Episode 25: Joseph Edelman - Founder of Perceptive Advisors

0:00This week on Generating Alpha, I sit down with none other than Joseph Edelman, founder and CEO of Perceptive Advisors and widely regarded as one of the greatest biotech. investors of the past two decades for his first ever podcast interview. Since founding Perceptive in 1999, Joe has built it into one of the most successful healthcare-focused investment firms in the world, with a track record that ranks among the best of any human-managed hedge fund over the past 25 years. Joe's investing approach is rooted in deep scientific understanding, paired with bold, high-conviction decision-making in one of the most volatile sectors in finance.

0:38Under his leadership, Perceptive has backed some of the most transformative biotech and life sciences companies, companies that are changing how we treat disease and advanced medicine. In this conversation, we explore his early life, how he developed his passion for science and investing, the founding and evolution of Perceptive, how he navigates uncertainty, and what it takes to win in one of the most complex and dynamic corners of the market. I had a lot of fun making this episode, and I hope you guys enjoyed listening to it. Thank you. Well, thank you, Joe, for joining me. I really appreciate it.

1:10Thank you for coming on. Absolutely. I want to start off where I always start off. Just tell me a little bit about your childhood, your upbringing, where you grew up. Yeah, I grew up in the city of San Francisco. My dad was a professor of biochemistry at UCSF.

1:31and I went you know he was a pretty well-known scientist member of the National Academy of Sciences and so I grew up around that kind of you know that's as far as the science you know now I have analysts who have PhDs and MDs you do need that and that's become more important as time has gone on. My background is generally more psychology. So I went to UCSD, University of California, San Diego, majored in psychology.

2:12And then I moved to New York at the age of 25. It's a bit of an unusual story. I didn't get my first job as an analyst until I was like 32 and I had no I just had an MBA from NYU and we can go into that you know the I was really like a part-time analyst at a very small firm but I got some attention for a short sale actually on a company which had a five-minute AIDS test for AIDS, HIV. And what happened was I did a pursuit of master's in business at NYU. And as part of that, in order to get, because by that time, I decided I'm not going to try to go into science. I started a PhD program in pharmacology.

3:06And then I realized very quickly it wasn't for me. And I thought, you know, maybe biotech analysis would combine you know scientific interest and interest in business and making money and so as part of my MBA I wrote a master's thesis for a biotech analyst who on on diagnostics and from that I learned enough to know that you know immunodiagnostics things like which hiv tests and hepatitis tests and other in vitro diagnostics was not well understood on wall street so anyway so my first job there was a company cambridge bioscience that had a a test a five minute test for hiv which right on the surface is stupid idea because you don't need an immediate answer what you want is complete accuracy you don't want to tell somebody who has hiv that so the way this is done is they do these tests that take, you know, a day, and then they repeat it before they give you an answer.

4:22So, and then they confirm it with a Western blot. So maybe whatever, you know, 48, 72 hours later, you get an answer, but you get the right answer. Do you have it or not? And that was one of many reasons I thought this would not sell well. Maybe I'll go into a little more about it because that really taught me the most important lesson of the stock market, something I call repeat surprise. What happened was this company, Cambridge Bioscience, the two sell side analysts on the street had, I think it was like 25 million and 30 million in first year sales. So I saw my chance to somebody to pay attention to me because, believe me, nobody knew who I was.

5:09and I said this would sell less than a million dollars. It was an interesting, because it was a one-page report and I just made my own rating, which was immediate sell. So the first line was really obnoxious. It was, if you own this stock, you must sell it immediately. That's the kind of, and people got really pissed off who held this stock. I was completely naive about some of this. I never visited the company, never talked to the company. And here I'm telling people, you know, you got to get out. But I said it would sell less than a million dollars. The first quarter, I don't know, maybe it was$50 ,000.

5:53The people, the two analysts who were, you know, 30 and 25, all of a sudden they're very biased. So the company is telling them, well, we didn't start our marketing campaign or something. So they slashed their number. But what do they go to? They go to 15 million or something like that. And I'm thinking I'm at a million. It's not even going to do half a million. So I lower my number to 800 ,000. Now we're at an average, if you look at a consensus, of 14 million. so this is where the repeat surprise comes in because the bulls were so biased and if you think about that this gets more extreme depending if you came out with a buy rating you know two weeks before the quarter how are you going to go from 25 million to 500 you're not going to do it you're not going to let yourself think it's possible you're not going to so now the average is still way too high the next quarter they do whatever 100 000 People have to lower it again.

7:00And I put the sell on at 15. I unfortunately went to a hold rating at like four and it ended up in bankruptcy at zero. The stock went to zero. The CEO, CFO ended up in jail for trying to cook the books. and that's so it was repeat negative surprises caused by two things the bias of the bulls wanting to believe you know the glass half full and then in this case the liberalism of the bear in other words i didn't need to go down and repeat surprise you still see it in the market i knew it would become you know less because market has grown tremendously in efficiency but um for instance amgem which is the world's biggest biotech company they had 18 positive surprises in a row and why because what would happen they were very good at keeping their first drug epigen was blowing away everybody's numbers and you try to raise your numbers the company would call you and tell you you're too high you're going to embarrass yourself and they would convince you that and sure enough because here positive surprises in that case the bulls can be very conservative they can be low which is really what they want anyway it's not that they're looking for accuracy the company can be conservative make sure that the numbers are achievable or beatable.

8:36And then bears are biased in that case. So they, yeah, they're thinking it's one off, they're going to miss next quarter. So they don't raise their numbers enough. So in the first case I gave you, people weren't lowering enough because of this combination of bias, in my case, being too liberal with the numbers. And in the case of Amgen, they wouldn't raise their numbers enough because company all that and by the way the I was a cell side analyst give you the background I went because of Cambridge Bioscience I got a job at Prudential of course I was a terrible cell side analyst I was literally the lowest rated biotech cell side analyst in history.

9:20I'm not, you know, I hate to say I'm lazy. I don't work super long hours. So a lot of what I was able to do was I surrounded myself. It was a guy, Wayne Rothbaum, who I was a mentor to, who was a workaholic. And I was really sort of teaching him more, the two things repeat surprise is very important and then just the basic perception reality that's this uh so if you look at a biotech stock or any stock has the element of perception reality but in the case of biotech there's three questions you're trying to answer does a drug work which is phase three trial will it be approved which is on the padu what's called the padufa date where the FDA says approved or not approved?

10:12And then will it sell enough to justify a higher price? Okay, so you've got three basic questions. Everything else is perception of those things in between. So you spend years, you know, a certain amount of early-stage data, but basically the perception will the drug work is what's driving the stuff. then it turns to let's say it works in phase three um will it be approved you know which is sometimes simple but oftentimes not and then after that on approval you know will they meet and we talk about how you value things but will they fall short of consensus or beat consensus and ultimately will they produce enough earnings to justify a higher stock price.

11:06And everything else is perception of those things. Now, we're in a pretty long bear market for biotech. Basically, people, I think, and I'm worried about this, obviously not enough along the way, that people would get discouraged over time that there would be less, simply because it's a very easy place to get blown up. and um you know if you're trying to answer all three questions which ultimately you need to do right because the ultimate reality would be the earnings the ultimate ultimate would be like a discounted cash flow of of earnings that's very hard to predict all three of those things very very easy for your drug you think is going to be a billion dollars to be you know five hundred million.

11:59We do a tremendous amount of work there, but it's still difficult. And of course, they're going to discount a certain level of earnings. That's just the way the market works, right? People think it's a$2 billion drug. It'll be discounted somewhat from there, but people are not going to value it as if it's going to be$200 million. They're going to pay. Right. So as time went on, I think in the last four or five years, it's a combination of inflation, interest rates, which. The reality of those things, how much they affect is less than the perception, but that's like a signal for people like don't be in simply on economic grounds, for instance, if if you have inflation, then a dollar today is relatively worth more than a dollar in the future.

12:51Um, so it's not been a popular group, but now I think it's, it's actually at a level where you've got winners and losers. But, you know, that's not the kind of easy environment where you just say buy biotech that I think you don't want to do. I think you need to, you know, get a story where you can have some, you know, either it's commercial. And for instance, we're big in a company, Verona, where you think that the sales are going to keep beating numbers. The earnings are going to justify a higher stock price. Or if it's developmental stage where you've got a very good chance of, you know, the drug working and so forth.

13:39So maybe I'll stop there. putting all those principles kind of into practice from a very high level if i was sitting in like a room with you guys during your research process versus a room at other biotech hedge funds what would you say kind of separates the research process what would i see differently on a high level with you guys not much not much an animal no probably not i've never uh you know i tell analysts you know because analysts um it's stressful and there's a tendency you know that they want to pick out something in the story that's either they can, you know, right or wrong. Unfortunately, the market being more efficient, you got to look at, you know, you really got to look at the whole pipeline.

14:24But I would say that the same, particularly at hedge funds, that they're debating the same things. Honestly, I think the market is extremely efficient. You can see it in often in the stock prices um so i don't think it's tremendously different we may be more long-term oriented than say a pod you know what a pod is like yeah like steve cohen's people more of a shorter term thing um where they're very focused on the catalyst maybe they're willing to that very big. And by the way, catalysts don't automatically work unless there's a difference between perception and reality. If everybody thinks the drug's going to work, you know, the drug stock may not go up on positive results.

15:16But I make all my analysts, I'm probably more focused on them modeling. I got everybody, you have to model it. And then we compare all the models so this would be long-term 10 years income models um i warn them that i don't believe their models because their models are 100 wrong by definition but it's it's still first the model gives me if it is on the right side of things let's say one of my analysts think there's a two billion dollar drug and other they're bad there's not being valued at a billion Then, you know, if it's a billion and a half, it still may be a good buy. It allows me to compare for weighting purposes where today's market, a lot of them, for instance, I would use, you know, a discount cash flow model, right?

16:13I would use that for one product company like a Celino or something or a company where there's no reason to put a P.E. multiple and you can get in trouble because. You had a company which, you know, you got to a point where it was earning, you know, a dollar and then a dollar 20 and then 50, whatever, you know, you might have a 20 P.E. that's somewhat reflective of its earnings growth. but if you have a company that's$1,$20,$1.50 and then$0.50 the market will discount that that won't be a 20p, that won't be a 10p that might end up being a 5p so for single product companies or companies with short patent lives that's what I'm going to reflex to mostly on the other hand we have other stocks where they have pipelines so you could deal with that which might have value they might have negative value or positive value by the way because if they're throwing their money away which happens all the time that's not good but let's see example like a company like a new valent which we're in which we think has multiple good drugs so that i might look when they're profitable and say hey they can do you know i'm gonna actually So at that point in time, that might get a PE multiple 20 or whatever, depending on the earnings growth at that time, because people will still be excited about what's coming up.

17:45The other way you could deal with that if you wanted to is just take the DCF and then add on a value for the pipeline. So this is to get long term target prices. So when you think about short-term and long-term, often that's perception, reality, not always, but, you know, short-term's perception, long-term's reality. One of the things that gets analysts stressed among many things is they, I keep saying, you know, I want a short-term view and a long-term view. That's what I'm going to come with. And then when you say, well, what do I value it on? A short-term opinion? Normally, you might say, well, short-term is all that matters, right?

18:32The problem is what's your confidence level in those things. So what I would say the ideal stock is something that you believe it's going to go up on short term. Let's say short term perception or in the case of Verona, you know, quarterly earnings. And you believe long term is worth a lot more. Those are hard to come by. A lot of times you have something where you say. I think let's say it's edgewise, you know, earlier stage company, I believe in this long term. There was this hiccup in the trials, but between the two drugs, I have high confidence that at least one of them will be approved within five years and will sell a billion dollars.

19:18But short term, you know, the data was slightly funky. And even though I think they can get past that with further testing, you know, I'd have to get into details. But there I might put more value on the long term because that I actually believe in. Say in that case, let's call it the 70 % likely it's going to work long term, but it's 50-50 short term. So maybe I reduce the position. One of the things that there's many things that I think may be differently than a lot of people. I don't think in terms of, first of all, buy low, sell high, throw that out. That's just a bias. that's not worthwhile all you got to do is say independent of whether you owned it in the past you sold it lower sold it higher or what the stock has done is say at this point in time objectively and this is the most important thing is just uh relentless objectivity which hard to do because it increases your uncertainty but is it worth more so for instance you don't want to get into biases like let's say you were an early investor in any you know apple computer and you're like you know it was a dollar it went to two dollars and you were worried about a quarter or something you're like i'm i'm taking my profit off the table you know 100 gain whatever you're not likely to buy it back at a hundred dollars it's too painful yeah but that's the kind of thing fascinates me i'm willing to like you know i'll get to a point there's one time i remember where i kept buying high and selling low three times in a row and i'm like i'm out of here i'm done with this shit i don't understand this stuff but theoretically you shouldn't care what and why does technical analysis work technical analysis that you do see it's like the higher it sells for the more it's work i mean it's kind of stupid in a way it should be it buy low sell high if it was all warren buffett um you would never buy something that's up 100 right so you don't want to think that you just want to think objectively and then you have to be willing to change your mind because um i give you the example of repeat negative surprise so all new information meaningful not just um oh the you know the stock act did a little funky one day uh can be reflected in position sizing so that's it so one thing no no buy low sell high and then And as far as you don't, you can go from 80 % confident to 60 % and not necessarily sell the whole position.

22:20Right? People want to say, I like it or I don't like it. This is one of the many things people need. They want to buy when it's cheap. And I've seen just insane examples of that, including ones that I, I was in a company called Pharmacyclics. we bought a dollar and a half it was one piece of data we didn't like my friend Wayne there's a book written about this by the way called for blood and money um he's like he's a very convincing guy I mean six and a half he's like drugs not going to work you know you got to sell it so we sell it then you know six now it's it's all the six and a half it goes to like 10 And he calls me up.

23:08He says, well, I might have been too, too cautious. So what did I do? I bought back maybe half. Couldn't buy, you know, even consciously knowing there's going to be this bias because you think about you bought a buck and a half, you told six and a half, you bought it back at 10. What if it goes to four now? You turned a winner into a loser, but that should theoretically still be a bias because right. Because what difference does it make if you lose money on a company you once made money in or you lose money on some other company because you didn't want to go back into the same one? But we didn't.

23:46And then because we were so early. We were the victims of essentially what repeat positive surprise. When it was a buck and a half, I tried to get the analyst. the blue sky target like what if this thing is just incredible everything's and he got to 18 bucks and i look back and i go might have and so what happened you know maybe that was too low because where we the relativity you know we were buying it so low and sure enough like two years later it ended up 272 dollars but we sold it at six and a half we made four times our money and by the way that traumatized Wayne he then started another company with a similar drug better but he sold that for seven billion so I tell this story like he got us out too early but he went on from making me you know 20 million dollars to making me 800 million dollars So he did okay in the end, but nobody's like him.

24:58Nobody's quite like him. He's just relentless person. And, um, anyway, so yeah. So, uh, let me stop there. You guys have, I mean, I've heard you guys have like 200 plus positions at any point in time, but you're also somewhat concentrated on the positions you believe in. And you've kind of compared that to like a poker analogy. Can you just talk a little bit about diversification and risk and how you think about sizing positions and concentration? I don't torture myself too much. People could look at Charlie Munger, like, what the hell is this guy? You don't need more than whatever it is, 10 positions or 20 positions.

25:44It's all true. but when i go back to like my sizing is more about relative you know if i still feel like let's say obviously one position if i'm going to have a small position it's liable to be very high risk but have higher return than one of my bigger positions so it has a different profile You know, some of this is because, you know, I like it to be a nice place to work and I see what's the harm. I'm not going to do something I don't like. We're going to I'm going to question the analyst. But there are quite a long list of biotech companies, which if the drug works, it's liable to be worth a lot more.

26:34These are earlier stage companies. And by the way, if you have 50 basis points or 100 basis points in a company like that, it could be a 10 bagger. You can make it's not like it's meaningless. It's not like buying 200, you know, big pharma companies where you're just diluting to a point where you're an index and that's all you are. Right now, I have one very large position. So it's got the analysts nervous. I hadn't had that for eight, 10 years. I have a position at 20 % of my fund is company Verona. And it fit what I said earlier, where they're beating numbers near term. We think it's minimum$3 billion peak, minimum$20 a share in earnings, peak earnings.

27:22These are pretty big numbers. Now, it's gone from$20 to$100. But still,$20 a share. you can do a discount cash flows on our most conservative number. It's still like 120. It's still above where it is. And my confidence is high. The reason I don't sell more is because I think they're going to beat the next quarter. I think it's, and I could go into that, but I don't know how much time you have about how that sort of coalesces. Because there was a point in time, basically, where the company got the approval. I never, because I'm a cynic, I always thought, oh, it's a drug for chronic obstructive pulmonary disease.

28:07It's a small drug. You know, I just dismiss things. I'm not the analyst. And I'm like, it's 500 million. And my two analysts are like, oh, we think it's a billion. The company says, yes, we think it's at least a billion. They got approval. They're in our office. and the CEO, who I like a lot, he's got a lot of experience. He was number two at United Therapeutics, which is a successful company. And I said, David, you still think it's a billion? And he's like, no, it's billions. And I'm like, tell me more. Because at 20 bucks, it's reflecting maybe 700 million in peak sales. Well, he said, we've talked to, we've done a lot of early meetings with different specialists, and we're getting very positive feedback.

28:59And I'm thinking, you know, that's interesting because he knows this space. I don't, but maybe that. And I said, do you have any outside market research firms? And he said, yes, Trinity. And I use Trinity. Like, what does Trinity think? Billions. So I get Trinity to do an analysis of it, and sure enough, they come out with$3 billion. And then every time we're meeting with them, you know, because now we're doing a lot of our own calls as Western, you know, different ways of doing it. You know, how much of this drug would you use this year, next year? You know, you can try that. You can compare it to an existing drug where you know the prescriptions.

29:40So trilogy is the most widely prescribed COPD drug. How much use versus trilogy, something like that. and from the pulmonologist and then you adjust for the price and trilogy is like one sixth the price um most of them were saying we think ultimately it will be about the same number of patients well if you do that math all of a sudden you're 15 billion you're not at three billion okay well that seems a little unreasonable it's too much medicare pay there's other reasons but then when I say this to David I'm like you know I can get to you know 13 billion I'm just sort of pricking the tires I'm just saying like how much is he going to push back now he knows this game he's a smart guy but he says to me you know it wouldn't be unreasonable to think it's 10 billion and I'm thinking 10 billion it's going to be a thousand dollar stock so then I'm like even though the stock's going up I'm pressing it because I have so much room.

30:53If you look at it now, you say, well, if I held it long term, what peak sales number would I absolutely need for the stock to not be selling for less, say, five, six years from now? And that would be under$2 billion. So I've still got room. On the other hand, if it's a$3 billion drug, it might be a 10 % compounded in return, nothing great so maybe it shouldn't be 20 but at that point in time where i thought they're going to beat near-term numbers oh by the way when it comes to repeat surprise you gave me the perfect answer i said you know i said david you know i love that the analysts are you know in the threes three and a half billion but we can't come up with less than five billion i said why do you think that is you know that's a little bit of a pressure question and he's like well it takes a while for analysts to catch up i feel like saying good answer because that's the phenomenon of repeat surprise where he's basically saying no they're too low they just haven't figured it out yet so now could he be biased of course could he be being promotional because big pharma's looking at him and he wants to tell the world he's got a$5 billion plus drug.

32:15I can't totally answer that. But every time I've talked to them, they're smiling. One of my analysts says they're chirpy. They seem totally unafraid of expectations for the quarter. That's how I really press that. Then you go down, I've got Arcelix, I've got other ones, mostly some pre-commercial company, Ascendis, which is commercial, which we think will be usually, if it's commercial, you're going to want to think that they can beat consensus, right? where it can be complicated is maybe, you know, they miss by a little bit the next quarter, but you still have reason to think that ultimately they're going to get sales levels that'll justify much higher stock price.

33:14But then you're back to the short term, long term. How do you, how do you integrate that, what you're learning as the quarters go on with what you're seeing in the stock price. Obviously, I don't like it if they miss a quarter, partly because if the drug was going to do so well, the company should have been able to sort of manage expectations like Amgen did, where they can keep beating. because if they're not if they start missing is it because you know they they're scared of what their stock will do or something so sizing it's it's it's it's an art it's not i don't do it scientifically you could do it scientifically simply by there's a a program that i didn't buy i thought it was but where they basically you say this is the upside is this$20 stock,$40 in upside,$10 in downside.

34:20My probability on the upside is X. My probability on the downside is Y. And it will spit out. And then you put parameters. I don't want to be more than 15%. It will tell you what your sizing should be based on the probabilities and the upside downside. So I feel like you've almost given a masterclass on biotech investing. I think at this and I'm ready to raise my own fund to invest in biotech. But I don't want to take too much of your time. So I have one final question I ask every single one of my guests. And that is, if you have one piece of advice to give to, I'm 15, a 15-year-old today, or anyone that's young in high school or college, what would it be?

34:59Specialize. It would be try as much as possible. Don't do quite what I did, you know, in figuring out what it is you want to do. and then learn as much about it as possible. So in the investment world, it would be an industry. Being a generalist is, you know, very hard. And, you know, you have to think about market efficiency. So you have to know every, you have to think in terms of, well, how am I going to, it's like poker. If you wanted to be a great poker player, I don't play poker, But you wouldn't like study all card games or study chess. You just spend all your time understanding everything there is about poker.

35:47That also makes you more marketable. So in general, try to find what you want to do early. And then if you can change because you do want to do what you like. You know, you don't don't. This is what Buffett type advice, you know. don't do you know for the money the money is tricky because vast majority of fields people can make a lot of money you know but what's more important is that you're going to enjoy what you're doing and hopefully it's something you can you know make decent money but by the way happiness is much less correlated with money than people. They just don't accept. That research is very clear.

36:40It was like maximal happiness was$125 ,000 a year. It was low. It was not something you should, and I can tell you from personal experience, I'm very materialistic. I own multiple houses, but it's all diminishing. It can go in the opposite direction. I know it sounds ridiculous, but when you have so much money you can buy anything nothing is that exciting anyway yeah what you want is ideally enough to get kids you know send them to school maybe a second house um i've told anyway you know i as people have asked me like what's most important once you start to make money you know usually say well business class on an airline and a a decent vacation home in the Berkshires and then you're kind of done because after that it's like who you marry who your friends are your health specialize as far as a career as quick as possible learn something in depth and then you can use that and then if that doesn't work out you gotta flip around and specialize in something else but you can't be jack of all trades Thank you for doing this.