The future of biotech is moving from bench to beach

Josh Wolfe:
Are you able to adjust the base and the treble on myself or no, is it just volume?

Danny Crichton:
Chris can do whatever he wants. Your track is totally separate from mine. Okay, we do have a little bit of that echo because of this room. All right, 3, 2, 1. Hello and welcome to Securities by Luxe Capital. I'm your host, Danny Crichton, and today I'm here with Josh Wolfe to talk about biotech. When I think about the most popular investment themes of the 2020s, my framework has been the three Cs. Climate, crypto, and content, or otherwise known as the metaverse, gaming, and virtual worlds. But there's one area that I think will increasingly be the definitive wildcard trend of the decade, and that is biotech and specifically the fusion of bio and software together. We've gotten some highlights of this market over the past decade, but now as the biotech market's reset, it seems we're entering a whole new and frankly exciting era for this area. Isn't that right Josh?

Josh Wolfe:
Well, zoom out and over the past three years you saw not only biotech players rush in and public market investors and thematic investors rush in, but you also saw historically software driven investments. So whether that was SoftBank or Tiger or others that previously were doing tech, suddenly were getting into health and bio. Broadly defined, right? So some more on the health tech and software side, but increasingly you're seeing people start to play in biotech that historically weren't there. So what ended up happening was you had a supply of investors goes up, demand goes up, valuations go up, and what goes down, cost of capital. Now, exactly as you're saying, you've got this public market sell off, you've got IPOs that were rocket ships that are now crashing down to earth. You've got demand going down, you've got valuations going down, and cost of capital is going up.

Danny Crichton:
Okay, so we have huge gyrations in the cycles, but what about all these companies caught in the middle?

Josh Wolfe:
Well, I think the reasonable thing you have to ask is what happens next? And I would predict consolidation. I think you're going to see a massive wave of consolidation. You have hundreds upon hundreds of biotech companies that are trading today at or below cash and for good reason, because many of them have less than a year of cash. And so you're going to see some big pharma companies, you're going to see some biotech companies, you're going to see some private companies, some of which in our portfolio start to buy these things up. Now, I think only three things matter if you are going to survive in this space. The first is having war chest of cash. You got to have a lot of money on the balance sheet.

Second, is having what I would consider supreme and celebrated science. Supreme meaning it's better than anybody else has and celebrated as in like people recognize that. And the third thing is killer management doing clever deals. Killer management's really smart capital allocators, high signal science, but able to do clever deals and extract maximum value, particularly out of potentially suffering peers. And so if a company has one of those things, they're screwed. Two of them, they're probably going to do pretty well. You got a killer management, you got a lot of cash you're going to do okay. All three of them, you're going to be money.

Danny Crichton:
Now, obviously, when you look at the FDA over the last couple of years, there's a lot of positive news across phase one, phase two, phase three clinical trials. A lot of it was positive. That's where a lot of these jumps came from but it seems like the FDA sort of pulled back or at least like the companies that are showing up maybe aren't as good as they were before.

Josh Wolfe:
It's a great temperature gauge if you actually look. I think something like 60 or 70% of news over the past few years was positive. So the FDA was basically like, yes, yes, yes, yes, no. Right now, all you hear is no, no, no, no, no. So only 20 or 30% of news that's coming out of clinical trials right now is positive and you take a step back. Why is that happening? It's happening because a lot of crap was funded over the past few years. You've got a ton of lower bar science. Remember, if you have a ton of money coming in, more stuff is getting funded. Not all of that stuff is high quality. It's great for the human condition that more and more things are going to get tried, but most of them are going to fail.

What you're seeing now is natural phenomenon of more stuff that got funded, failing, and, to me, it shows that the immune system, which is the FDA for allowing drugs to get through is working. Now what happens next here with all these failures, you're going to see people making massive cuts and there's only three things if you're a biotech that you can really cut. You can cut people, you can cut programs or pipeline, and you can cut your property. Try getting a lease as a biotech company anytime over the past two years, impossible. You are paying top dollar, you're going to far end outside of Cambridge.

Danny Crichton:
Even the last year you and I have been on these email threads with founders in our portfolio negotiating leases for laboratory spaces in Cambridge, Seattle, San Francisco. It doesn't even exist. We actually have to get into the pipeline before these buildings get built just to be part of it.

Josh Wolfe:
I think that's going to change. You're going to see huge amounts of the subleases available. People are going to be trying to get out of their space. They're going to be reducing their headcount, something you haven't seen in a very long time. That's the thing to watch for. I think the people, the programs, the pipeline, the property, where those cuts are happening and the people that have the cash taking advantage of the people that don't.

Danny Crichton:
The other phenomenon here, which is a positive thing, is as all this money gets spent, you get democratization of access to tools and science and techniques that 10 or 20 years ago you needed a billion dollars in a giant government program to fund.

Josh Wolfe:
This relates to something I was just reading the Wall Street Journal last week, which is Eric Green over at the National Human Genome Research Institute had a consortium of about a hundred scientists decentralized around the world, and they filled in the last 8% gap in the human genome map. So if you remember back in the 1990s, seller on genomics, Craig Venter against Francis Collins racing to kind of map The Human Genome Project and then they sort of won. They got to the end roughly, roughly the same time, different approaches. But what was interesting is they actually never finished. They actually got it 92% done, not a hundred percent done, and that was sort of left for 20 years. In the last, basically, four or five years, a couple of factors of having first, sequencing technology has gotten a lot better.

We actually can sequence more of the DNA. Second, the cost has gone down extraordinary. So this new project that filled in the last 8% gap cost several million dollars compared to $3 billion in the original human genome project. So we're seeing like a thousand X cost decline in genetics. And then third, and I think it's just really interesting when you think about the power of the internet, The Human Genome Project was a huge centralized efforts rundown of the NIH, Craig Venter, private company, doing the exact same thing. Here we had a consortium of decentralized scientists all around the world using the internet to basically fill in the gaps. They found a hack, hydatidiform moles was the hack. And so here's the challenge. You have two sets of DNA, one for your mother, one for your father. It's actually very easy to confound those two together when you're sequencing.

Using the mole. The scientist, that mole, only has DNA from your father, not your mother. Has two copies from the patrimony line, not the matrilineal line. And so the scientists were actually able to figure out the rest of the sequencing using that specific mole. Two scientists who led the project actually came together over a pizza box and go, "We can connect all the dots here together. We can fill out the last 8%." So I think it's an amazing story of bio progress. We now have eight more genes and 200 we don't even know what they do so that's going to give us a ton of work to do over the next couple of years to figure out more on the human genome. And it's a huge indication of just how much democratization has happened in bio. The cost, the knowledge, the talent and these networks have formed to really create a best biotech industry going into the 2020s.

Danny Crichton:
Well, the beautiful thing about democratization, as you noted is as these things get cheaper and cheaper and it was $3 billion for the first genome and now it's like hundreds of dollars or less and that that's going to keep going this trend, you still have this associated phenomenon that people know as Eroom's law, which is the inverse of Moore's Law, which is that no matter how many tools and technologies we have, it seems that the cost to get a drug keeps increasing, which is this weird phenomenon. And it's not really that weird when you look at the regulatory aspects and the cost to do this and enroll patients. Just like you can't use nine people to make a baby faster. You can't enroll patients much quicker. You can't run the drug trials much faster for safety and efficacy.

There are people that are starting to look at how do we use simulation modeling, computational techniques, to basically be able to streamline and speed up some of those clinical trials, particularly for phase one and phase two for safety, and toxicity, and efficacy, before you're actually putting it into humans. That itself is also democratizing the small biotech company who used to have to go to a CRO and run these trials and develop the drugs externally, sometimes in China. Now, we're able to do this increasingly leveraging bench tools, widespread network of science and scientists, and try to accelerate that process.
So very excited about just the onslaught of tools and technologies that I think is going to end up accelerating this and starting to chip at that Eroom's law and bringing down the cost and the timeframe to get drugs to market.

Josh Wolfe:
Well, I couldn't agree more. I think you look at all the platforms at every single phase of biotech today. You go from benchling in the laboratory, collecting experimental data, being able to correlate that in data sheets, your lab notebooks, et cetera, all the way through democratized clinical trials. You are right. Every facet of drug discovery drug development is seeing some combination of cutting edge technology and software involved. So yes, lab notebooks and ELNs and LIMs, electronic lab notebooks and lab information management, that is tying in with automation. So I'm absolutely convinced that in the same way that a rocker, or a band, would have to go and get a physical, talking about real estate, have to get a physical space in a studio and rent the time and the instruments or bring their guitar, and their piano, and their drums, and their singer, and their vocalist, over time, all of those things became virtualized inside of programs like GarageBand and Logic and Pro Tools.

Okay, so stick with this analogy for a second. You'll see where I'm going. And then all of a sudden you look at science. Today, you need wet chemistry, you need benches, you need beakers, you need centrifuges. Increasingly, a scientist will be able to shed the white lab coat and not be tethered to the bench and they could be on a beach in the Bahamas with an iPad and set an experiment just like they would a song on a temporal basis, a sequence from one machine to the next with robots and automation doing that in the cloud. The idea of a cloud lab integrating with these lab tools, the lab information management systems and the electronic lab notebooks is going to unleash the creativity of the scientist who won't have to be tethered to the bench.

Danny Crichton:
Now I think that's very positive. You're starting a biotech company in 2022. You're just getting started. You get to build on top of all these platforms and design a culture and an organization around the kind of tools you have available. What about all these kinds of mid-market companies, the companies that are just getting started that were out five, six years ago, probably built in the old paradigm, this new paradigm is sort of showing up. Are they just screwed or do they have a potential to migrate over?

Josh Wolfe:
Well, it depends where they are in their science. And so, you know, you still might have a discovery platform, but you're going to ultimately, as you go to clinic, need medicinal chemists and somebody that can run clinical trials and so that isn't going to change. What I think is going to change are people that made these CapEx heavy decisions, building out their own labs, in some cases, investing in obsolete equipment, when if you imagine that future that I described before about lab automation, you are shifting from a CapEx decision of doing the outlay yourself to an OpEx decision.

And so it becomes very much like a startup in 2000 having to go and get their own servers and their racks and do it all in house to suddenly having something like AWS where you can do the core of whatever it is that you're making that's valuable and be able to shift the other stuff to the cloud and basically outsource it to Amazon. So I think that same phenomenon is going to happen in biotech and it's going to feel so far into the older generation. I mean they're like, "No, you have to go in and you have to work at the bench, and you have to do the science." And now people are going to say, "No, you can actually outsource many parts of this."

Danny Crichton:
And the last piece here, so obviously XBI, the core sort of biotech index massively down last year, still sort of hovering at some of its historic lows. Are you a long-term buy, long-term hold, sell, wait and see? Where do you stand broadly as an index side of the market?

Josh Wolfe:
Well, I strongly believe that we are in a phase where we are going to go from passive indexation back to stock pickers. And I think that what you've seen over the past 10 years of a dollar in means indiscriminately buy. Now, you can separate that thematically, but now it is a dollar out sell. And when things were going up, they all seem correlated now, things are going down. The XBI is quite heavily correlated whether you look at one extreme like Cathie Wood and ARKK, or you look at the NASDAQ or you look at the Russell 2000 as a proxy, even for publicly traded venture companies, all of those things are basically correlated close to one. Some are down 50%, some are down 70%, some are down 80%, but by and large it's a passive indexation just culling.

And so I think what you have to do is become a discriminating stock picker. And there are long short hedge funds that are excellent at this. There are individual thematic buyers that are long buyers that are very good at this, but it's going to come down to the individual company. And again, the criteria for the individual company that I would be a proponent of, whether it's in our portfolio on the private side or somebody on the public side, number one war chest, balance sheet, ton of cash. Number two, do you have really cutting edge science that is both celebrated and supreme compared to everybody else? And number three, do you have really killer management that's going to be doing clever deals?

Danny Crichton:
Josh, thanks so much for joining us.

Josh Wolfe:
Awesome, Danny, thank you.

Danny Crichton:
To me, the core lesson of this biotech conversation is not to focus on short term prices, but to actually look long term at the full decade that's ahead of us in this industry. We talked a lot about prices, real estate, the changes in the costs and the democratization of scientific tools and all that is related to prices today. And it's hard obviously in a space like biotech where the XBI, the primary biotech stock index has had massive gyrations over the past few years. Two years ago when Covid was spreading all around the world, the XBI soared as many investors dumped their money believing in the future of healthcare, of pharma and bio devices. And then over the last couple of months we've seen a complete collapse ending down 80, 90% for recovering. When we look at the stock prices, it can be hard to see the future of biotech.

We can look and say, "Wow, these prices are really low. What are we going to do next?" But when you look at the fundamental theses that are driving this industry. When you look at the democratization of software, the fact that electronic lab notebooks allow anyone working from a beach to control their lab, when you look at simulations and the future of clinical trials, when you look at the power to connect diverse people, as we were talking about with this new human genome project and the completion from 92% to a hundred percent. To me, we're seeing the core foundational abstractions. The ingredients that will allow a massive new wave of biotech startups to emerge. And that means we have to ignore the short-term stock gyrations in order to see the long-term advantages of this industry. Obviously, Moderna has gone up, it has gone down, but nonetheless, it's mRNA technology is still the core platform that will be used, hopefully, for other drugs targeting viruses like HIV in the future.

To me, when I look forward in the 2020s, as I mentioned at the beginning of this episode, what I see is a wild card around biotech. Yes, crypto, and climate, and content, are going to be huge themes going forward. There's almost no world in which I don't think the Metaverse, or Bitcoin, or large scale direct carbon capture is not going to be important for the world. But in the next 10 years, we see this fundamental gain in biotech and that means we have to ignore all of the little data that we're seeing today to see the long term trends forward. To me, that's super exciting. And if you are a young engineer, if you're someone who is afraid to get into the biotech world, the best part is that it is a great community.

One of the things I've been most impressed by as we've connected with the space is just how many people are excited about the potential over the next decade? How many people are willing to teach, and train, and bring people on board in much the same way that crypto got people excited in the early 2010s. To me, biotech is having that same renaissance right now. And so if you're at all interested in the future of this space, connect, reach out to folks, join companies, because this is where the future is.