Eric Fry has a somewhat contrarian “Tech Panic” teaser pitch running for his Fry’s Investment Report newsletter ($49 first year, $79 renewal, 90-day refund period), mostly focused on the fact that he thinks the current AI boom is a mirror of the 2000 dot-com boom, and will similarly crash, leading to disaster for the “Magnificent Seven” stocks…
… and he’s right that there are some similarities (and some differences), and that the stock market is being led by a small number of companies (though that’s pretty often true), and that valuations are “optimistic” for a lot of the big tech stocks. Investors have noticed that large cap stocks have boomed, and now trade at almost-unprecedented valuations — especially NVIDIA (NVDA), which, as we’ve often noted, has a story that rhymes pretty nicely with Cisco (CSCO) in the 1990s, but even giants like Microsoft (MSFT) are valued more richly than they’ve been in 20+ years.
Lots of folks agree that the market is top-heavy and “feels” pretty risky, lots of folks see a crash coming at some point… nobody knows exactly when, or how bad it will be. That’s the sad truth — forecasts of the broad market (or the macro economy) are little more than guesses, flips of the coin… except that a stock market forecast is probably less likely to be right than a coin flip, because there are thousands of different ways the future could evolve. It seems pretty clear that some AI-driven story stocks are in a valuation “bubble”… but if we compare the AI boom to the dot-com boom there’s no way to be at all sure whether we’re in 1996, with huge gains yet to come… or early 2000, with an epic crash around the corner…. or something in between.
Heck, for all we know stocks could stay relatively stable for ten years now — humans don’t get to know the future, all we really know is that we’ll probably overreact to it, with paroxysms of fear and greed, because that’s how we always behave.
More importantly for our purposes, Eric Fry believes that the winners of this next phase will be the “Next-Gen Stocks” who can survive and thrive even if the tech stocks crash… and eventually he hints at one of them, so we can look into that for you.
Here’s how he talks up that bit:
“…. they’re a unique class of stocks — of businesses — that are essential for the growth and prosperity of society, as a whole.
“They are the types of businesses that all Americans use on a regular basis… and they tend to flourish in all economic conditions, even during recessions.
“During the 2008 Financial Crisis, for example…
“While the U.S. economy lost over 8.7 million jobs, Next-Gen companies ADDED over one million jobs.”
And he doesn’t just go back to the dot-com bubble, but to the Great Depression (which, of course, followed the “Roaring Twenties” — lots of folks are drawing those comparisons these days, 100 years later).
“The concentration of tech stocks has now eclipsed — not only — the dot-com boom… but the bubble of The Great Depression in the 1930’s…
“But on the flip side… Next-Gen companies are set to be in a severe shortage of 10 million employees by 2030.
“Can you see where the REAL demand is rotating right now?
“OUT of ‘big tech’ and INTO Next-Gen Stocks…”
“… and while major tech stocks appear headed for a violent reckoning, I believe Next-Gen Stocks stand to create an entirely new generational wave of millionaires in the years ahead.”
And he says he’s done this before… and that the “smart money” is coming to a similar conclusion right now…
“In 2001, I went on public television ‘pounding the table’ to buy a specific Next-Gen Stock, all while the dot-com crash was still in full force.
“Those who listened and invested in that Next-Gen Stock saw it double over the next three years all while the S&P 500 was producing a massive loss for everyone else….
“Nine months after the dot-com crash, tech stocks had plunged over -50% from their highs!
“But Next-Gen Stocks, as an entire sector, were up over 40%….
“So, while your friends, financial advisors, and mainstream media outlets cheer on the “next leg higher” in names like Nvidia, Apple, and Microsoft…
Are you getting our free Daily Update
“reveal” emails? If not,
just click here…“The insiders — the true ‘smart money’, they’re all piling into ‘off-the-radar’ Next-Gen Stocks instead.”
So what are those “Next-Gen Stocks?” Really just, “healthcare stocks” — which until recent years were always considered to be relatively safe places for “widows and orphans” to stash their money, in steady leading companies like Johnson & Johnson. This is often a sector folks look to when they get nervous about other stuff, if only because of the demographic shift in the world’s most profitable healthcare market (U.S. baby boomers are getting to those “max healthcare spending” years), though it’s not always a “sexy” enough market to inspire a lot of teaser pitches — I think the last big healthcare sector pitch we looked at, aside from all the “AI drug discovery” and “next hot biotech” pitches, was Dr. David Eifrig’s “Healthcare Singularity” pitch a couple years ago.
But Eric Fry is also trying to sell a newsletter, so they’re not just healthcare stocks… they’re “AI-Healthcare” stocks. From Fry:
“I believe “AI-Healthcare” investments could create more wealth than we’ve ever seen in the sector….
“It’s a total transformation…
“From surgical procedures…
“To medical diagnostics…
“To medical education…
“And that’s just scratching the surface.”
Finally, then, we get to the “#1 Next-Gen Stock”, and the hints from Eric Fry about which one is his favorite. He does talk up all the AI stories we’ve heard many times over the past year — the fact that “AI Drug Discovery” companies are cutting drug development time in half, or that AI systems are getting to be better (and faster) at finding tumors than radiologists… but really, he seems to be leaning on the “defensive” argument for health care stocks…
“The critical point here is…
“Healthcare is an evergreen necessity, in any market condition.
“‘Healthcare Stocks Offer Resilience, Plus Growth’ — BlackRock, $10 Trillion Asset Manager”
That particular quote is from a BlackRock Health Sciences analyst, in a note last year about the appeal of the sector — and that might be right, we’ll find out in the fullness of time, but we should note that the manager of a sector fund (BlackRock Health Sciences Opportunities Fund (SHSAX), in this case) is always incentivized to tell us that their sector is cheap and appealing. For what it’s worth, that BlackRock fund has pretty much exactly mimicked the total return of the S&P Health Care Sector over the past decade…. and the health care sector outperformed the broader market for much of the past decade, but has, no surprise, trailed the market over the past year.
Then we finally get to the specific pick:
“The Next 1,000% Investment
“I’ve compiled everything into a new guide, called: The #1 Next-Gen Stock.
“What I believe could be my fifth 1,000% winner in this sector….
“Because this stock allows you to ride the entire next wave of innovations in this sector — from ONE simple investment.
“Kim, think of this company as a toll road…
“And virtually any historic innovation in this sector that comes to market, may go through this particular company.”
Hmmm… that’s a particularly lawyer-chosen phrase there, “may go through.” The investment metaphor of a toll road, of course, usually implies that you pretty much have to use it if you want the most convenient path, and therefore you have to pay. That might not be the case here.
Other clues:
“Essentially, this company is a bank — providing financing for all kinds of new innovations, in exchange for permanent royalties.
“We’re talking investing in what will become the biggest advances of the 21st century, in ONE single stock.
“In fact, this company has already secured the largest royalty portfolio in this sector’s history — and growing.
“So instead of investing your money into one, two, or three different stocks in this sector, that could potentially rise…
“With this company, you can get paid for a generation of innovation that’s being built… without having to own more than ONE single stock!”
OK… so some kind of healthcare royalty stock. And since we’re talking up a stock that will survive Fry’s impending tech collapse, we have to assume that he means a stock that’s got some royalty revenue now — not just, like the AI drug discovery stocks, the potential for royalty revenue perhaps 8-10 years from now, when their first wave of AI-discovered drugs might be commercialized.
And one final crop of clues…
“It’s no surprise that the world’s financial elite are already in.
“Morgan Stanley owns 46 million shares of this company.
“Vanguard 37 million shares.
“BlackRock (the world’s #1 asset manager) owns 21 million shares.
“Not to mention State Street, JPMorgan, Goldman Sachs, Bank of America, and more.”
So… hoodat? This is the largest publicly traded pharmaceutical royalty company, Royalty Pharma (RPRX).
Which is a bit of a buzzkill for yours truly, I’m sad to say, because I owned this one for a few years after their IPO, and I generally love the strategy of investing through royalties… but they just haven’t been able to replace their expiring royalty cash flow at reasonable enough prices for me to hold on, which means there hasn’t been any revenue growth, which means investors never really got interested. Kind of like a toll road… but a road that has to be rebuilt every ten years, with most of those tolls going to pay for the rebuilding.
That doesn’t mean I’m an expert on this company, to be clear. Here’s what I wrote to the Irregulars when I finally sold my RPRX position last Summer:
I’ve been really wrong about Royalty Pharma (RPRX), which has tried to build a growing royalty portfolio, and in some ways has succeeded, mostly replacing their expiring drug royalties with new investments in drugs that are either selling well or in advanced development and likely to be approved… but it’s been a slog, their costs are high, and the short lifecycle of drug royalties makes the churn substantial enough that replacing their revenue is increasingly difficult. I’ve held on because they’ve paid a solid dividend and kept growing that, gradually, and because they do seem to be making intelligent decisions in drug acquisitions and financing deals… but this is both a less-steady business and a slower grower than I anticipated when I started buying shares shortly after the IPO. What pushes me to think more negatively about it now is that we’re also seeing increased insider selling, at the same time that they’re also facing increased borrowing costs for their substantial debt balance, and a share count that continues to gradually climb higher.
It’s time to recognize that I was probably just wrong about Royalty Pharma — the valuation looks quite rational to me, but the business hasn’t really improved in the way I thought it would, and that means we’re either in an unlucky dip here that could recover, or I’m just thinking wrong about the value of the stock. Increasingly, I think it’s the latter, and I’m not willing to hold through more meaningful losses if that’s the case, so I’ll take my 20% loss and cut out of this holding. RPRX leaves the portfolio at just under $30 per share, for a total loss of about 21% since I started buying about three years ago.
And that’s actually just about where RPRX sits a year later, too — it’s been bouncing around between $27 and $30 since I sold but at the moment it’s at the lower end of that range, down another 8% or so, while the S&P 500 has climbed 24%. And it looks fundamentally cheap, at about 7X expected adjusted earnings and 13X GAAP earnings, with a 3%+ dividend yield… but there’s still not a ton of hope that they can really create levered per-share returns anytime soon. So far, since their 2020 IPO, they’ve grown their top-line revenue at about the same rate as they’ve grown their share count (revenue per share has been shrinking since 2021), and that may turn if they’re really building future royalty streams that will be larger than their past deals, which is entirely possible, but that’s not guaranteed.
Right now, analysts expect them to grow from $2.35b in revenue in 2023 to $2.64b this year and $3.2 billion in 2026, which is decent 10% growth that should lead to at least 10% EBITDA and earnings growth, with good cash flow, but both the EBITDA growth and the GAAP earnings per share growth estimates for that same three year period (2023-2026) is only 5%. So you can see why the stock is trading at a pretty low valuation — analysts expect the business to grow reasonably, but to have disappointing earnings growth over the next few years.
This is a royalty company, essentially run by a handful of healthcare analysts and bankers, so their margins are extremely high and almost all the revenue drops to the bottom line, and they have good economies of scale… but no real way to substantially improve the economies of scale from here. And it’s also financing expensive drug development projects that take at least a few years to turn into revenue, at pretty hefty cost (some royalties are bought when the drug is promising but in mid-stage development, with some uncertainty about approval… some when the drug is already approved, and the drugmaker just needs capital to commercialize the drug — investing in manufacturing, a sales force, marketing, etc.), so the value of those potential future revenue streams is heavily impacted by interest rates (since every long-term investment is driven by interest rates… and since they use some debt), which I’m sure has also put some pressure on the stock over the past year.
The challenge comes from the fact that they’re not really stockpiling future potential blockbusters — they’re cycling through high-probability drugs, as some go off-patent every year, and they use the cash flow from their royalty and milestone payments to fund the investments they make in the next crop of deals that should replace that cash flow, usually with a lag between the royalty investment and when it starts actually contributing to cash flow (they invest about $2 billion per year in buying more royalties, buying ~8 new drugs per year, about half of which are “development-stage” and probably many years from generating revenue… though about 2/3 of their development-stage drugs do end up getting approved for commercial sale).
This is the best portfolio manager in drug royalties, I would argue, certainly the biggest, and they’re more likely to get the best deals and build a strong portfolio over time… but unlike, say, mining royalties, time really matters — drug patents expire after 20 years, and take about ten years to get through regulatory approval, so for the most part these up-front investments by Royalty Pharma require a company to have great sales during their ~10 year commercial patent-protected phase, which sometimes fails to happen, and I think that means they really need at least one or two of the drugs they finance to grow into larger-than-expected blockbusters every few years, otherwise the financial model doesn’t have much potential for wealth-building. It’s a tough business, and a hit-driven business, and I still find the idea of it compelling… but my experience with this stock tells me that I don’t have the insight to risk my money here… even though they do find those hits sometimes (their partnerships/royalties with Immunomedics and Biohaven turned into great returns, with an improved probability of more long-term success, when those companies were acquired by big pharma, for example).
Which isn’t to say it won’t work out, over time. It’s a good business model, and they’re arguably better at it than anyone else, particularly when it comes to large-scale deals, and it’s a pretty efficient platform — if you want a more detailed overview, they have a recent Investor Presentation. They think they can compound at a “low teens” internal rate of return, maybe more than that if they use more debt, and that’s pretty attractive for a company that trades at a low-teens earnings multiple and pays a solid dividend. They just haven’t been able to prove that over the past couple years, so we’ll see if they turn that around.
Because I always find these royalty stories tempting, I’ll leave you with the less-tempting chart of their performance so far — since the IPO, they’ve had falling per-share free cash flow, earnings and EBITDA, and have lost about 39% for early investors… the only positive line there, at the top, is the 23% growth in their share count.
Bottoming out now? Building for the future? Or just in decline? That’s your call to make… it is, after all, your money. Please let us know what you think with a comment below.
Disclosure: Of the companies mentioned above, I own shares of NVIDIA and have stop-loss trades entered for NVIDIA that could trip at any time. I otherwise will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.
