers had anything to do with our portfolio."

Maybe they don't?

You could use whatever reasons you want to justify exhibiting a good/lucky share price performance, why not use the story of 1 in 1000 Japanese suicidal users of tamiflu jumping out of a building which therefore increases relenza's relative marketing position? There were some major university studies in this area too a couple of years ago...

Fact is your post is full of confirmation bias, go look at Roche's sales of tamiflu and see how many "ducks in sewerage" have affected their stockpiling/sales.

Perhaps the pervasive luck theme is more evident in the fact that swine flu has spread and gripped the media yet again. If you attribute your dumb luck now to
tamiflu's relative flaws, I wonder how much self-congratulatory praise you will give yourself if GSk can, as you subtly suggest, eclipse Roche in sales due to this 'lucky' study.

In my humble opinion, its completely unlikely considering tamiflu is a simple oral tablet and relenza an inhalant. Notwithstanding the fact that relenza has always been more effective than tamiflu, its delivery system was and is always the problem.

John Hempton said...


Go back to the original post. I understood the delivery issues, the psychological side effects and the resistance.

But they all worked out more important - as government have already started to weight towards Relenza.

But yes - the spate of Swine Flu stories improve the weighting. But things like this really help. Imagine being the marketing team who has to convince the government to make the incremental stockpile into Relenza.

Manna from heaven.


Oh yes - it is confirmation bias - but I have yet to find too much rejection bias here. And boy do I look for it.


Dean said...

Hi John
I found this comment in your quarterly very interesting "We need new ideas and the process for generating them is serendipitous rather than systematic."

That describes my approach and I often consider it one of my weaknesses. Though whenever I try to implement a more systematic approach I enjoy investing less and so revert. It's encouraging to know that a professional money manager can accidentally succeed.

I think you sell yourself short on the luck aspect, though you did cover that with a reference to skill in your quarterly. Coincidentally I spoke about Biota and luck early this week.

"Investing is about putting yourself in the most probable positions, it's about being where others will consider you lucky. Take my Biota investment. I had no idea Swine Flu was about to hit or influenza would develop resistance to Tamiflu, but I did know; it was undervalued, that due to political interference from an ex-political power broker with large vested interest the world had too large a percentage stockpile of Tamiflu, that Biota had a second generation flu drug in late trials, that there was almost no chance of losing money, etc. So I invested heavily and while you may say I got lucky, I'd say I get lucky by investing in situations with lots of potential luck / catalysts."

BirdFlu5Bagger said...

I think John's investment in Biota and subsequent "findings" with respect to Tamiflu are similar to my "lucky" investment in the only publicly traded egg producer long before the media, SELL side analysts, or other portfolio managers ever heard of H5N1 (hope I got the strain correct).

I stumbled upon an article in a local (Riverside, CA) paper with respect to several poultry farms having to euthanize then burn their entire flocks. I thought to myself, "isn't there a vaccine for this? How fast will this spread? What if other poultry farms have this problem? What will be the ramifications? Are there any publicly traded firms which could benefit?"

I did a little (couple of hours) research and came up with a small cap specialty pharma firm in NC (taken out later at a nice premium by Pfizer's animal health division) and the only publicly traded egg producer in the USA (Cal-Maine/CALM which trades on the NDAQ).

Loaded them both up. Got a 1.8 bagger on the specialty pharma firm 2 years later (not a bad return). The return on CALM was a little over a 5 bagger in less than 2 years. The premature CBS and Barrons' trash talk helped fuel a lot of too early to the party short selling followed by some almost too late to the party short squeezing.

The late to the party CNCB hype was an indication of market top. Smart money was long gone that investment as it was way too late to be "eggs"ited by it anymore (price chart was parabolic).

FD: wouldn't advise an investment in CALM quite yet. It's somewhat seasonal cyclical with respect to revenues: holiday baking et al (mid Nov thru mid April). Also one must look at legal issues the poultry business faces with respect to feces disposal. Soymeal prices and hedging strategies must also be considered as well as the China/US trade dispute on chicken exports.

Let's hope John and clients have a 5 bagger plus in the making with their Biota.

David said...

when does Relenza come off patent? That will drop sales by 50% I suppose, so the royalties should keep comeing.

John Hempton said...

The two big negatives are the drug coming off patent - varies by jurisdiction - but about five years


The shareholder-unfriendly management.


Unknown said...

Great financial analysis but not a great medical one. Relenza's big problem is that Relenza is non-indicated for people with asthma or chronic obstructive pulmonary disease, and also people with lactose allergies. That means that it will never be widely used in the medical field.

But hey, it doesn't really mater what may happen in the markets.

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