Peter Thiel Explains Biotech Investing Rationale: Get Rid of Randomness
The value placed on biotechnology companies has soared, but are their chances of success any better?
Technology investors are bringing new ideas to biotechnology.
Peter Thiel knows a promising tech startup when he sees one. The investor was the first outside investor in Facebook. But does he have the same touch in biotech?
The prominent Silicon Valley venture capitalist’s investment fund has put its largest ever bet on a biotech company called Stemcentrx, a private and all-but-unheard-of San Francisco company developing cancer drugs that debuted this week with a spectacular valuation worth billions (see “Peter Thiel Backs Biotech ‘Unicorn’ Fighting Cancer Stem Cells”).
As a startup only beginning to test its drugs, the valuation ascribed to the company raised questions from readers and commenters on Twitter, who wondered how it could be worth so much, and if it was simply a case of hype. After all, there is a public biotech company named OncoMed with a similar approach to cancer and similar drugs that’s worth only a fraction of that amount.
What’s clear is that investors have been bidding up biotech stocks to unprecedented levels. There have been a record number of biotech IPOs over the last three years, and the Nasdaq biotech index is up 250 percent over the same time frame. That is thanks in part to optimism over new treatments, like one for hepatitis C, that have broken sales records. One side effect of the stock market boom is that investor money has been flowing much more quickly, and in greater amounts, to smaller, private biotech companies.
Thiel, who also cofounded PayPal and is now head of the investment firm Founders Fund, is a relative newcomer to biotech (see “A Contrarian in Biotech”). MIT Technology Review spoke to Thiel at his offices near the Golden Gate Bridge and asked him about his approach to biotech investing. What follows is an edited excerpt of that conversation.
How much of the value placed on Stemcentrx do you think is due to your endorsement of it? Is the golden touch yours, or theirs?
I certainly hope it’s not mine. Since I think that … Seriously, I think that it’s theirs. I don’t think that we would be seen as particularly sophisticated biotech investors. I think that if we had done this in a software context that might be true, but I don’t think in a biotech context we’d be seen as particularly sophisticated.
This is the largest amount of money Founders Fund has ever invested into a single company. What do you like about this company?
I like Brian [Slingerland] and Scott [Dylla]. The two cofounders are very strong and complementary. I do think it’s a classic Silicon Valley model of a very strong technical and very strong business combination. We don’t actually see two strong cofounders paired like that very much anymore. On the software side we often do things where it is just technical founders.
Also, our theory was that it was a biotech company that looked like a software company. We think software companies can be very capital-efficient and get incredible returns on capital, and that is why we invested.
What’s challenging about investing in biotechnology companies?
This goes back to that famous Bill Gates line, where he said he liked programming computers as a kid because they always did what he told them to. They would never do anything different. A big difference between biology and software is that software does what it is told, and biology doesn’t.
One of the challenges with biotechnology generally is that biology feels too complicated and too random. It feels like there are too many things that can go wrong. You do this one little experiment and you can get a good result. But then there are five other contingencies that have to work the right way as well. I think that creates a world where the researchers, the scientists, and the entrepreneurs that start companies don’t really feel that they have agency.
How do you know what an early stage biotech company is actually worth?
There is disturbingly little intuition into what biotech companies are worth. If you are able to produce a drug that cures some sizeable disease for which there is no cure at all, that is worth billions, or tens of billions of dollars. And if you don’t succeed it’s worth nothing.
You have to get through basic research, preclinical, Phase I, II, and III, and then marketing. So approaching it analytically, the question is how do you discount [the risk of failure at each step]. If you do half on each step, and there are six steps, that’s 2 to the 6th, or 64. So something worth a billion at the end means you start at [a value of] $16 million.
The thing I don’t like about this as an investor is that the numbers are totally arbitrary. They are just made-up numbers. And our feeling with many biotechs is that people understate these probabilities. They say it’s half, but maybe it’s just one in 10. And if even if just one of these steps is one in 10, you are really screwed. I would be very nervous to invest in a company where it gets pitched as a series of contingencies that “this has to work, and this has to work, and this has to work.”
So is Stemcentrx doing it differently?
The question is, can you change those probabilities into different numbers? The reason we invested in Stemcentrx at a valuation that would have been higher than many other biotechs we looked at is that we felt the whole company was designed to get these probabilities as close to one as possible at every step, to get rid of as much of this randomness or contingency as possible. That is something that we found deeply reassuring.
One of the very unusual things they do is graft human cancer into the mice. It’s a somewhat more expensive way to do this than studying cancer in cell culture. It’s a somewhat harder structure to build. But drugs tested this way are much more likely to work in humans. They convinced me there is a surprising amount that has gone wrong with the cancer cell lines people have been studying. This framework of getting rid of probabilistic contingencies leads us to think it is quite a valuable company and is quite an unusual company. It runs counter to so much of the culture of the way biotech gets done.
What should a high valuation tell the next investor that comes along about this company?
It would tell you that the company has done a better job deploying its capital [than other companies]. That it’s more efficient. If you look at Facebook, it’s worth more than $200 billion, which is eight or 10 times the cash it raised in its entire history. That is because somehow you are able to invest the money very efficiently in scaling the business. But if biotech companies tend to invest money in ways that are pseudo random, then a lot of it must get wasted. You end up doing things where you say, “I am not sure it’s going to work.” Well, that sounds like a wasteful thing to do. The standard excuse that biotech companies have is that, “We don’t know if it’s going to work, so we have to do it this way.” That has to be inefficient.
Stemcentrx actually makes its own drugs. It does everything itself. But you also invest in Emerald Therapeutics, which has a “lab in the cloud” where anyone can outsource scientific projects. Is there a contradiction there?
There are many experiments you can outsource. But if you are trying to build an end-to-end next-generation pharma company, then actually doing a lot of these things internally is correct. The ability to do complex coӧrdination of different pieces of a business and make them work together is a very underrated entrepreneurial skill. I think that is what Elon Musk has done really well at Tesla, doing end-to-end car assembly, and owning all the stages of the process. This turns out to be really critical. Some other electric car competitors outsourced key components and then the people they relied on ended up being unreliable or failing.
This idea was very much in my mind by the time we invested in Stemcentrx in 2012. They had an annoyingly complicated problem, all these pieces you have to bring together, and they said, “We are just going to do it ourselves.” That is a mind-set that I very deeply share. I don’t want to name names, but there are other companies where, in some ways, this was the key thing that failed.
It’s interesting that a lot of technology outfits are getting into biology. Google has announced a number of plans. You have invested in longevity research. What do you think makes actual programmers want to start programming biology?
The big picture is the question of whether biological science can be transformed into an information science. Can something that seems chaotic, fractal, and generally random be transformed into something more deterministic and more controlled?
I think of aging and maybe just mortality as random things that go wrong. The older you get, the more random things happen, the more breaks. If it’s not cancer, you could get hit by an asteroid. So on some level, technology is trying to overcome the randomness that is nature. That is a question on the level of a company. Can you get rid of randomness in building a company? But the philosophical version of the question is whether we can get rid of randomness in its entirety and overcome the randomness that I think of as the evil part of nature.