The New Xoma - A Modified Risk Way Of Investing In The Genetic Era

You may have heard that this year's Nobel Prize in Physiology or Medicine went to Jeffery Hall, Michael Rosbash, and Michael Young for their work in unraveling the workings of our body's daily clock - the circadian rhythm. You may not think too much about partying all night or getting up at 2 am for work, but your body thinks about it plenty. We know that the 24 hour light/dark cycle effects our chemistry and health, but they have found that plant leaves, for example, can open up and close even when put in complete dark - controlled not by light, but by genes.

As explained in the Biotechin.Asia report on the Nobel Prize, it's the genes that the prize winners solved to advance our understanding of the clock. This years Nobel Prize reflects the genetic revolution I wrote an article about. I called it "Insider Wisdom And The New Medicine". There is a revolution going on in medicine and it could usher in a whole new array of effective, more palatable therapy. But how do you invest safely in something this new? The genetic developers are typically tiny upstart companies going into a sea of red to put drugs through clinical trials for FDA approval. But only about one of 10 ever gets approved and the casualty rate of these stocks is high. You can own stock in the large biopharmas that are now more than ever tending to collaborate with the more promising candidates of the small caps, and often buy them out. This is lower risk, but you would likely be better off with a biotech ETF.

If you want to venture into the topsy turvy arena of the genetic revolution with the smaller companies, there is another choice now developing that offers much higher return. The Ligand "model" is what it's often called and Ligand Pharmaceuticals is the first to decisively go down this road. A Forbes 2015 article details this nicely. Up until 2008, Ligand had been swinging the trials bat with no earnings home runs to show for it. As the Forbes piece relates:

On his first day as chief executive of Ligand Pharmaceuticals in January 2007, John Higgins was shown into a conference room in the biotech firm's 135,000-square-foot San Diego headquarters. Inside was a table so mammoth, Higgins recalls, "you could practically land a corporate jet on it." 

The new CEO immediately instructed the head of facilities to find a carpenter and cut it up into smaller tables. Higgins wasn't some scientist-turned-empire builder trying to make Ligand into the next Amgen or Genentech. He was a hit man, brought in amid a raid by activist Daniel Loeb of Third Point LLC to stem the losses at the once-promising biotech firm and turn whatever was left into quick cash. 

What was left was an array of promising medicine needing big money for trials. Higgins started his hit by slashing Ligand's workforce from 365 down to around 20, where it is today. You could say he turned Ligand into the Wal-Mart of biotech. He proceeded to "farm out" Ligand's better prospects to the big companies with what you hear so much of today - royalty agreements, milestone payments on successful trials, and other high volume, less-than-home-run reward. The Higgins philosophy:

... no matter how many Nobel Prize-winning scientists you put on your advisory staff, there's no certainty your decision making about a drug will be right ... He's rebuilt the company along lines that would make a Texas wildcatter proud: spreading bets and relying on other people's money to find winners

I won't recount the results of this "hit man" other than to say they were extremely successful. After turning EBITDA positive, cash flow climbed like a clock from $2 million in 2012 to 60 million current TTM. The stock had swooned from a speculative $140 in 2004 to around $8 in 2010, when the Higgins plan took hold. It's now a cash flow rich $143 . As the article summed it up:

No question Higgins has wrung the romance of biotech right out of Ligand. But there's also no question he's made it Loeb-proof. There's nothing left for a takeover artist to cut. "No other biotech has this story," Higgins says. "No other biotech with success could show a flat expense line."

OK, so you've missed the train on Ligand. But there is another train boarding - Xoma Corp (XOMA). About three years after Higgins first took his seat at the much smaller tables at Ligand, Xoma began adopting this same business model. From a 2010 write-up in Wikenvest:

XOMA has evolved into a sort of research and development outsourcing company." 

But they didn't decisively ditch the old model until 2015, when disaster struck. A failed Phase III endpoint smashed the stock down from around $100 to the mid-teens in a day. The stock has been in this doghouse ever since, until now. Ironically, it was the same Gevokizumab that ran the stock up recently when it was announced it was being farmed out to Novartis for development against other things. It's a versatile monoclonal antibody, what the "mab" stands for at the end of the drug name.
This model switch is drawing some attention as seen by the massive upgrade in Barron's in September:

We are upgrading our rating on Xoma to Outperform from Neutral and increasing our 12-month price target to $19 from $9. 

We drew a line in the sand requiring a deal to validate the new business model of lean operating expenses and licensing revenues and Xoma (ticker: XOMA) delivered. So we are upgrading and increasing our price target to include potential royalties on gevokizumab and canakinumab for cardiovascular-disease sales.

In my insiders and genetic medicine article linked above, I detail why the Baker Brothers are perhaps the savviest insiders in medicine to pay attention to. The Bakers had XOMA as one of their small, select handful of mega-weighted stocks until the 2015 disaster, when they abandoned ship. But this was heavy validation of their basic concept and pipeline, as is the major corroboration now with Novartis. Genetically programmed antibodies are a major Baker interest.

The similarity between XOMA and LGND is being noticed by biotech pundits, but Xoma has a long hill to climb to be as successful with this as Ligand. However, if they continue to progress, they will inevitably command the kind of "royalty premium" that Ligand now enjoys - a five year average multiple on its revenue of 22! Adjusting Xoma's current 4 multiple to Ligand's current 27 implies another six fold increase in the stock, not even counting future revenue growth.

They reported their quarter Nov. 6 and it was a crazy, massive beat. As for their press releases, I find the latest one listed at their website from October 4 interesting. It's titled "XOMA Announces Multiple New License Agreements For Proprietary Phage Display Libraries." Phage displays are cataloged antibody configurations that apparently can be "looked up" to match the profile of specific disorders being worked on. The US National Library of Medicine, has a section called "Phage Display - A Powerful Technique For Immunotherapy" and Xoma is a major trafficker in phage display, claiming in the press release, "XOMA's premier antibody discovery platform includes three phage display libraries, which are among the largest in the world."