In this podcast, Motley Fool senior analyst Bill Mann and host Deidre Woollard discuss:
- The high value of getting a leg up on the competition in the semiconductor industry.
- If companies can do anything to keep secrets from leaking out.
- Why Alphabet's adtech is attracting regulators' attention.
Motley Fool host Ricky Mulvey and analyst Kirsten Guerra take a look at Vertex Pharmaceuticals and its role at the center of cystic fibrosis treatment.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on June 15, 2023.
Deidre Woollard: The shadowy world of stealing tech secrets and Google's ad tech business raises European eyebrows. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Woollard here with Motley Fool analyst, Bill Mann. How are you today Bill?
Bill Mann: Hey Deidre. How are you?
Deidre Woollard: I'm doing well. You brought up the story that I want to dive into because it sounds like the plot of a movie. You've got an executive, he's formerly at Samsung and another Korean manufacturer. He attempts to steal trade secrets and build a chip factory not even a mile away from the existing chip factory in China. What's the backstory here?
Bill Mann: It's a bold statement isn't it? Obviously, when something like this happens, this is a multimillion-dollar facility and it's industrial espionage on a massive scale. This is a fairly high ranking official at Samsung who stole the blueprints. When I say stole, let's start that again. Allegedly stole. I don't want us to end up on the wrong side of the law. According to the allegations, stole blueprints and designs to replicate an entire chip factory in China. Manufacturing has started, was in the city of Xi'an. You could basically see the new facility, the copied facility rising from the original Samsung facility. It's almost as if they were not particularly worried about getting caught.
Deidre Woollard: Yeah. Well, and I found it interesting that in this story, one deal fell through and he was able to find new backers. So this sort of seems like, is it a bit of a free for all with IP or companies not that concerned about where the information is coming from or is it a difference between design and know-how?
Bill Mann: They're estimating that the data that he stole was in the range of $200 million. The interesting thing to me is when you say backers, you would immediately say, well, someone within China was doing the backing, but there were Taiwanese firms involved, there were Japanese firms involved. He hired away 18 Korean experts and technologists as part of this audacious plot, if you will. It really just goes to show, on the one hand, the lengths to which companies will go and countries will go to steal, but also in this environment where semiconductors and chips are essentially the lifeblood of so many industries, is the lifeblood of so many economies. What you're talking about here is it's espionage on a geopolitical level. To say that it's company to company is one thing, but to say that this is something that in a world in which China is being restricted from access to equipment from ASML, for example. This is a huge potential deal and I guarantee you this is not the only place where this is happening.
Deidre Woollard: You mentioned ASML, so we've got this situation right now where we're trying to build factories in the US, we're trying to restrict China from knowing things. When we look ahead to the future, what do you think is going to happen to overall chip technology looking ahead like a decade? Are we going to develop separate pads here?
Bill Mann: I don't know, and I know that's a terrible answer because we're supposed to know things, but I really don't know. But I do suspect that this is, as I said, not the only time that this is happening. China will in fact not sit idly by and just say, well, we don't have access to chips. We might as well do something else. They will be developing very quickly. They don't have anywhere near the know-how to replicate ASML's technology or even Taiwan Semiconductor's technology. I would suspect that there will continue to be efforts if they are not available on formal channels, through more informal channels.
Deidre Woollard: It's not just the chips. There was a story that came out in Bloomberg a couple of weeks ago about a chemist to Coca-Cola, Shannon Yu, she tried to steal the secrets to Coca-Cola's can lining formula. She was setting up this new business in China. How big of a threat is this for companies in the US?
Bill Mann: It's a spectacularly large threat. I thought that was such a, I don't want to say a funny story, but it was so interesting because you assume if someone is stealing anything from Coca-Cola, it's the vaunted formula for Coca-Cola itself, but instead there is a lining that goes inside the cans which allows Coca-Cola products to be preserved longer, to remain fresh and that's what she was after. It doesn't seem on certain levels like that's that big a deal, but I can assure you that is a highly proprietary piece of technology that Coca-Cola has spent millions developing and is not interested in having it shared.
Deidre Woollard: Absolutely, and I think one of the things that always surprises me about stories like this is that despite all of the cybersecurity things we have in place, it gets relatively easy for someone who has knowledge of things to walk away with them. In that story, she was downloading things multiple times and the company seems to be aware of it, but didn't necessarily confront her about it.
Bill Mann: Yeah, cat videos that she was uploading at the same time. Who knows what they're doing to mask their activity? But in a knowledge economy, you're exactly right. The knowledge goes down the elevator every single day and leaves the building. Yes, there is a great capability and all sorts of incentive for people to take that knowledge with them. As former NFL Commissioner Roone Arledge said, "Whatever the question is here, the answer is money."
Deidre Woollard: The answer is always money. Is there anything that companies can do to stop this sort of thing or is this always trying to plug a hole that there's just another hole that's just going to pop up?
Bill Mann: Well, I think that there are an endless amount of ways in which companies and other competent bodies will try to steal. It's been going on since as long as there has been money. Yes, there are an endless amount of ways that they will continue to have to plug their holes. This sounds like a fairly negative story, it is important to note that once again, they were caught. We know about this because this alleged activity was unearthed. It's going to continue to happen, but I think that we are probably better at finding and upending espionage than people might think.
Deidre Woollard: Absolutely. Well, switching from text secrets to monopolies, earlier this year, the US Justice Department, they sued Alphabet over having a monopoly in the ad tech space. Now the EU, they're getting in on the act. The European Commission says that Google may have abused its dominant position by basically favoring its own ad tech services. The interesting thing about this is Google, they're active on all sides of the ad tech transaction, sell-side, buy-side. They've got the exchange in the middle so the concern is, there's a monopoly here. Is this a problem and what do you think might happen next?
Bill Mann: I want to make sure that I add this little disclaimer, which is this. I am not an attorney nor am I a trade attorney. So anybody who is a trade attorney who is listening to this be like, you don't have this or this right. I'm going to just try to be as best I can a layman who is setting the table properly. US and EU antitrust laws are a little bit different from each other. The standards for antitrust in the US are much higher and generally speaking, in order to win an antitrust case, the thing that needs to be proven is harm to the customer, whoever the end-customer is that is generally speaking, who the U.S. antitrust laws are focused on. In Europe, it's not quite the same. They are focused on a number of different parties.
Bill Mann: There is a term of art called a refusal to deal. The threshold by which in Europe antitrust law can find that a company has refused to deal is much lower. In this case, what Google is primarily being accused of, is shutting out other competitors for its ad space, for its ad-tech, and making sure that its own ad technology, its own ad partners got premacy on the Google system. They've already paid more than $8 billion worth of fines in Europe, which sounds like a lot until you realize that they make manifold that amount. You could almost view it as a cost of doing business. In this case, Europe is suing with the possible outcome of Google having to break up its ad business either in Europe or worldwide. They actually do have the power to do this. They did say that this suit is not a presumption of a finding. It is, however, a pretty massive exposure for Google itself.
Deidre Woodlard: Well, in the response to the announcement, Google's VP of Global ads, Dan Taylor, he published this post. It seems like monopoly one-to-ones, or there are lots of other competitors in the ad space. This position actually helped that little guy. There was like a point to the other guys. That's like no, this our position actually helps the little guy. Is this a compelling argument?
Bill Mann: No, it's not a compelling argument. I mean, I don't think so. I mean, I'm not sure under US law that they would be able to prove harm to consumers. But this is what we're talking about here. Yes, there are plenty of different places you can go. But Google is by far the dominant one. They have so much capacity to put their thumb on the scales. I mean, did they I'm not guy, and under no circumstances what I suggest, what they have or have not done, but they very much do have the capacity to shut anybody out, including Glenn, the ad guy or it's really hard to look at a case like this and say, well, Google had all opportunity. Are we really saying that, there was never a case in which they made sure that they were getting the best of the other side of the business.
Deidre Woodlard: Well, both the US and the EUR saying that Google may need to break up the business, and potentially sell ad exchange. That's the story. That's the thing right in the middle between the buy and the sell side. If that happens, any idea of any company you'd like to see as a potential buyer?
Bill Mann: Though, I would imagine that if they were going to be broken apart, that ad exchange would become its own business. I mean, I don't think that what Google would do would be to say, well, Apple, you take it because then you have the same problem. But it's just a little bit in a different place of the alphabet. I think that if we go down the road, and if Google does have to break out certain components of their business, those certain components of their business are going to almost by necessity be independent.
Deidre Woodlard: But we'll have to stay tuned, and see what happens with this one. Thanks for your time today, Bill.
Bill Mann: Hey, thank you, Deidre.
Deidre Woodlard: We've got even more monopoly discussion up next. Ricky Mulvey in Motley Fool, analysts, Kirsten Guerra dive into a biotech company that owns a virtual monopoly for life-changing treatments.
Ricky Mulvey: You can innovate and generate solid free cash flow. Joining us now to talk about a company doing just that. It's Motley Fool analysts, Kirsten Guerra. Good to see again.
Kirsten Guerra: Thanks for having me on, Ricky.
Ricky Mulvey: Wanted to talk about Vertex Pharmaceuticals, ticker VRTX. To set the table, what does this company do?
Kirsten Guerra: Yeah. Vertex Pharmaceuticals, as you can probably tell by the name, they are biopharmaceuticals company. They have a whole commercial drug development program. Their bread and butter, really, that drives their cashflows right now is a suite of cystic fibrosis drugs. In this space, specifically, they have a virtual monopoly at this point. They sell those drugs under several different names. You may have heard of TRIKAFTA, ZyDeco or Combi Kalydeco. These different titles are these different names serve different mutations. They're approved for various different age groups. But they all target the cystic fibrosis patient population. They're all really in that area. Let me back up for a second. If there's anyone unfamiliar with cystic fibrosis, it is a genetic condition that just deals with the fluids of the lungs and digestive system where those fluids become too viscous essentially, so it causes a lot of mucus buildup, and it can impact quality of life. This area for Vertex, they've been very successful in this area, as they said, they have a virtual monopoly here it is, provides the dominant cash flow for the company. But of course, being a biopharmaceuticals company, they also have a pretty extensive drug pipeline as well with different drugs for different conditions in various stages of that pipeline. I'm sure that we'll get into that.
Ricky Mulvey: Yeah, TRIKAFTA, is this the big cash cow for Vertex, but is this something that could be disrupted by a generic treatment or competitors working on something similar?
Kirsten Guerra: Yeah, definitely. I mean, there are other ways to treat cystic fibrosis. First of all, you can take simple things like antibiotics just to prevent lung infection or you can take medicines that will thin the mucus that's building up. There's also like vests that have these high-frequency oscillations that physically break up the mucus from this condition. But all of those things are band-aids or they're more like band-aids. Whereas the Vertex cystic fibrosis suite, they all really treat the underlying condition. They actually go in, and correct the misshapen protein that causes cystic fibrosis. To be clear, it's not a cure. This still requires that patients take daily tablets, but it's way better than all of those band-aid options. Could a generic treatment come in and disrupt that? Absolutely. When I call it a near-monopoly, that based on the quality of life that's offered. Like I said, there are all of these other treatments you can do. But the quality of life here as much higher with this drug suite. It's been shown to let, those who take TRIKAFTA have shown significantly lower levels of anxiety and depression, than non TRIKAFTA patients. Because of that, it is definitely priced for monopoly status.
Kirsten Guerra: So any threat to that would potentially drive down the price, whether it's a generic or even a comparable branded drug that's able to come to market. With all that said, it's easier said than done. It's not as if competitors aren't out here trying they are competing development pipelines exist in this space. AbbVie, for example, just recently canceled their development program for cystic fibrosis. They didn't make it to our Phase 2, but their Chief Scientific Officer came out recently and said that it's simply, "does not work". And so again, it's easier said than done to actually compete with a drug like this.
Ricky Mulvey: So approval process is very difficult for these drug companies and they're working on some bleeding-edge stuff like a non-opioid pain killer, CRISPR treatment for sickle-cell. How do you think about regulatory risk for investors and Vertex or investors considering it?
Kirsten Guerra: They have a substantial pipeline going on here, focusing on a lot more specialty markets. And all of those are in various stages of the regulatory process that you mentioned. So for example, there's some under-development for sickle cell disease and beta-thalassemia, muscular dystrophy, type one diabetes, among others. As they said, they're all in various stages. Some as early as just being researched, some that have moved into phases 1,2,3. And the way to think about those phases is that realistically any of these drugs can and will fail at any point. The higher the Phase drug makes it into, the more likely it will come to market. But the likelihood is still quite low. This is still very risky. And so to think about that regulatory framework, I think you just have to be aware upfront and accept the fact that this is an industry where a lot of the future cash flows that you might be excited for on the horizon potentially just won't come to pass. And so that's why a substantial pipeline is key. And maybe of ten treatments, if that's what's in development and maybe only one of them comes to pass. And that's how these things are priced out. You mentioned CRISPR, some of the corporate audit.
Ricky Mulvey: Let's talk about it. What's going on with the work with CRISPR Therapeutics?
Kirsten Guerra: So crisper, some of their more advanced stage pipeline development programs actually are with CRISPR, with CRISPR Therapeutics using the CRISPR gene editing technology. So they're trying to develop one-time treatments here that focus on, the partnership with CRISPR is specifically toward blood disorders, sickle cell disease, and beta-thalassemia right now with CRISPR, those studies are ongoing in phase 3, which as I mentioned, is one of the later stages. But they have already filed their biologics license applications to the FDA, including a request for priority review. So typically the review processes around 12 months and they're trying to do that even quicker. That's not yet approved to be clear. But in this space, anything like that is a positive sign. Management here knows far more about the success or failure of the trial at this point. So any indication we get of how they're communicating that with the FDA is going to be a positive sign.
Ricky Mulvey: In the human trials that have been going on for years now, there were 31 sickle cell patients that were all freed from symptoms, even though they had all been previously diagnosed with severe cases. Good MPR story about it and I'm hopeful for those people with this new treatment. Anything else in the development pipeline you want to chat about?
Kirsten Guerra: I would say that for anyone interested in seeing more that is in the pipeline, I would just search up, google Vertex Pharmaceuticals pipeline. They have a great visual. The first result that comes up should be their website. They have a great visual of everything they have in the pipeline, what stage it's at, what they're trying to treat, what thereafter? Acute pain. They have had a pretty widely publicized effort in acute pain, a non-opioid pain drug, last March was when it was announced that Phase two resulted in outperformance of placebo and important early first step in that development program. Phase 3 should've started late 2022. That's expected to come with results in late 2023 or early 2024. Still behind the scenes. A lot of times with these drugs, you just assume that progress is being made until suddenly you are informed whether that is true or whether something has ended. But that's where that one is. That again, as I said, that's widely publicized. I think a lot of people are excited for the opportunity there.
Ricky Mulvey: The person driving the ship is Reshma Kewalramani , that's the CEO. Is leadership something you focus on with this company? Or do you want to make sure that the CEO is not Martin Shkreli and then you just move on to the development pipeline.
Kirsten Guerra: A little bit. The Shkreli background, it's interesting. Because his background is just business. Kewalramani , she does have a business background, general management program grad from Harvard, but she also has graduated from the med program at Boston University, went through residency, nephrology fellowship. She was a physician before joining Vertex. So she has a clear proven interest in the field beyond just that business acumen. And if you look at the investor or the insider holdings of this company, it's quite low, less than one percent. That's very standard across the industry. Maybe not for every company, but it's pretty standard that most shares tend to be held by institutional investors.
This is just a space where biotech is very tough. It requires tons of cash up front, really long timelines, and they really need that alignment with their investors. So it's best for them to institutional investors that are really willing to fund and hold for longer terms, not a retail investor that's in and out. So that the bigger thing that I would be concerned about in this space that I would look for is if you're looking at biotechs that are smaller cap have single-product pipelines instead of Vertex is many irons in the fire approach, high-retail ownership might be something that concerns me. It could be a sign that they went to institutional investors and couldn't get a lot of backing, and so they're just trying to market themselves in another venue and then maybe an unsafe way for retail investors. So I would just look in that area for if they are doing a lot of clear marketing, if they're speaking to you with a lot of marketing language or their boasting about like every unimportant advancement along the way, anything they can possibly spend as positive, I'd look out for that. But when you look at how Kewalramani speaks or read the transcripts, she always speaks with a very long-term focus for the company. She's very measured in how she presents results moving forward. It does not sound like marketing jargon or a hype cycle. So that's what I look for and I don't see a lot of concern here with Vertex.
Ricky Mulvey: On devaluation, vertex does have a higher sticker price than many other biotech pharma companies like Gilead, Amgen, Biogen. Do you think the growth story for this company warrants that higher sticker price?
Kirsten Guerra: I definitely do. There's a couple of ways to think about valuation. If you look at like forward price to earnings ratio, for example, Giliead is somewhere around 10 or 11. Amgen is around 13. Vertex right now is around 22. The first thing you notice about that, of course, is that it's higher. I think maybe what's more interesting is that if you look at, if you look at the trend over the past year or so, where Giliead, like I said, 10 or 11, it's very flat around that area. Amgen, again also pretty flat around 13, vertex 22 now, but was 17 just over a year ago. So you actually see a pretty clear rise there. And so what does that mean. It can be a number of things. Many things influenced the market of course, but I think biotech analysts consensus seems to be rising on the progressive updates that we're getting in this pipeline. This is one of the more advanced pipelines in the space.
So you just see that rising interest based on continued positive feedback coming from the company. My preference in thinking about valuation here is to do more of an expectations investing approach to take the current price that it's at. And then back that out into, what are the revenue and operating margins that are really expected here based on that price. And if you do that, there's a number of ways to do this. You can come up with different numbers. I came up with something around five percent revenue growth, 50 percent operating margins where in terms of operating margins, that's where Vertex operates about right now. And then i dropped that to 40 percent in perpetuity.
Given that outcome, I think that that's where Vertex is today. That's pretty reasonable in terms of expectations. It is dragged down, largely over concerns that we talked about the potential for competitors to enter the space or generics. But I think it is not factoring in a lot of expectation for the pipeline. It's a balance of those two things, the uncertainty of generics and in my opinion, maybe not weighing the potential of their advanced pipeline quite enough. That's how I think about valuation, but there's definite risk here. I don't mean to say that there's not most pipelines again, do not work out. It's very possible that most of the things in their pipeline don't work out. But if even one or two does, that could be a very substantial contribution to the company going forward for their cashflows.
Ricky Mulvey: Kirsten Guerra, thank you for your time and your insights.
Deidre Woollard: As always, people on the program may have interest in the stocks they talk about on the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Woollard. Thanks for listening. We'll see you tomorrow.
