GlaxoSmithKline Makes a Big Bet on DNA

Eager to offset headwinds tied to patent expiration on its best-selling Advair, GlaxoSmithKline (GSK -0.92%) is investing $300 million in DNA-sequencing company 23andMe. Can insight from 23andMe's millions of customers help GlaxoSmithKline create better medicine?

In this clip from The Motley Fool's Industry Focus: Healthcare, host Kristine Harjes and Motley Fool contributor Todd Campbell explain why investors might want to take a wait-and-see approach to GlaxoSmithKline's shares following this latest news.

A full transcript follows the video.

This video was recorded on July 25, 2018.

Kristine Harjes: Next up -- GlaxoSmithKline, the British pharma giant, reported earnings just this morning. Todd, what's the scoop?

Todd Campbell: Pretty meh. [laughs] The sales were flat on an as-reported basis at £7.3 billion pounds for the quarter. If you back out currency conversion, they grew 4%. But you never know what currency is going to do, up or down, or whatever. It is what it is. You're talking about low single-digit growth one way or the other for GSK, not an overly exciting report that's moving the needle for investors.

Harjes: [laughs] So, if it's not that exciting, why are we talking about this?

Campbell: Because there was one little tidbit in GlaxoSmithKline's release that I found incredibly fascinating, and I think maybe you will, too. The company has decided to refocus its research and development approach. As part of that, they're investing $300 million in the DNA testing site, 23andMe.

Harjes: Which is super interesting. We don't talk a lot about 23andMe because it's a private company, but I am fascinated by this organization. Even dating back to when I was at the latest JPMorgan Healthcare Conference, seeing their CEO speak, she's amazing. This is a very cool company. It has the largest database of genetic information out there because of consumers saying, "Yes, please, sequence my genes," and they hold on to that data. About 80% of the people who have participated have opted into research. If 23andMe has five million customers, that gives you four million people's genomes that have been sequenced.

And now -- this is causing a little bit of alarm, so far, that I've seen in the Twittersphere and elsewhere -- you have this commercial company, GlaxoSmithKline, buying the rights to use that data to help grow their portfolio and their pipeline.

Campbell: These are exclusive rights, too. About three years ago, 23andMe established an R&D team to try to figure out whether or not they could take some of the information that they're gleaning from processing all this DNA -- again, you have to opt in to this. They're not just using this data, you have to opt in to say it's OK. Like you said, about 80% of people have agreed to it. I would agree to it, too, because frankly, anything we can do to develop cures and treatments that work better, I'm all for.

This is really an interesting decision, because it gives GlaxoSmithKline exclusive access to that treasure trove of data. Glaxo's CEO, who joined relatively recently, Barron, he had this to say about it. He said, "By studying genetically validated targets, we think we can cut the cost of development in half; or, putting it in a different way, develop twice as many medicines for the same price." That's a pretty big statement.

Essentially, if you can validate your targets using DNA analysis better, enroll patients based on DNA analysis, so that you're only enrolling the patients most likely to respond, wow, you could probably get drugs to market more quickly, more successfully. That's really important, because historically, 90% of drugs that head into clinical trials end up in laboratory dustbins rather than pharmacy shelves.

Harjes: Hal Barron had a lot of interesting things to say. He's actually a fairly new member of their team, he's the head of Pharma. The CEO is Emma Walmsley.

Campbell: Oh, yeah, my bad, sorry!

Harjes: He had all these great quotes about how knowing what the drug is going to target and validating it leads to having a significantly greater chance of ultimately demonstrating benefit in patients. This is very exciting. This is GlaxoSmithKline saying they are going to make genetic sequencing and genetic targeting the heart of their R&D efforts.

And really, they kind of need it. There has been pressure on this company for a while to break up their pharma unit from their consumer unit. This is a company that is straddled with a lot of debt, so the $300 million stake in 23andMe is an interesting decision for that reason, as well. Ultimately, their pharma unit has a pretty limited pipeline. If they were ever going to break into two companies, they need to turn that around before it has legs to stand on.

Campbell: It's interesting to think about how this deal even came about happening. Richard Scheller, 23andMe's head of Therapeutics, he actually used to work with Barron and Genentech. They're obviously very comfortable with each other. It's going to be interesting to see how development of medicines occurs.

There's a little interesting backstory that might be helpful for investors to know. The FDA had initially balked in 2003 at 23andMe sharing this genetic data regarding whether or not you might end up with Parkinson's or something with patients. Just because you have the genetic propensity for it doesn't necessarily mean you will develop it. That all cleared up this past year, earlier this year, when the FDA gave it the green light to share information, I think it was on ten different diseases, including Parkinson's and late onset Alzheimer's disease. That cleared the way for GlaxoSmithKline to step up and say, "OK, the FDA has given us their blessing for this data to be shared with patients. Now, let's go ahead and leverage that data to create some new drugs." Parkinson's disease, that's actually going to be their first target, they said.

Harjes: Yeah, super interesting. This is a company that's definitely firing on all cylinders. According to PitchBook estimates, this $300 million funding could value the company at around $2.5 billion, which is huge, especially for a private company. It's a good reminder to me to not neglect private companies. We don't always have as much visibility into them, but they're still part of this business universe that we cover.

A couple of interesting stats that I stumbled into about venture capital in healthcare. We're about halfway through 2018. So far this year, the total deal value for venture-backed IPOs in the U.S. stands at $6.9 billion. A disproportionate number of IPOs that have come out have been part of the healthcare industry. It's important to keep an eye on what's going on in the private markets with funding of these various companies, because a lot of them will end up coming public. Of the 41 venture-backed companies that are based in the U.S. that have IPO-ed in the last six months, 27 of those 41 were healthcare companies. VC in healthcare is pretty hot, and something to keep an eye on.

Campbell: You mentioned what the estimates are right now in the valuation for 23andMe, that's a pretty nice return for those existing investors. Last fall, when they did their last funding raise, I think they estimated the valuation of the company was about $1.5 billion. We don't know what percentage Glaxo bought, but it's obviously a fairly significant percentage. Unfortunately, we can't go out and buy that stock.

That raises the question, should we buy GlaxoSmithKline's stock based on its deal with 23andMe? I think that's a tough argument to make. GlaxoSmithKline is such a large company -- it's actually bigger than Eli Lilly, which we talked about earlier in the show. And, it's going to take some time for drugs to come out of this collaboration, if they ever do, to move the needle for the company. In the meantime, GlaxoSmithKline is still facing the threat of generic Advair, Advair being their top-selling asthma drug. Generic versions of that have been delayed so far by the FDA, but that's not going to continue forever. At some point, we will see generic versions of Advair become available, and that will throw about $2 billion worth of GlaxoSmithKline's sales into question.

Harjes: Yeah, this company is in a pretty tough spot. They have debt to equity through the roof. Most investors in them right now are likely income investors that are looking at the 5.3% dividend -- and yet, that is threatened by the financial issues that the company has. Management has said they plan to tie their dividend to cash flow generation soon. As an income investor, I might start to cut some ties with this company, and that's not going to be good for the stock, if that does happen. So, things to keep an eye on. I do appreciate that Glaxo is making the effort to look way down the road and try to right their ship for the future. As long-term investors, that's what we like to see companies doing. For me, at least, this stock not a buy at the moment.