Are small-cap stocks poised for a breakout? That's what some analysts and hedge fund managers are arguing.
The idea is that passive investing, or tossing a bunch of money into an index fund and forgetting about it because you have better stuff to do, is driving a wedge between small companies and their larger counterparts. That's because index fund managers must allocate money to correlate with the proportional representation of the benchmark they're trying to replicate, such as the S&P 500. That means many index funds are buying more and more shares of the Amazons and Facebooks of the world while leaving out companies with lower market valuations, which are less likely to be included in market benchmarks.
If that's true, and you stop and consider the trillions of dollars wrapped up in passive investing, then it suggests that the value of many assets is being inflated due to the popularity of passive investing -- and that small-cap stocks are being overlooked and undervalued. That might give individual investors a nudge to increase their exposure to smaller companies. Here's why Personalis (PSNL -6.23%) and Coherus BioSciences (CHRS) are worth a closer look in December.
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Wall Street has soured on this biological data platform
Personalis launched onto the market this summer valued at over $800 million, but shares sank 65% since its initial public offering (IPO). The company is part of a new industry built on mining massive biological datasets for insights on how to treat diseases, what genes or proteins may be driving diseases, and where to look for new drug candidates. The data-heavy approach could lower healthcare costs for patients, insurance companies, and biopharma companies while improving treatment outcomes.
Personalis has received little love compared to its competitors in the space. Peer Adaptive Biotechnologies boasts a close relationship with Microsoft, while Guardant Health expects to generate over $200 million in full-year 2019 sales. But Wall Street hasn't been very impressed with Personalis.
Analysts are worried that the company has struggled to court major pharmaceutical customers and that its top customer generated 63% of total revenue in the first nine months of 2019. Perhaps the technology platform, which provides information on all 20,000 human genes to identify biomarkers relevant to the disease in question, is too ambitious and unwieldy. Most competitors limit their products to between 50 and 500 genes.
Those are legitimate concerns, but analysts might be proven wrong in 2020. The company recently launched its ImmunoID NeXT Platform, which looks at all 20,000 human genes, and inked important new deals. New customers leveraging the tool include the University of New Mexico (drug discovery for ovarian cancer), Invectys (analyzing biomarkers within a clinical trial in blood cancers), and Merck (drug discovery).
To be fair, it will take many more customers and more significant relationships for Personalis to become a sustainable business. It has yet to prove that its whole-genome approach to biomarker discovery is useful, valuable, or fits in the drug discovery workflows of potential customers. But the business has enough cash to fund operations through at least 2021 and is valued at less than $300 million. Investors with an abundance of patience and an appetite for risk could make out handsomely with a small stake in the company.
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A rare success in a lucrative market
Analysts have oscillated between euphoria and depression when modeling the market opportunities of biosimilars, which are essentially the generic versions of biologic drugs. But because making an exact replica of a protein or monoclonal antibody is very difficult, and the off-patent versions are pretty darn close and do the same thing in the body, everyone shuns the word "generics", calling them biosimilars instead.
On one hand, many of the world's top-selling drugs are biologics and many of those have or are beginning to lose patent exclusivity. That seemed to suggest multiple multibillion-dollar bounties were on the horizon. On the other hand, patent disputes, clinical trials, drug manufacturing, and quality control issues all have a funny way of sabotaging commercialization efforts. Even after scaling those hurdles, companies have had to contend with hesitant doctors and insurance companies already comfortable with prescribing and reimbursing the branded versions.
Coherus BioSciences has been one of the lucky few to achieve success. The company's first biosimilar is Udenyca, which is modeled on Neulasta (pegfilgrastim), a drug for producing white blood cells after receiving cancer treatment, from Amgen. It generated $232 million in revenue in the first nine months of 2019. That enabled the business to produce an operating profit of $63 million and operating cash flow of $11 million in that span. While growth may slow as the market becomes saturated, the copycat biologic could generate $450 million to $500 million in revenue in 2020.
That will provide more than enough financial flexibility to pursue the company's growth strategy. Coherus BioSciences expects to file a biologics license application (BLA) with American regulators before the end of 2019 for a biosimilar of Lucentis (ranibizumab), a blockbuster treatment for wet age-related macular degeneration. An application for a biosimilar of the world's top-selling drug, Humira (adalimumab), a drug for a wide range of autoimmune diseases, will be filed in 2020.
Assuming all goes according to plan, Coherus BioSciences will launch the Lucentis copycat in 2021 and the Humira copycat in 2023. That gives the biopharma an intriguing growth runway, especially if it can lean on experience from the market launch of Udenyca to commercialize new products. Given a market valuation of $1.3 billion and profitable operations that are generating cash, investors may want to take a closer look before fourth-quarter 2019 earnings are in early next year.
