Mon, 12 Sep 2011
Sequoia's David Poppe says the fund likes the tailwinds in health care but has tried to avoid the reimbursement risks.
McDevitt: Last question is dealing with the funds health-care stake. About a quarter of the portfolio is there, and what’s interesting to me, one of the things that stuck out to me, was that almost none of the companies or none of the companies are really traditional big pharma, something you find in a lot of other value portfolios.
On other hand, there are more diagnostic companies, more equipment, I won't say medical equipment, but just medical supply companies. What do you like about those types of companies like Idexx, Becton Dickinson and their business models?
Poppe: What we don’t like about traditional big pharma and about some of the med devices or other companies is there is a lot of reimbursement risk. There is a lot of "unknowability," what’s going to happen with pricing down the road. I think we all know that there is a potential crisis coming in terms of health-care cost and who is going to pay for what, but we don’t know when it’s going to come or what it will look like. In some ways, our answer has been to just avoid the sector.
There are, obviously, some tailwinds in health care with an aging population. We've tried to look at things that don’t have reimbursement risk or that just have dominant positions, Becton Dickinson is a good example, a very dominant position and a very low-cost item that's not ever likely to be a focus of reimbursement pressure, which is the glass syringes.
They are supplying a lot of the sharps for most of the hospitals in the country. It’s an extremely low-cost item. They are extremely good at it. It’s more about efficient distribution than it is about anything else, and they've got the best system. So we like that business. Again, you benefit from increasing use of health care, utilization of health care, but you don’t have so much reimbursement risk.
Idexx is interesting because it's veterinary medicine. It’s not human medicine. So there is no reimbursement risk. Your risk is really in a bad economy, the fact is, people will spend less money on their pets. So there is some cyclicality or cyclical risk there, but you don’t have reimbursement risk. You also have ... a situation where animals really are living longer, households are smaller, people are willing to spend more money taking care of the pet. Those have all been tailwinds for Idexx, believe it or not, and the lack of reimbursement just makes it a better business.
In pharmaceutical, we own Valeant, and Valeant is an interesting company because it's primarily buying or trying to find orphan drugs, maybe older branded drugs that have gone off-patent but there is no generic that’s come to market and sell those in the United States, in Latin America, in Eastern Europe. They have been really successful there. They are led by a CEO who is very entrepreneurial. I think of him as a value investor in pharmaceuticals, who’s been able to find products in some cases that the big pharma companies don’t want because they are too small, and plug them into a really good sales network and do very well.
So we like the tailwinds in health care, but what we've tried to do is avoid the reimbursement risks. So we have not been as interested in medical devices in the large pharmaceutical companies.
The large pharmaceutical companies, I would also say, have not been good capital allocators over the last 10 years. Their R&D efforts have mostly not produced good returns for shareholders and now they are faced with a situation where their biggest and often best blockbuster drugs are going off patent, and we haven’t been attracted to that sector, even though traditionally they have made a lot of money. We think the R&D that they've done over the last 10 years has just not paid off.
McDevitt: And you mentioned with Valeant before that they essentially do not really have an R&D budget; they are not doing primary research?
Poppe: Right. Valeant is basically buying companies that have good older drugs. They are not doing R&D. So in a sense they are letting other people do the R&D for them, and they are also focusing a lot outside the United States where reimbursement issues oftentimes are much different.
McDevitt: Now, Valeant has been a fantastic holding for the fund, and is up, I believe, 80% or 90% so far even just this year. Are you getting concerned at all about the valuation there?
Poppe: The valuation is high, and compared to the rest of the sector it’s quite high, but I think the issues are also quite different for Valeant, which is Valeant doesn’t have patent expirations to worry about. Valeant doesn’t have billion-dollar commitments to R&D to worry about. All the cash that Valeant generates basically is free cash. You’ve got a CEO who is allocating that free cash to buying more products to plug into that good sales pipeline that they have. I think Valeant is worth more.
I own Valeant, so I would think that, but I think Valeant is worth more than the rest of the sector. I do think implicit in the stock price at this point is an expectation that they will be doing more good M&A, and so there is some pressure there on them. They are going to have to find the next great idea if the stock price is going to grow from here.
McDevitt: That is a rarity--someone who is good at doing M&A, right?
Poppe: M&A is tough. I do think for them, the good news is they are buying effectively bolt-on single products or companies that have a handful of good products that Valeant knows they can plug into their system because they already have, say, a big business in Poland or a big business in Brazil. They have got a salesforce. There is a lot of synergy when you can combine two salesforces and maybe take out half the people. They don’t need to do a big transformative acquisition, but they do need to find consistently good products that they can plug into the system that they have now.
McDevitt: Excellent. David, thank you so much for your time.
Poppe: Thank you.