Nov 12, 2020

Mind Your Variables

By Michael Caldwell

Mind Your Variables

The election is behind us now, as is the first release of COVID vaccine data, so those are no longer topical, right? Well, not exactly, but everyone would likely agree that the probability distribution of outcomes (however you define that) from here looks a lot different than it did two weeks ago. We think it uncontroversial to say that we have greater certainty on the outcomes ahead on multiple fronts, as a result of these datapoints.

Investors love certainty. Heck, everyone loves certainty. Is it better when the cable guy says he will show up between noon and 6pm, or when the cable guy says he will show up between noon and 1pm? Even if the cable guy shows up at 1:30pm in the latter scenario, it is still better than having to block off your entire afternoon and early evening to be ready for the 10-minute visit that needs to happen for your internet to keep working. There is a premium on certainty.

Investors consistently pay a premium for companies that have recurring revenue models. Why? Because the recurring revenue models give companies and investors alike greater visibility on future revenue; there is more certainty that dollars will be flowing in tomorrow in a recurring revenue model than in a model where new sales to new customers need to be made every day for revenue to stay flat. Lots of value can be created in both models, but investors prefer the recurring models and valuations reflect that.

These concepts port to development-stage therapeutics. Stick with us on this because it's more straightforward than you may think. Plenty of the clinical trials that go on in the industry are “science projects,” a term we use to describe strategies that require hypothesis generation in order to reach the ultimate outcome of bringing a drug to market. We at Driehaus much prefer to invest in development-stage drug companies that are seeking to confirm a hypothesis than those companies that are doing “science projects.”

If you are reading this, you have probably heard us talk about Alzheimer’s before. We view Alzheimer’s as a massive opportunity to improve the lives of patients, families and caregivers alike. The world needs new Alzheimer’s drugs. However, we do not believe the world at-large understands the pathophysiology (why and how disease comes about) of Alzheimer’s disease and so most of the experiments (clinical trials) that are being done in humans in Alzheimer’s are hypothesis-generating “science projects,” based on our assessment. That is okay, and progress will come, but that profile is not for us.

We like to invest in companies targeting diseases that are understood, but lack good treatment options for various reasons, many of which relate to new technological advancements as well as advancements in the understanding of disease. In fact, we think these situations warrant premia for multiple reasons, not least of which is that the world at-large understands what’s going on with a disease, and we may even understand what it takes to positively impact that disease.

Certainty is valuable, and that is why we look for it.

This information is not intended to provide investment advice. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, market sectors, other investments or to adopt any investment strategy or strategies. You should assess your own investment needs based on your individual financial circumstances and investment objectives. This material is not intended to be relied upon as a forecast or research. The opinions expressed are those of Driehaus Capital Management LLC (“Driehaus”) as of November 2020 and are subject to change at any time due to changes in market or economic conditions. The information has not been updated since November 2020 and may not reflect recent market activity. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Driehaus to be reliable and are not necessarily all inclusive. Driehaus does not guarantee the accuracy or completeness of this informa­tion. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

About Michael Caldwell

Michael Caldwell is a portfolio manager and a senior analyst on the US Growth Equities Team with a focus on the health care sector.

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