The Long Game In Life Sciences: $181B Fund Baillie Gifford Invests Big In Private Companies

 

By Steve Dickman , CONTRIBUTOR - April 12, 2017 @ 8:47am (Forbes

Traditional life sciences investors have made lots and lots of money from recent multibillion-dollar exits like Receptos, Alios and Acerta. But lately I’ve noticed a different life sciences investing strategy, one closer to the way social/mobile/software investors invest. By paying higher entry prices for later mega-rounds in ambitious life sciences companies, including both therapeutics and non-therapeutics companies, these deep-pocketed investors hope to reproduce their earlier successes investing in the likes of Amazon and Tesla. Their capital, which comes without the usual board seats and tight monitoring, is deeply welcome, because it allows these companies (similar to consumer companies like Airbnb and Uber) to stay under the radar much longer than if they would have to file for an initial public offering (IPO). By the time some of these companies finally surface, they may have catalyzed profound change as well as making money.

My curiosity about this new approach took me to Edinburgh, to the shadow of its imposing castle, where I got to look at this type of investing through the eyes of one of its top practitioners, an investment management firm known as Baillie Gifford.

Edinburgh castle in Scotland (Credit: OLI SCARFF/AFP/Getty Images)

Edinburgh castle in Scotland (Credit: OLI SCARFF/AFP/Getty Images)

Never heard of Baillie Gifford? Neither had I when they first approached me in 2015 through a mutual acquaintance at MIT for a friendly chat. It turns out that Baillie Gifford is a global investment fund that quietly deploys the assets of some of the largest pension funds in the United States as well as investing on behalf of many other clients. After doing business for over 100 years, Baillie Gifford currently has 145 billion GBP ($181 billion) under management.

“Life sciences companies are an increasingly important part of our research agenda.” That was the essence of what the Baillie Gifford team told me back in 2015. Talk about turning talk into action. Barely 18 months later, the fund had made six investments in life sciences companies in rounds totaling over $1 billion.

Table 1. Baillie Gifford’s publicly disclosed life sciences and healthcare investments (not including health IT investment ZocDoc). Data from Pitchbook and Crunchbase

Table 1. Baillie Gifford’s publicly disclosed life sciences and healthcare investments (not including health IT investment ZocDoc). Data from Pitchbook and Crunchbase

The common theme among all of these investments is growth. In order to have a chance at making outsize returns (think at least 50% a year if not 100% or 200%) an investor has to bet on a company that can change the world–before the change has happened. Baillie Gifford’s strategy in finding these investments focuses on identifying “mega-trends,” major changes that may be slow to take hold, but once in place, can be extremely influential. Widespread access to the internet would be one example of a modern megatrend. Within biotech, the trend toward ever-cheaper and ever-more-widespread gene sequencing would be another.

Trying to make money this way is very different from traditional biotech venture investing. But the size and number of recent such financings show the growing popularity of this model. Recipients include the synthetic biology companies Ginkgo Bioworks and Zymergen; the Google-funded, data-intense companies Flatiron Health and Verily; the Illumina spinout GRAIL; and the medical device company Intarcia Therapeutics. The Baillie Gifford portfolio alone contains Ginkgo, Flatiron and Intarcia along with therapeutics companies CureVac, Denali Therapeutics and UNITY Biotechnology.

Baillie Gifford is not the only fund coming into life sciences and healthcare investments with big dollars and long-term views. Domestic U.S. fund Alaska Permanent Fund was a big pre-IPO investor in Juno. More recently, that fund invested in the $61 million Series A round of Cambridge, MA-based biotech Codiak Biosciences and in the $217 million Series A round of Denali. Sovereign wealth funds such as Singapore-based Temasek are also increasingly joining syndicates in biotech companies such as Alzheimer’s therapeutics developer TauRx, also based in Singapore, as well as U.S.-based companies such as gene editing-focused biotech Homology Medicines and primary care-focused healthcare play Iora Health. Based on various analyses my firm has carried out on fund flows in this sector, I expect other sovereign wealth funds to increase, in some cases significantly, their investing activity in life sciences and healthcare.

Fewer. Larger. Later. 

In contrast to typical life sciences venture capitalists (VCs) who invest in ten therapeutics companies hoping to make big multiples on two or three of them, Baillie Gifford invests in fewer life science opportunities and puts much larger amounts of money to work in each investment. The team is also unconventional. Unlike the typical crossover fund or hedge fund team stuffed with M.D.-Ph.D.s and clinical development experts, the Baillie Gifford team consists of generalists. Tom Slater is one example. A 2000 computer science graduate, Slater joined Baillie Gifford straight out of college. After working on Asia and UK equity teams, Slater joined the Long Term Global Growth team in 2009, and since 2015, he has been head of U.S. Equities. Because Baillie Gifford is owned jointly by its 41 partners, Slater has considerable “skin in the game.”

Tom Slater

Tom Slater

Like VC investors, Baillie Gifford does not expect every deal to result in a big return, said Slater, “because you have this power law in returns. What really matters is how much you make when you are right, not how often you are right.” To give an example of this thinking, a $1,000 investment in 55 shares of the Amazon IPO at $18 a share in 1997 would have yielded a split-adjusted $603,240 value as of April 5, 2017. That kind of return can make up for quite a few failures. Like many funds, Baillie Gifford has historically been an Amazon investor.

So why the shift to healthcare? It goes back to the new investment models enabled by, among other things, Amazon’s web services and other cloud computing resources. “You had seen this revolution happen in advertising and retail,” Slater said, “based on the application of ‘capital-light’ business models. Our contention is that the trends that have driven those revolutions–the continued progress of Moore’s law, the application of advanced software, the miniaturization of hardware–would enable businesses in other areas, leading to massive change. We’ve now seen it in automotive with Tesla. But in the biggest industry in the world, the healthcare industry, there has been so little traction for these new models.”

So, starting in 2012, Baillie Gifford went looking for such opportunities. But, Slater said, “we couldn’t find those in large, listed companies.” Hence the shift to investing in private companies. One goal was to seek out areas in which companies can operate with a much lower capital base than they have been able to historically. After investing, for example, in AirBnB and Dropbox, Baillie Gifford went looking for opportunities within healthcare in which large amounts of capital “might influence the chances of success. They do need capital to do some of these things,” Slater said.

One Tesla-like example in the healthcare space is Intuitive Surgical, a publicly traded robotic surgery company. “There you have had this limitation of what a human can do with their hands,” Slater said. “That limitation has been in place for centuries. And then suddenly, you enter a world that is driven by Moore’s Law and miniaturization. Could you see exponential improvements in what could be done surgically? We thought you would.” An investment in Intuitive Surgical ten years ago, in early April 2007, would, by April, 2017, have yielded a 515% return compared to a 66% return on the S&P 500.

To be clear, Baillie Gifford does not consider every life science investment opportunity a “capital-light” business. “There’s no suggestion that therapeutics companies are going to be ‘capital-light,’” said Slater. But adding capital early can create a daunting barrier to entry for potential competitors. That is the theory, anyway, proven more on consumer-facing businesses than in life sciences businesses, which typically are subject to considerably greater regulatory scrutiny. Therefore, it remains to be seen whether it actually works out this way in life sciences.

Along the way, Slater said, the Baillie Gifford team realized that the traditional VC-based biotech funding model “is not working particularly well.” VC investors in biotech, for example, are “doing small rounds and then looking for relatively short-term milestones,” Slater said. “And therefore people are orienting their companies around these milestones or proof points rather than thinking about the long-term investment profile.” By allowing the companies to stay private indefinitely and thinking in 20-year rather than 10-year time scales, Baillie Gifford intends to overcome this type of short-term thinking.

Breeding a better horse

The mindset Slater calls “patient capital” and even “permanent capital” is key to understanding why Baillie Gifford gets access to these opportunities. Again in contrast to conventional venture capital or especially crossover investors, Baillie Gifford’s goal is not a quick exit. As the term “permanent capital” implies, in good investments, it may not seek to exit at all, or at least not for 25 years or more. In this regard, Baillie Gifford’s model is closer to that of a family office investing over generations rather than a venture capital or private equity fund trying to make outsized returns in a 10 years or fewer.

Even though these investments are likely to be illiquid for years and to demand even larger amounts of capital along the way, the growth potential is such that it is usually not easy for an investor to get in. Here, along with its track record, Baillie Gifford’s hands-off philosophy plays a pivotal role. “We can be holders of private companies in substantially greater size, just as we are in public companies. We will judge you over a sensible time frame. We will provide you with the resources to do what you need to do.” Interestingly, despite its sometimes outsize investments, Baillie Gifford does not take seats on the boards of directors of its investment companies. That said, Baillie Gifford is no pushover. “We are typically asking the challenging questions,” Slater said, “We’re not just lovey-dovey. We do that as outside shareholders, not in the boardroom.”

This approach, which also reduces the time commitment that is required once the investment is made, represents a big difference from VC investing. “We won’t be asking the guys at Denali to give us an update every 12 weeks,” said Slater. (Management teams love this, of course.) “We’d like to have an in-depth conversation once every 12-18 months. Our approach is giving them time and trusting in their expertise.” A horse racing analogy comes to mind. It would be easy enough to hang around the racetrack, read the Racing Form and try to pick winning horses every day. Baillie Gifford’s approach is to buy into the farm that is trying to breed a better horse.

Sticking with the private markets 

Public companies are not that interesting as investments for Baillie Gifford. Slater and I talked about Castlight Health, a company I discussed recently with Bryan Roberts of Venrock. Roberts, an early investor in Receptos, has had nine exits of a billion dollars or more as a VC investor. In my view, he has done very well in changing the world himself with early investments in companies like Illumina and AthenaHealth. Roberts led the seed round of Castlight in 2008. Although it had a great run-up to the IPO and a great initial stock performance afterward, that company has come upon some hard times. Roberts told me that he had warned the management team when the stock was at $48 a share that it would someday be in single digits. Currently it is at $3.80 a share.

Slater’s question about Castlight, where he invested in the IPO, is a different one. “How do you be a supportive shareholder to Castlight today? When the share price has already gone to $4, how do you say to them, ‘Keep your eye on what is happening three to five years from now and if you can achieve that, the stock will take care of itself?’” It’s difficult, Slater said, “particularly in Silicon Valley where stock options are an important component of remuneration.” That is, the management and employees could easily decide to leave such a company and join a startup at which the return on the stock options could be both larger and quicker. “If they had stayed private,” Slater reflected, “it might have been quite a different story.”

Other features of private companies also drive Baillie Gifford’s decisions to invest. Instead of protecting their vested interests in existing markets, private companies are incentivized to learn more, learn faster and be more efficient about learning as new areas emerge. To pick a biotech example, Slater mentioned immuno-oncology, an area in which Baillie Gifford does not have any announced investments. “It’s about learning [and a company’s ability to learn],” he said. “The whole industry is learning about T-cells, learning about the immune system. Whoever learns the fastest over the next five or ten years will be the winner.”

Trusting in culture

Investing this way requires deep trust in management and the culture that senior managers instill. Slater said that Baillie Gifford works hard on “understanding company culture and trying to make judgments about people, the organizations that they build, what they are optimizing for and what their motivations are. Those things have an influence over whether they can build a really big company or if they will be the first to get their product to market rather than who wins the horse race today. There is a first-in-class, best-in-class thing with T-cells that is not the same as with small molecules.”

The power of culture in companies is often underestimated, Slater said. One of Baillie Gifford’s advisors is Professor John Kay of Oxford University, author of the 2012 book Obliquity, whose subtitle is “Why Our Goals Are Best Achieved Indirectly.” Slater said he agrees with Kay that companies that try to make money as an end in itself rarely make the big money. It’s companies that have a different purpose that are worthy of investment. One such example is Amazon, which focused on customer satisfaction to the exclusion of profits for its first 20 years. “They pursued the customer experience with the confidence that the economics would follow,” said Slater.

Of course, powerful investors are also a signal that a company might be on a success track. Baillie Gifford’s co-investors include Jeff Bezos’ fund Bezos Expeditions (in Denali and Unity), the Mayo Clinic (in Unity), ARCH Ventures (in Denali and Unity), Roche Venture Fund (in Flatiron) and Venrock (in Intarcia). These investors do not at all guarantee a positive outcome, but working with them offers Baillie Gifford some valuable insights, Slater said. Building trust relationships with thought leaders such as Jay Flatley, until recently the CEO of Illumina, took some work. Baillie Gifford was one of the investors that strongly supported Flatley in resisting several overtures by Roche in 2011, when Illumina was valued at roughly one-quarter of its current value. Ever since then, Slater said, the Baillie Gifford team has been able to benefit from Flatley’s wisdom.

Breeding microbes. Breeding money? 

The area of Baillie Gifford’s interest that most intrigues me is synthetic biology. Companies like Zymergen, Twist Bioscience and Baillie Gifford investee company Ginkgo Bioworks are attempting to overturn decades of best practices in agriculture, industrial chemicals and food production by designing and constructing novel artificial biological pathways, organisms or devices and redesigning natural biological systems. In some cases, synthetic biology is attempting to replace oil-based raw materials with lab-grown starting materials and intermediates. Industrial applications like this demand large amounts of capital and leave little room for error, since the outputs will be judged instantly against long-held industry standards. Investing in these companies at a late stage of development, as Baillie Gifford is doing, would seem to invite potential disaster, especially for non-specialist investors.

While acknowledging the risk, Slater reframed this potential pitfall as a strength on Baillie Gifford’s part. “This whole area of synthetic biology is a vast opportunity,” he said. “Partly it’s about the raw economics of driving down pricing. Partly it’s about being able to satisfy demand in a way that existing production methods have failed to satisfy. I think partly it’s about certainty of pricing and not being tied to the volatility of the oil price. A lot of the people who take up these types of products would be quite sensitive to that. So I think you have a really interesting, massive opportunity set. From the work we did, Ginkgo seemed to be in a particularly interesting position. There are some characteristics of that business model you can liken to the tech companies, particularly when you think about scaling. The people are impressive. Their reputations are strong.”

After I noticed this trend of non-specialist funds investing in late-stage life sciences companies, I asked a managing partner at a very active life sciences hedge fund accustomed to making crossover investments into biotech companies why I was not seeing his fund making investments in companies like Ginkgo and Zymergen. He said that his team’s expertise is investing in clinical candidates and taking clinical risk. At least for now, he said, he prefers to leave those other types investments to others.

To sum up my understanding of Baillie Gifford’s approach: when Baillie Gifford identifies and researches investment opportunities, it is using pattern recognition just as intensely as traditional venture capital, just on different features. The two approaches overlap strongly when it comes to evaluating management, but the stakes are higher for Baillie Gifford since, without any board seats, its opportunities for oversight will be considerably less. In contrast to venture capital investors, the focus of the fund’s research is not the underlying science or the indication areas, except to say that the market size is large. Instead, in addition to seeking stellar management teams, Baillie looks for opportunities that have been vetted by more traditional investors, with a preference for strong VC performers such as ARCH Ventures. It then seeks to use its capital to tip the scales by lengthening a company’s runway and allowing the management team to delay raising additional capital, a very time-consuming and labor-intensive exercise.

It is too early to say if life sciences will prove amenable to this approach. But Baillie Gifford’s track record seems to indicate that, even without deep scientific and clinical expertise, the group has plenty of expertise where it ultimately matters: in making money.

To be fair, even some traditional venture capital investors such as Venrock, for example, do not expect to exit from their investments in the traditional 10-year time frame. Bryan Roberts of Venrock told me in an onstage interview in January that his average sitting on the board of a Venrock investment is 12 years.

Steve runs CBT Advisors, a Cambridge, MA-based consultancy focused on strategy and story in the life sciences. A former venture capitalist, he also wrote for Nature and The Economist.