The Exchanges

Q And so at what point in time did you decide to set out and start your own firm?

A So that happened at the end of 2006. I had been at Paul Capital for five years. I'd become a partner there. And that was going well with Paul Royalty Fund number one. Then when I was there, we raised Paul Royalty Fund number two, which is about over two times the size. And we're about to go out and raise the next fund. And that's a time which forces a discussion internally, as you know from your background, about economics, and this is a movie played over and over again, but myself and two other partners there basically couldn't come to agreement And we left without anything firm. And in hindsight, it was probably much riskier than I thought at the time. I had a very good job. I was doing very well and had four kids and a mortgage and all that stuff. And you go from that to making zero. It's a bit like jumping out of the airplane with a parachute on, and you don't know if it's going to engage until you're actually outside the airplane and going down. But We were very fortunate because when we left Paul Capital, the LPs called me, and we had to be very careful because we had certain non-solicits and all that stuff, but we followed it to the letter of the law. But it gave us an opportunity to have access to capital. We left Paul Capital in the fall of 2006, set up healthcare royalty partners, and we're able to close on some capital about July of 2007.

AI assessment note: “So that happened at the end of 2006.”

Q Well, let's walk through some more. I mean, we've touched on some of this in the sourcing. You've mentioned these regional teams. What do they actually do to find these investments?

A We have both a top-down and a bottoms-up approach. So from a top-down standpoint, one of the things we've done on the scientific side is we've created a research team, which really culminated in two substantial senior hires. One is our chief medical officer. He has a lot of clinical regulatory expertise, and one is our head of research, who's a PhD scientist by background. So our research team, really headed by head of research, will put out these white papers every six months or so. So for example, he authored one on migraines a couple of years ago. Hasn't been any new development in migraines for two decades. People use what are called triptans, sumatriptan, and other things, and they work reasonably well, but they don't work on everyone. So there's a whole new class of drugs called CGRPs, and what we did is we put together a white paper, not to be externally published, just for internal investment consumption, and reviewed the entire landscape, What drugs were about to be approved? What impact that would have on existing drugs? What impact it would have on things like Botox? Botox, interestingly enough, is used for severe migraines. So once that was written and published, for lack of a better word, internally, then each of the regional leads goes out and tries to fund companies in their region that fit that investment thesis. And we had a view about what was going to work an…

AI assessment note: “each of the regional leads goes out and tries to fund companies in their region”

Q You mentioned 90% of them are FDA approved. What are the situations when you will take the approval risk?

A We've done a dozen, a little more than a dozen deals where The phase three data has read out or been announced, but even after that, it takes about a year plus or minus to get approval by either the FDA or the EMEA in Europe or the corresponding regulatory authority in Japan. So there is this period where the phase three data has read out. During that time period, the companies are getting ready to launch the product. They've applied to the FDA. There's a back and forth. Knowledge takes a little bit longer than the companies hope, but the companies need to prepare. And so they need capital to get ready to launch the product, to hire a sales force, to assign manufacturing contracts, because a lot of the manufacturing is done by these contract manufacturers on an outsource basis. So they need some capital, but not all. So we may put a portion, maybe a third of the capital in Six months before approval, three months before approval, and then have it set up that when it's approved, the second tranche, the post-approval tranche with two-thirds of the capital goes in. So those are the situations where we may do something, and knock on wood, we've been very good about predicting that. And the second part of the answer is we're looking for drugs based on our experience and our team, including a group of senior advisors that we have worked with us on an exclusive basis, have Tremendous …

AI assessment note: “We've done a dozen, a little more than a dozen deals where The phase three data”

Q What do these deal dynamics look like in this space?

A It's like anything, it's tough to get deals done, and you got to find the win-win, what works for the company and what works for you. We look at a lot of deals. We look at I don't know, last year we looked at 150 or 200 deals, and we'll do four or five a year, something like that. So a lot of it we try to screen out at the beginning. We have your typical funnel. We're adding stuff to the top of the funnel all the time, trying to screen through these various criteria that I laid out, and then we're trying to assess what's the willingness of the counterparty to do something, and what's the return relative to the risk, and are we in the same zip code, so to speak, As the company. Into that, it spits out four or five. So I would say on the company side, and that's most of our business, It's really, what are their capital needs? What are their opportunities? What are their alternatives to raise capital, whether that's doing equity or a convert or something like that? And then how are we positioned relative on a cost of capital basis? And one of the things that we do and an advantage is that the structures are not all the same in terms of what part of the cash flow that you're Buying. So again, I'll use the shingles vaccine because it's a theme and it's easy. We paid them a hundred and ninety million dollars at closing, but of course our sales projections and therefore royalty cash f…

AI assessment note: “last year we looked at 150 or 200 deals, and we'll do four or five”

Q Once you've purchased this royalty stream, do you take any role in trying to help that stream become more valuable?

A It's unlike the venture capital or more classic private equity model. We don't sit on boards. Typically we don't change out management. On a very rare occasion, we've had to step in and be involved, but not very often. It's not what we're set up to do. We're not a loan to own type of investor. On the other hand, it's not quite as simple as just buying a publicly traded bond in GSK and collecting your interest every quarter. So it's a little bit in between, and I would describe it more as active portfolio management. So in the case of the shingles vaccine, when you have GlaxoSmithKline that's the marketer, at underwriting, you're just making a bet, essentially, that GSK is incented, and that they're good, and the product's good enough that you're going to be aligned. With some smaller companies, we do have quarterly meetings where we sit down with the company, and historically we've done it in person, and it's more like a board level review of information, and so we do have a dialogue with companies. We try to be helpful to them, but we're not really operationally involved. In the business. And we're not set up to do that as a business model. That would take a lot more people than we have. So most of our alpha, if you will, is in the underwriting.

AI assessment note: “We try to be helpful to them, but we're not really operationally involved.”

Q Well, why don't we just start with your background and how in the world someone finds their way into pharmaceutical royalties?

A Yeah, well, it's certainly not a natural path into investing in pharmaceutical royalties, for sure. My background is not all that glamorous. I grew up in Nashville, Tennessee, went to Vanderbilt University to undergraduate, thought I was going to be a lawyer, or at least my parents thought I was going to be a lawyer my whole life. But I ended up, this was in the late eighties, I ended up getting a job in New York and Working on Wall Street a couple of years, subsequently did go back to law school, University of Virginia, and in law school you have these summer clerkships, and it's three years, so you have two summers, and I did that for two summers and figured out that I didn't want to be a lawyer for the rest of my life, and so I ended up going right out of law school directly back into investment banking. I wanted to focus on High growth, exciting company. So I went to work for Raymond James, and they were focused on more of the growth sectors of the economy and Their program at the time, you rotate it around into different departments, so I was in the technology group for six months, and then I was in what we called leisure and entertainment, which was casinos and restaurants, and then I ended up, my last rotation was in the healthcare group, and I just ended up staying there. At the time, I was focused more on what we call healthcare services, so nursing homes and various p…

AI assessment note: “I grew up in Nashville, Tennessee, went to Vanderbilt University to undergraduate”

Q And so would that small company be using the hundred ninety million dollars for future R&D, given that this one drug already would have had approval?

A That's exactly right. The small company had moved on to a new therapeutic category. In their particular case, they were focused on cancer products. They were looking to raise capital to fund their own clinical trials on their own cancer products. And they basically have two options. They can raise equity. And they didn't like their stock price. Most companies don't like their stock price, right? The people who are in the biotech business are, fortunately, natural optimists, and so they always view the future as being better. Many times it is, sometimes it's not, but in any case, they wanted to raise capital. They didn't like their stock price. It's not a company that can go to JP Morgan and take out a loan. These companies are burning money, and they have a very interesting business model issue, which is The business model are long-term capital projects. It takes years to do these clinical trials, and to get it approved can take 10 years, and it costs a lot of money, and yet they finance it on a short-term basis every year, every other year, so they're constantly out raising capital, these smaller biopharmaceutical companies that are the primary owners of these royalties, so long story short, they wanted to Essentially reallocate those dollars to their own products, and so that's why you have a business transaction.

AI assessment note: “That's exactly right. The small company had moved on to a new therapeutic category.”

Q Are there reasons why you exclude maybe medical devices that could have A similar looking trajectory?

A Yes. Two reasons. Number one, if you look at our team, the DNA of our team is really pharmaceuticals. So if you look at the background of people, they've been trained and grown up professionally in the pharmaceutical, pharmaceutical investing area. So that's the background. And it's a little bit of You don't know what you don't know. There are different elements in medical devices that are different from pharmaceuticals, different patent characteristics, different reimbursement characteristics, so in some ways we stick to our knitting, and the other is For what we do, which is trying to acquire protected, sustainable cash flow, pharmaceuticals is the most attractive area. Why? Because you have patents, and the patents are strongest in pharmaceuticals, where you have a patent on a chemical entity, as opposed to a certain type of device. And device, typically, you can engineer around the patent, you can do it a different way. If you have a patent on the chemical entity, there's really no way to get around that. So we look for strong patents that gives you protected cash flow. We look for long patent life and high barriers to entry so that that's a sustainable cash flow. And maybe the most important thing is we look for the marketing company that's selling the product that's either the dominant or one of the most dominant in their sector. Going back to the shingles vaccine, GlaxoS…

AI assessment note: “Yes. Two reasons. Number one, if you look at our team”

Q And then as you start walking through the due diligence process, you mentioned trying to eliminate the binary risks just as a starting point. I want to start with how much do your decisions tie to the science, and how much of it are the people or the company that will implement the commercial plan?

A It's both. You have to have both, and you can have a great product, but products don't sell themselves. They're sold by people and companies and management teams. And you can also have a product that's maybe okay, maybe not great, maybe it's not high science, but if you have a marketing company that dominates a certain area, they can do very well with those products. We've seen that in the dermatology area, for example. Not a lot of high science in dermatology. You're treating acne and things like that, but there's certain companies that have a long history there. They have a large product portfolio, so they're not just selling one product to their dermatologist. They're selling a suite of products, and they have relationships, right? The sales force has relationships with these doctors, so we really look for both, and one thing about focusing on drugs that are already approved by the FDA is we're not really taking science risk. We know the drug works. You have the clinical trials that have been conducted. You know the results from that. If it works, thumbs up. The royalty's valuable. If it fails, it's binary. The royalty's worth zero because there's not going to be any sales or royalty cash flow. So once we get past that, we do want medically necessary products. People need to take their epilepsy drugs, right? They're going to get Their shingles vaccine. They're going to take …

AI assessment note: “It's both. You have to have both, and you can have a great product”

Q In the AI era, asset and wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. When you're sizing up the commercial market opportunity, how do you balance out the importance of, just call it volume and price?

A Yeah, well, that used to be going back 1015 years, you just assume prices went up five, 10% every year. You put that in your model and the power of compounding, you do that over 10 years, it makes a big difference. Not so much anymore. The one area in our diligence that's changed the most in the last decade has been this willingness to pay, and particularly in the U.S. market I'm talking about now, but the idea of drug pricing, drug reimbursement, what price increases can you bake in? And we're looking at a deal now where the company historically had taken nine or 10% price increases. This drug's been on the market for a while, and now they're taking three percent price increases, so more like inflation. So it really is asset specific, and it's not something where you just make generalizations. You have to go deep, and so what's changed in our diligence process is And I'd say the last five to seven years in particular is we go out and we talk to the insurance companies. We surveyed insurance companies, and again, going back to this shingles vaccine example, I think we talked to insurance companies that represented, I don't remember exactly, but something like 70, 80, ninety million lives in the U.S., so a very large swath of the population to get a sense of Not just what the price is today, that's relatively easy to figure out, but what's the price going to be two, three, four,…

AI assessment note: “The one area in our diligence that's changed the most... has been this willingness to pay”

Q You mentioned portfolio management, and how do you think about the construction of your portfolio, say, in an individual fund?

A Diversification, diversification, diversification. As much as you love any product, and you love them all when you sign the contracts, kind of like your children, you love them all when they come out. But we just try to be diversified. So we have that diversification or concentration limits built into the fund documents, the limited partnership agreement around no more than a certain amount per product, no more than a certain amount per marketing entity, no more than a certain amount in the therapeutic category, but it's highly diversified. That's really what we try to do. And if you look at our last portfolio, Which we finished investing last about six months ago, seven months ago. We had 25 investments. That was 28 different products across 11 different therapeutic categories. So very, very diversified. So if there's some, I'm using quotes, silver bullet in cancer that comes out, which is not likely to be, but if there were, you may be harmed, but you're not going to be killed. That's sort of our orientation is not bet the farm on any, any one product. So we, we're very focused on diversification. Fortunately, we have, most of our investors are large government pension funds. That's And so they're doing it because they're looking for non-correlated yield and they're big institutions. And so we've set up some co-investment vehicles that allow us to fight out of our weight clas…

AI assessment note: “We had 25 investments. That was 28 different products across 11 different therapeutic categories.”

Q Do you tend to bump into those competitors on the same deals?

A We do. We certainly do. It's against a little bit different flavor if it's a royalty purchase or a credit type of deal. Those tend to be different, but a lot of the deals that we close are on a proprietary basis. And or no intermediary is involved. Most of the deals we do do not involve an intermediary, some kind of investment banker. And that's because we're out there every day developing these relationships. And it's not that the companies don't know what they're doing. They, in fact, the best deals to get done are with a sophisticated counterparty who knows generally what the market is and is looking for speed and certainty. So you can win On speed and certainty. And so we're trying to find that intersection, that rare intersection between a high quality asset and the right risk return, the very few circumstances where those intersect. It means you look at a lot, you do very few.

AI assessment note: “We do. We certainly do. It's against a little bit different flavor”

Q Just to get a sense of that base rate, of the 70 investments you've done, how many of them have you had negative returns on your capital?

A If you look at our core investments, so that's probably 60 of the 70. There's a few non-core things we did where we invested in some equity. We don't do that anymore because that didn't go well, but the core focus, which is all that we're doing and have been doing for the last five years, I think of the realized deals, right? We still have a portfolio that's out there. Realized deals, I think there's one, maybe two, where we didn't get our capital back. And it wasn't a zero. One, fortunately, was a very small product. We probably lost a little bit. That's the only one I can think of where we've lost capital and we've, we've got an existing portfolio. We'll see, see how those play outs. There's some that these are long-term investments that yet be realized.

AI assessment note: “Realized deals, I think there's one, maybe two, where we didn't get our capital back.”

Q And you mentioned the market is nine billion. How big is that in the scale of all of the, maybe it's FDA approved drugs each year?

A Well, I think the way to think about it is what's the total amount of capital raised to fund these biopharmaceutical companies and how much of that is this royalty financing? And the answer is nine billion is a drop in the bucket. Still, even though it's been massive growth in our little niche of the world, it's a drop in the bucket. If you look at primarily equity raised, either venture capital raised or IPOs or following equity, it's a small fraction. There's two, three, four, five times as much money raised in the equity markets each year, but the equity markets can be volatile, right? We're certainly seeing that now. And so What we try to do is we're kind of always there as a financing source, and a lot of it is about just getting the word out, just educating people that this is an option. One of the things we've done was gone to a regional sourcing approach. So we've opened offices in Boston. I mentioned that the Boston company with the shingles vaccine, San Francisco, London, and then the greater New York area. So we try to get locally Uh, have people on the ground and be involved in that community and educate people. These companies are raising capital all the time. Every time may not be the right time for our type of financing, but at some point in their corporate financing history, it will be the right time. And so we're trying to find those intersections.

AI assessment note: “the answer is nine billion is a drop in the bucket”