The mRNA Option

Published on 12/09/21 | Saurav Sen | 4,296 Words

The BuyGist:

  • mRNA is a new phenomenon that has the potential to significantly improve our lives beyond the pandemic.
  • We’ve been reading about mRNA for a while (as have many people) but we never thought about investing in BioNTech or Moderna – two champions of mRNA technology – because we thought that all the potential growth was priced in.
  • But then we looked at our Watch List, and we were frankly amazed at the modest growth expectations built into BioNTech and Moderna’s stock prices.
  • But we realized that those modest expectations would require us to dig into mRNA’s potential beyond this pandemic.
  • We dig into mRNA, how it works, its potential beyond Covid-19, and whether it makes sense to invest in the technology.

What is the big deal?

The big deal is that this erstwhile theoretical technology got validated during the Covid-19 pandemic. mRNA (messenger ribonucleic acid, if you must know) as a technology is not new; it wasn’t discovered in 2020. But until now, it wasn’t taken too seriously by the scientific community. Covid-19 has been tragic, but mRNA may just be one of the few positive things to have come out of it. The pandemic was, to a large extent, a real-world clinical trial. So far, so good. If the last 12 months are any indication of things to come, mRNA is the next big thing in medicine.

Now, we at The Buylyst are not experts in the field of Medicine. We’re investors. We look for, as Charlie Munger puts it, “…a horse with one chance in two of winning and which pays you three to one.” We believe mRNA as a technology is such a “horse”. In this article, we dig into that hypothesis.

Our exploration of mRNA is an exception because it is outside our expertise. In fact, Healthcare as a field is outside our comfort zone. That hasn’t stopped us from investing in healthcare. But so far, our investment has been top-down – a thematic bet on the inevitability of growth in global demand for healthcare. With mRNA, this will be our first crack at some bottom-up candidates – specifically two companies called Moderna and BioNTech. However, we maintain that our focus is more on mRNA’s potential rather than the specific competitive advantages of these companies.

Both these companies have been front-and-center in the global effort to revert to normalcy. Their vaccines have been the most preferred Covid-19 vaccines across the world. Most of us take it for granted but the underlying technology – mRNA – in these vaccines is a first. If you’ve taken one of their vaccines, you’ve validated a technology that was considered impractical just a few years ago. Moderna and BioNTech have proven that mRNA is not only viable but a triumph.

We’ve been eyeing these two candidates as potential investments for some time now. But we’ve steered clear because they always seemed to be priced for perfection. However, before the Omicron variant came to fore, both stocks had taken a beating over a few weeks. Just a couple of weeks ago, both stocks seemed to be reasonably priced. Well, what is “reasonably priced?”, you might ask.

We keep tabs on our investment universe through our Watch List, where we estimate “what revenue growth do we need to believe to consider buying the stock?”. In this article, we won’t get into the details of how we do it; you can read about our methodology here. But here’s what we see:

Obviously, the historical 3-year annualized revenue growth number will end up being an aberration when we look back. However, regardless of what the historical number is, it’s our “revenue growth we need to believe” estimates for both companies that piqued our interest. If mRNA is indeed the next big thing in medicine, we thought, would it be so unreasonable to expect these companies to growth at a clip of, say, 6% annually?

The rest of the article is our attempt to answer this question. To do that. we will dig into what mRNA is, why it might be the next big thing, and then we’ll peel the layers of “what we need to believe if we were to buy stocks of BioNTech or Moderna today.”

Trick and Treat

We won’t even pretend to be experts in medicine or science. If you’re not an expert either, this section will be a case of the “blind leading the blind”. But we are investors looking for a safe bet, a SWAN bet. We don’t need a PhD in this field – we just need to be “satisficed”. We need to know enough to confidently say that “…a horse with one chance in two of winning and which pays you three to one.”  To figure out if BioNTech or Moderna are SWAN bets, we need to try and understand the technology upon which both firms are building their future.

We’re dumbing down mRNA for ourselves, so if this is too, well, dumb for you, feel free to skip this section. But, as investors, it’s important to understand some basics:

  1. mRNA Vaccines are NOT inoculation.
  2. mRNA is a type of molecule that already exists in our bodies.
  3. “m” stands for messenger.
  4. Think of mRNA as a piece of code or instructions sent by our DNA to our cells to produce a certain kind of protein. This isn’t an analogy; this is what happens.
  5. The code or the instructions or the recipe lies in the shape and sequence of the mRNA.
  6. The code is recognized by ribosomes in our cells, which convert the code into a specific kind of protein.
  7. mRNA vaccines take a short cut. They circumvent the first step when the DNA sends the mRNA to instruct cells to create a specific protein. A synthetically produced mRNA strand is injected into the body that instructs our cells to produce a type of protein that’s found on the coronavirus.
  8. When the particular type of protein (called the “spike protein” in this case) is released, our immune system recognizes it and stores the information.
  9. If our body gets infected with the virus – with that particular type of protein – our immune system recognizes it in infected cells and mounts a swift response.
  10. Essentially, mRNA tricks the body into thinking that it’s seen this enemy before, without ever having met the enemy.

This was how we explained the process to ourselves. Hopefully, you found it useful. The key point in that little list above is this:

The identifiable protein needs to be mapped and then backed into the requisite mRNA strand that would trigger the proper immune system response. The immune system needs a clear “picture” of what to look for should our bodies come in contact with the deadly virus. Protein-mapping starts with mapping the genome of the virus. This takes time – it took 2 months from the time when the first reports of the coronavirus…to the date when the genome sequence of the virus was released online. Then it took almost a year before the first vaccine doses were distributed. However, this was much faster than anything before. The world moved at record speed, and if proper public policies are in place, the time from virus discovery to vaccine distribution will only get shorter.

This brings us to the advantages of mRNA over traditional vaccines. There are 3 main advantages:

  1. Safety
  2. Efficacy
  3. Production

mRNA vaccines are safer than live-attenuated or viral-vectored vaccines because mRNA is non-infectious. It tricks the body into believing that it has seen the virus rather than actually inserting some of the virus or an “inactive” version of the virus. The risk of infection is much, much lower than the risk from inoculation.

The most recent data from this current pandemic tells us that mRNA vaccines have been superbly effective at preventing severe disease or hospitalization. Take a look at this data comparing Pfizer/BioNTech, Moderna, and J&J/Janssen vaccines. The vaccine efficacy rates in the clinical trials were 95%, 94% and 67% respectively. Although J&J/Janssen is not a traditional vaccine, it’s not mRNA. Moderna’s management team showed us more recent data:

We do know now that efficacy rates of mRNA vaccines decrease over time. But that is countered by the fact that mRNA vaccines are reasonably fast and cheap to produce. This brilliant article in the Wall Street Journal suggests that mRNA vaccines are fast to produce but hard to scale. We’re not so sure about the scaling criticism. The rate at which vaccines were produced and scaled in 2021 was unprecedented. However, production is somewhat complicated because mRNA vaccines need to be stored in difficult temperatures ranging from 20-80 degrees below freezing – this makes it harder to scale in a single production facility. But there is no doubt that mRNA vaccines are cheaper and faster to produce. Traditional vaccines generally take 5-10 years from conception to production. mRNA vaccines took a little over a year to produce, albeit with very lenient government approval procedures because of the global emergency.

mRNA vaccines are safer, more efficient, and cheaper to produce. There are some supply-chain bottlenecks that could be ironed out over time (if mRNA becomes more mainstream). But it’s success during this pandemic could prove to be a turning point in Medicine. The success of mRNA is dependent on mapping the protein that we want our immune system to attack. That could be a virus like the SARS-COV-2 or it could be something more complicated. The vaccine story is great, but it is the application of mRNA technology for more advanced therapeutics that really excites us.

The C-word

Curing cancer would feature in the top 3, if not the top position of any “priorities of humanity” list. Almost 10 million people die of cancer – each year. Compare that to 5.3 million deaths related to Covid-19 since late 2019. mRNA has the potential to make significant progress in cancer treatment. The fundamental technology is the same. The application is different.

mRNA vaccines are prophylactic – they protect people from the virus. It’s defensive. But cancer treatment is different – the tumor is already present in the body, and it must be attacked. Fortunately, mRNA can not only trick the body into producing strong antibody responses (as we see in the Covid-19 vaccines) but it can also induce potent T-cell responses. T-cells are white-blood cells that are part of the immune system and are produced from stem cells in the bone marrow. T-cells are known to kill cancer cells. mRNA can “wake up” the part of our immune system that was dormant while cancer cells multiplied.

The funny thing is that mRNA research before the pandemic was largely focused on cancer treatment. BioNTech’s reason for existence was finding mRNA-based cancer treatments. Then the pandemic hit, and they quickly changed stripes. That’s another huge advantage of mRNA as a technology – it has tremendous economies-of-scope. And that’s largely because mRNA vaccines or treatments don’t require producing the protein it’s meant to attack.

Treating cancer – by inducing T-cells to attack malignant tumors – is obviously more complicated than protecting against a virus. Recall that with the Covid-19 vaccines, they required the virus’s genome mapped before any production work could begin. The implicit point was that it would be a one-size fits all vaccine – against a homogenous foreign entity. In the case of cancer, every tumor is different. And so, a one-treatment-fits-all approach doesn’t work well. But mRNA can be “personalized”.

Treating cancer would require first mapping the protein in the unique set of cancer cells. One can imagine that this is complicated to do each time, and is bound to be expensive. But we’re optimistic about this because, based on our research, protein mapping is in no small part a software problem. Mapping proteins is hard. Recall from the previous section that the shape and structure of proteins determines what they do. This is largely a software puzzle. Artificial Intelligence might have just found its first really useful use-case.

Check out this breakthrough by Google’s Deepmind AI software. AI was employed to predict the shape and structure of proteins – down to an astounding accuracy. This is the power of software. Mapping protein structure from genome sequences is a software and AI challenge. Genome sequencing itself has progressed exponentially over the last 20 years, without which the world could not have responded to the Covid-19 pandemic as fast as it did. Harvard geneticist George Church estimates that:

“…sequencing is 10 million times cheaper and 100,000 times higher quality than it was just a few years ago.”

This progress in genome mapping – the first important step in mRNA treatments – is largely due to advances in computer processing power and software. At The Buylyst, our biggest bet is the exponential growth in data & insights with the help of self-programming computers, i.e. Artificial Intelligence.

Treating cancer using mRNA would require accurately mapping cancer cell proteins to create the perfect tailor-made mRNA strand needed to wake up the body’s dormant T-cells…to attack the cancer cells. This would, in part, require progress in software – something we, at The Buylyst – will never bet against.

What do we need to believe?

BioNTech and Moderna are the two obvious mRNA bets. Moderna’s stock ticker is literally MRNA. But both companies are betting heavily on mRNA being standard operating procedure for several widespread diseases. Dr. Ugur Sahin, CEO of BioNTech says:

“The mrna breakthrough was made possible by scientific co-operation over three decades that helped transform a promising concept into a highly potent and versatile biopharmaceutical platform. We believe that in 15 years, one-third of all newly approved drugs will be based on mrna.”

Even if Dr. Sahin is wrong by a margin of 50%, the upside is massive. Sure, both BioNTech’s and Moderna’s stock prices reflect this enthusiasm. But we wonder if the market is still underestimating the potential of mRNA and of the dominant position these two pioneers of the technology might hold in the next 5 to 10 years.

We believe the underpriced upside, if there is any, will be largely attributable to the inherent economies-of-scope of the mRNA technology. It’s potential to treat some forms of cancers, for example, is probably underpriced. It’s potential to treat future (almost inevitable) pandemics is probably underpriced. But the trouble with making an outright bet on this is that pesky little word called “probably”.

What is the probability of mRNA being as successful as Dr. Sahin envisions? What will be BioNTech’s market share in the mRNA-drugs market? What will happen over the next 5 years in that gap between declining vaccine sales and impending mRNA vaccines/drugs for other widespread diseases?

These are the types of questions that any logical investor would ask. Usually, when we invest in themes, we have a decent idea of the probability of that theme – or the underlying revenue growth vector – growing exponentially over the next few years. And that probability is usually very high – close to 90%. It’s always the magnitude of the vector that stumps us. What is the market size of AI semiconductors in 2030, for example? Who knows? But will sales of AI chips grow over the next decade? We’re about 90% sure it will. In this case, we don’t know the probability, but given the success of mRNA in this pandemic (with the live day-by-day results we’re all witnessing), we’re inclined to believe that mRNA will be a big deal. So, how do we evaluate BioNTech or Moderna as SWAN investments?

Based on our Watch List estimates, here’s what we need to believe about BioNTech and Moderna over the next 5 years (as of December 9th, 2021):

  1. BioNTech: 6% annualized revenue growth rate
  2. Moderna: 4% annualized revenue growth rate

Of course, compared to the last couple of years, these numbers are paltry. But what happens when the pandemic (fingers crossed) completely subsides? Do these numbers hold up? Well, to buy into these numbers, we’d need to believe:

  1. mRNA – as a technology – will be used for therapeutic treatments of deadly, widespread diseases such as cancer.
  2. Dr. Sahin’s prediction that mRNA will account for about 1/3rd of all drugs will be at least partly true.
  3. BioNTech and Moderna will carve out significant market shares in the mRNA drug space.

Let’s make some back-of-the-envelope estimates. Let’s make some logical assumptions and see where it shakes out. Here’s a tongue-twister: what do we need to believe to validate our “revenue growth we need to believe” numbers?  Let’s try this:

  1. Let’s assume that in 10 years, 1/5th of all drugs will be based on mRNA (Dr. Sahin thinks it will be one-third in 15 years).
  2. We know that the total annual sales of all pharma treatments is $1.6 trillion or $1,600 billion.
  3. Let’s assume that the $1.6 trillion number grows at a modest pace of 3% per year for 10 years. That compounds to roughly $2.6 trillion in 10 years.
  4. That implies that about $520 billion (20%) in sales will be attributable to mRNA.
  5. Let’s assume BioNTech and Moderna have the same market share in that brave new world.
  6. What market share would we need to assume for BioNTech and Moderna to justify the “revenue growth we need to believe” in the previous chart?

The answer for “market share we need to believe”: About 6% for BioNTech. 3% for Moderna.

To us, 6% is decidedly believable. Now, bear in mind that when we estimate “revenue growth we need to believe”, we hold fixed costs constant over 5 years. In this case, that assumption will need to be stressed because R&D costs are bound to increase. But just some back of the envelope estimates suggest that the “market share we need to believe” will still be short of 10% even if we bake in a 10% annual growth in R&D Expense. But, to be safe, let’s stick with this: we need to believe that each of these companies will carve out a 10% market share in the world of mRNA-based treatments.

For such a specialized technology such as mRNA, especially when applied to things like cancer and immunotherapy, we doubt the market will be too fragmented. In our view, it’s highly likely that if mRNA becomes the next big thing in Medicine, BioNTech and Moderna will be big players. We can’t possibly have the data to back this up – we doubt anyone can. But this is why investing is hard – we need to make decisions with imperfect information. The bet is that producing mRNA treatments is hard and not many companies will be able to do it at scale. And in our little back-of-the-envelope estimates, we aren’t even accounting for the fact that mRNA drugs are likely to have much higher pricing than the average drug price.

Can we believe that each of these firms will have a, say, 10% market share in the mRNA drug world? Do we believe mRNA will corner 20% of the total pharma market? Let’s call this the 10-20 assumption.

Our answer is Yes. We can live with the 10-20 assumption. The beauty of Expectations Investing is that we don’t need to forecast revenue year-by-year. We just need to estimate what’s baked into the current price, and then ask ourselves whether we can believe it easily. In this case, the 10-20 assumption also totally circumvents the thorny business of predicting revenue in 2022, 2023 or 2024 while these companies ramp up their “beyond Covid” portfolios. We expect the stocks to be volatile in the short term, but it’s the long-term cash flow potential that we care about.

Both companies are betting their respective houses on a world beyond Covid-19. See BioNTech’s pipeline below.

Now, we don’t have the expertise to comment on these pipelines. We will drive ourselves crazy by trying to predict the efficacy of BioNTech’s BNT111’s Phase 2 trials, for example. We’d rather go with our usual Option Theory thinking. There’s a chance that BioNTech and Moderna’s revenues and free cash flow (and therefore stock price) will all rise beyond market expectations because of mRNA’s potential. How much should we pay to participate in that potential upside? The answer, unlike Option Pricing Theory, is subjective. We’re just looking for a mispriced gamble; we don’t need a precise option-value calculation.

“To us investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.” – Charlie Munger

In our view, it’s worth taking a chance on both these companies because we can sleep well at night with the 10-20 assumption. Both will be long-term bets that may pay off handsomely in, say, 3-5 years. Here’s an important point: our Healthcare bet will remain a top-down bet. Investing in BioNTech and Moderna will also be a top-down bet – on a subtheme called mRNA. We will not pretend to know about the intricacies of each company’s competitive advantage or details of their new oncology drugs.

In the next couple of weeks, we will decide whether we want to invest a sum-total of 3% of the portfolio in BioNTech & Moderna, at 1.5% each. We were tempted to allocate 5% but since this bet involves a lot that we don’t know, we will make these companies “earn” a 5% allocation over time. If we go ahead, it would take our total Healthcare bet to about 8%. We can sleep well with that. Before we pull the trigger on BioNTech & Moderna (if we do), we will present our thesis in our usual graphical format. Until then, we hope that our little foray into mRNA has helped you in your healthcare investing journey. If you’ve already invested in these companies because you have more insight into the biology and chemistry of mRNA, we hope that an investor’s perspective has added to your comfort with these investments.

At The Buylyst, we always strive to make things as simple as possible. Investing is not that complicated; no need to lose sleep to make market-beating returns.

Many happy returns.

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