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HGSI Tour and Foolish Questions

On Tuesday, January 4th, Kevin D. (TMFGetFit), Jeff Fischer (of the Rule Breaker Port) and I toured Human Genome Sciences (HGS). HGS is a short drive from Washington DC, right outside the Beltway and remarkably close to Celera. In true Fool style the trip was made in Kevin's smokin fast Ford Escort and was accompanied by stock discussions and Starbuck's coffee. After a few wrong turns caused by the lively discussion we found the offices of HGS. There to greet us was quite an entourage of important folks including Dr. Haseltine, the assertive Chairman and CEO of HGS who spent nearly the entire day with us. It was enough to make us giggle, three ordinary guys getting the red carpet treatment due to the Fool power of grassroots investing. I guess I shouldn't be surprised – squint hard enough and you can see the shadows of two million Fool daily readers behind us. Perhaps the recent “unexplainable” run-up of CRA had something to do with it also? : ) Well, regardless, we learned lots of neat stuff. What follows is a “brain dump” of many of the things that we learned while there and answers to selected Foolish questions.

Is their drug development in HGSI's future or are they committed to remaining an information oriented enterprise?

HGS bills itself as “a biopharmaceutical company with the mission to discover, develop, manufacture and market new gene- and protein based drugs.” Unlike Celera, HGS is a pharmaceutical company first, and a bioinformatics company second. Bioinformatics apparently is a sideline used by HGS to keep the cash flow moving while they exploit their prolific heap of gene patents.

How does HGS compare to other pharmaceutical companies?

Not surprisingly, HGS maintains that it is not the same as Pfizer, Merck and the big pharmas. While the big pharmas focus on finding small molecule drugs (those that are easily digested by humans) HGS focuses on the use of genes and proteins to develop drugs, growth factors and signaling molecules. Growth factors and signaling molecules manipulate and stimulate cells to perform various tasks. This is a much more direct route than typical drugs that may affect a cascade of chemical reactions to alter a cell's behavior. For example, a signaling molecule can directly cause a stem cell (a cell which has not yet developed) to differentiate and form a useful cell such as a smooth muscle cell.

What advantages does an information focused business model have over the traditional vertical biotech model? What have you done to streamline your pipeline and keep capital costs down in comparison to the larger companies such as Amgen?

HGS maintains that its biggest advantage is the infrastructure for genomic drug development that it has put together since its inception. They call it the Functional Genomics Program which is a process that first identifies a gene, then finds a practical use, obtains patent protection and pushes the drug through FDA approval and marketing.

Two key parts of this process are the extensive library of actual genes that it holds and its in-house software program. The library is filled with multiple copies of the 14,000 or so known human genes thereby enabling their researchers to quickly perform trial and error experiments on a large scale. The software program provides a transparent view of the activities and progress of all HGS researchers and the results of the aforementioned experiments. The software program also allows the researcher to input information relevant to patentability for later use in patent filing.

Is there any possibility of cooperative agreements with other bioinformatics companies (CRA)?
As mentioned previously, bioinformatics is mostly a sideline for HGS. If, in the future, a subscription to CRA would become advantageous Dr. Haseltine stated that it would be considered.

Who owns what when there is a collaboration?

Amazing question that, I've never seen the words “who” “what” and “when” used in the same sentence. Maybe we can work in “where” and “why”? : )

HGS seems to be more aggressive in taking a piece of the pie than CRA or Incyte. While CRA will license freely and Incyte will license for a lesser portion of the profits, HGS plans to avoid selling out too cheaply. It structures each of its deals independently, but vows to limit the length and magnitude of the rights conveyed in any agreement. At the same time Dr. Haseltine noted that the expense and risk of any one drug development process can be spread around to the big pharmas by using these agreements. Also, Dr. Haseltine noted that the extent of their patent portfolio is so large that it could not possibly be fully exploited solely by HGS in the twenty years before the rights are lost.

How has the competitive landscape changed with Celera and HGP poised to complete the entire genome?

Dr. Haseltine and others at HGS fervently maintain that the lion's share of the useful genes in the human genome have been discovered, purified and patented by themselves, Incyte and a few others. While he agreed that the mapping of the entire genome is important, it has less immediate practical effect and wouldn't significantly help or hurt them.

Where does HGSI stand in the current Genomics "land-grab"?

Not sure that my numbers are exact here, but it appears that HGS has filed FULL patent applications on over 7500 of the 14000 or so genes that are currently known to exist. Comparisons to the HGP support the conclusion that few genes exist to be discovered because only 6% of the genes found by the HGP so far were not previously identified.

Do they worry about potential government interference in regard to the patentablity of genetic information? Can their business model survive in a regulated (i.e. patents banned) landscape?

This did not appear to be such a large concern for HGSI due to the fact that their patents include a full range of claims in addition to the usual composition of matter claims to the genes themselves. Also, they noted that several steps are required to isolate and produce the gene making the invention sufficiently “man made” to justify patentability. Finally, they noted that if patents on genetic treatments are banned wholesale then the whole drug industry will tank and there is nothing anyone can do about it.

Do they see a trend within the pharmaceutical industry towards outsourcing to companies like HGSI, INCY, CRA, etc. or will there be a push for internal development?

Dr. Haseltine noted that the need for short-term, double-digit growth in revenue and the “innovator's dilemma” that large pharmas face will restrict their ability to innovate. As evidence he cited the recent merger talks that have prevailed within the industry and the increasing willingness of the large companies to pay top dollar for the rights to pharmaceuticals that have not even completed FDA approval.

Which of your strengths has most benefited your organization, and with whom have you surrounded yourself to compensate for your weaknesses?

It appears that HGS's greatest strengths are its streamlined innovation process and its strong patent portfolio. They did not identify their weaknesses but it was evident that they have to constantly worry about cash flow. To remedy this HGS plans to selectively form agreements with the large pharmas (as described above) to defray the costs of full drug development. Dr. Haseltine also mentioned that plans are in the works to market their in-house software to enable the development of genomic drugs by other companies.

Are there other companies developing drugs for indications similar to those in HGSI's pipeline? Any estimates of market potential? It would also be interesting to gain insight on how management decides whether to sell genomics info to others, or to convert info into drug candidate for the pipeline?
HGS takes a backwards approach to their development of drugs. They focus on the market need first by evaluating four criteria, 1) unmet need in the marketplace, 2) a dearth of competition, 3) an effective predictive animal model and 4) the existence of a cell based screen.
The areas that HGS is tackling so far are tissue repair, cancer and autoimmune systems. It currently has three drugs in Phase II trials Myeloid Progenitor Inhibitory Factor-1 (MPIF-1), Keratinocyte Growth Factor-2 (KGF-2) and Vascular Endothelial Growth Factor-2 (VEGF-2). Thank God for acronyms.
MPIF-1 is a protein designed to protect blood precursor cells. Its use is in chemotherapy because it shields the bone marrow cells from the radiation by causing them to become dormant. Also note that this has the potential to reduce or eliminate the need for Amgen's two biggest drugs.
KGF-2 is a protein designed to speed the repair of damaged mucosal tissues and to heal serious, chronic wounds to the skin. Delivery of the protein spurs growth of the tissues that are slow to heal, an area that has been confounding the medical community for years.
VEGF-2 has shown an ability to spur the revascularization of tissue. The biggest applications here would be in treating limb ischemia and heart ischemia. The growth of new blood vessels allows these tissues to regain their original function.

Well, I think that's about all I can get down on paper now. I apologize if it is much shorter than the CRA report, but hopefully more info will come out in discussion.

Take note that this company is extremely complex due to the fact that it is so vertical, covering the entire process of drug development from identifying the genes to manufacture and sale of the drugs. For this reason, those looking to invest should do a lot of homework – in fact I got a little edgy during the tour thinking about how much I had missed when deciding to invest in HGS several months ago. Hopefully, however, this post will get you started or spark your interest.

All that said, the approval of any one of the above drugs should make this stock go ballistic.

Fool On,

Greg Carlin

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