Today's article is as painful for me to write as it may be for many Real Money readers to read. On May 15, I wrote an article titled, Finding Good Picks Among 13Fs. The article was a kickoff to 13F season, the period after each calendar quarter when investment professionals reveal their quarterly holdings. In that column, I focused on one of my favorite investors, Seth Klarman and the picks made by his fund Baupost.
I noted that Klarman had taken numerous stakes in biotech companies over the past several years and had done so with fantastic success. I also pointed out that Baupost recently made a $300 million Idenix Pharmaceuticals (IDIX), picking up 30% of the company in the process. Despite this move by Baupost, I sat still.
It turns out that Idenix was working on various viral drugs including a hepatitis C drug. Recently, I knew that Gilead Sciences (GILD) had launched a hepatitis C drug that supposedly cost $1,000 a dose and that demand was expected to be robust.
Apparently, Merck (MRK) felt the same way about hepatitis C because they agreed to buy Idenix for $3.5 billion. Prior to the deal's announcement, Idenix was being valued at $1 billion or around $7 a share. Merck is paying more than $23 a share. The stock rallied 230% overnight. Klarman made a cool billion in less than six months. I made nothing watching from the sidelines.
As painful as it was to watch this gain happen before my very eyes, the lesson is instructive. Biotechs are very speculative investments, but the payoffs can be immense. Klarman, who is a noted deep value investor, has nonetheless made many investments in this field with great success. His formula seems to be to pick companies with strong drug candidates in phase 2 or phase 3 trials that are focused on areas such as cancer and other serious viral diseases.
The beauty for individual investors, as proven by Idenix, is that you can screen away many of the speculative element by focusing on the names that investors like Klarman choose to invest in. You did not have to invest in Idenix at the same time Klarman did to make money. The real money is made when the companies are acquired or reach milestones in the Federal Drug Administration's (FDA) approval process. And as you can see, the upside is often gains in the triple digits. So if one or two don't pan out, the winners will offset the losers by a wide margin.
For years, Klarman has understood this skewed big biotech payoff. We just got to see one in real time. I'm sure there will be others. Now that you've been taught to fish, it's time to go out and reel in your own big catch.