Motley Fool Hidden Gems Investing - Selling Secrets Across The Globe

Episode Date: June 15, 2023

  A former Samsung executive allegedly stole plans in order to build a chip plant down the road from the existing factory. What could possibly go wrong? (00:15) Bill Mann and Deidre Woollard discuss: - The high value of getting a leg up on the competition in the semiconductor industry. - If companies can do anything to keep secrets from leaking out. - Why Alphabet’s adtech is attracting regulators’ attention. (13:53) Ricky Mulvey and Kirsten Guerra take a look at Vertex Pharmaceuticals and its role at the center of cystic fibrosis treatment. Companies discussed: GOOG, GOOGL,KO, VRTX, SSNLFHost: Deidre Woollard Guests: Bill Mann, Ricky Mulvey, Kirsten Guerra Producer: Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. The shadowy world of stealing tech secrets and Google's ad tech business raises European eyebrows. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Bill Mann. How are you today, Bill? Hey, Deidre. How are you? I'm doing well. You brought up the story that I want to dive into because it sounds like the plot of a movie. You've got an executive. He's formerly at Samsung and another Korean manufacturer. He attempts to steal trade secrets and build a chip factory not even a mile away from the

existing chip factory in China. What's the backstory here? It's a bold statement, isn't it? Yeah. Yeah. So, obviously, when something like this happens, I mean, this is a multi-million dollar facility. And it's industrial espionage on a massive scale. And so this is a fairly high ranking official at Samsung who stole the blueprints. When I say stole, let's start that again. Allegedly stole. I don't want us to end up on the wrong side of the law. According to the allegations, stole blueprints and designs to replicate an entire chip factory in China. And so manufacturing has started was in the city of Xi'an. And you could basically see the new facility, the copied facility rising from the original Samsung facility. So

it was it's almost as if they were not particularly worried about getting caught. Yeah. Well, and I found it interesting that in this story, one deal fell through and he was able to find new backers. So this sort of seems like, is it a bit of a free-for-all with IP? Are companies not that concerned about where the information is coming from? Or is it kind of a difference between design and know-how? You know, so they're estimating that the data that he stole was in the range of $200 million. The interesting thing to me is when you say backers. You're not you would immediately say, well, OK, someone within China was doing the backing. But there were Taiwanese firms involved. There were Japanese firms involved. He hired away

18 Korean experts and technologists, you know, as part of this this audacious plot, if you will. And it really just goes to show, on the one hand, the lengths to which companies will go and countries will go to steal, but also in this environment where semiconductors and chips are essentially the lifeblood of so many industries and the lifeblood of so many economies, what you're talking about here is it's espionage on a geopolitical level. To say that it's company to company is one thing, but to say that this is something that in a world in which China is being restricted from access to equipment from ASML, for example, this is a huge, huge potential deal. And I guarantee you, this is not the only place

where this is happening. Yeah, you mentioned ASML. So, we've got this situation right now where we're trying to build factories in the U.S., we're trying to restrict China from knowing things. When we look ahead to the future, what do you think is going to happen to overall chip technology looking ahead like a decade? Are we going to develop separate paths here? I don't know. And I know that's a terrible answer because we're supposed to know things, but I really don't know. But I do suspect that this is, as I said, not the only time that this is happening. China will, in fact, not sit idly by and just say, well, we don't have access to chips. We might as well

do something else. So they will be developing very quickly. They don't have anywhere near the know-how to replicate ASML's technology or even Taiwan Semiconductor's technology. So I would suspect that there will continue to be efforts if they are not available on formal channels through more informal channels. It's not just the chips. There was a story that came out in Bloomberg a couple of weeks ago about chemist at Coca-Cola, Shannon Yu. She tried to steal the secrets to Coca-Cola's can lining formula. She was setting up this new business in China. How big of a threat is this for companies in the U.S.? It's a spectacularly large threat. I don't want to say a funny story, but it was so interesting

because you assume if someone is stealing anything from Coca-Cola, it's the vaunted formula for Coca-Cola itself. Right. But instead, there is a there is a lining that goes inside the cans, which allows Coca-Cola, Coca-Cola products to to be preserved longer, to remain fresh. And that's what she was after. And it doesn't seem on certain levels like that's that big a deal. But I can assure you that that is a highly proprietary piece of technology that Coca-Cola has spent millions developing and is not interested in having it shared. Yeah, absolutely. And I think one of the things that always surprises me about stories like this is that despite all of the cybersecurity things we have in place, it gets relatively easy

for someone who has knowledge of things to sort of walk away with them. In that story, she was downloading things multiple times, and the company seemed to be aware of it, but didn't necessarily confront her about it. Yeah, she had cat videos that she was uploading at the same time. Who knows what they're doing to mask their activity? But in a knowledge economy, you're exactly right. The knowledge goes down the elevator every single day and leaves the building. So yes, there is a great capability and all sorts of incentive for people to take that knowledge with them. And as former NFL Commissioner Rune Arledge said, whatever the question is here, the answer is money.

The answer is always money. Is there anything that companies can do to stop this sort of thing, or is this always trying to plug a hole that there's another hole that's just going to pop up? Well, I think that there are an endless amount of ways in which companies and other competent bodies will try to steal. It's been going on since as long as there has been money. So, yes, I mean, there are and there are a an endless amount of ways that they will continue to have to plug their holes. I would I mean, this sounds like a a fairly negative story. It is important to note that once again, they were caught. We know about this because because this alleged activity was unearthed.

So, yeah, I mean, it's going to continue to happen, but I think that we are probably better at finding and upending espionage than people might think. Yeah, absolutely. Well, switching from tech secrets to monopolies, earlier this year, the U.S. Justice Department, they sued Alphabet over having a monopoly in the ad tech space. Now the EU, they're getting in on the act. the European Commission says that Google may have abused its dominant position by basically favoring its own ad tech services. And the interesting thing about this is Google,

they're active on all sides of the ad tech transaction, sell side, buy side. They've got the exchange in the middle. So the concern is there's a monopoly here. Is this a problem? And what do you think might happen next? So I want to make sure that I add this little disclaimer, which is this. I am not an attorney, nor am I a trade attorney. So anybody who is a trade attorney who is listening to this be like, ah, you don't have this, this or this right. So I'm going to just try to be as best I can a layman who is setting the table properly. So U.S. and EU antitrust laws are a little bit different from each other. The standards for antitrust in the U.S. are much higher. And generally speaking, in order to win an

antitrust case, the thing that needs to be proven is harm to the customer. Whoever the end customer is, that is generally speaking who the U.S. antitrust laws are focused on. In Europe, it's not quite the same. They are actually they are focused on a number of different parties. And there is a there is a term of art called a refusal to deal. And the and the threshold by which a in Europe antitrust law can find that a company has refused to deal is much lower, right? So, in this case, what Google is primarily being accused of is shutting out other competitors for its ad space, for its ad tech, and making sure that its own ad technology, its own ad partners got primacy on the Google system.

So they've already paid more than $8 billion worth of fines in Europe, which sounds like a lot until you realize that they make manifold that amount. So you could almost view it as a cost of doing business. In this case, Europe is suing with the possible outcome of Google having to break up its ad business, either in Europe or worldwide. And they actually do have the power to do this. They did say that this suit is not a presumption of a finding. It is, however, a pretty massive exposure for Google itself. Well, in the response to the announcement, Google's VP of Global Ads, Dan Taylor, he published this post.

It seems sort of like Monopoly 101. Oh, there's lots of other competitors in the ad space, and this position actually helps the little guy. There's that guy! Yeah. We always like to point to the other guys. And that's like, no, no, this actually this our position actually helps the little guy. Is this a compelling argument? No, it's not a compelling argument. I mean, I don't think so. I mean, I'm not sure that I'm not sure under U.S. law that they would be able to prove harm to consumers. But this isn't what we're talking about here. Yes, there are plenty of there are plenty of different places you can go. But Google is by far the dominant one, and so they have so much capacity to put their thumb on the scales. I mean, did they? I'm not under no circumstances what I suggest what they have or have not done, but they very much do have the capacity to shut anybody out, including Glenn, the ad guy. Or it's really, really hard to look at a case like this and say, well, Google had all sorts

of opportunity. Are we really saying that there was never a case in which they made sure that they were getting the best of the other side of the business? Well, both the U.S. and the EU are saying that Google may need to break up the business and potentially sell ad exchange. That's the thing right in the middle between the buy and the sell side. If that happens, any idea of any company you'd like to see as a potential buyer? Oh, I would imagine that if they were going to be broken apart, that ad exchange would

become its own business. I mean, I don't think that what Google would do would be to say, well, Apple, you take it, because then you have the same problem, but it's just a little bit in a different place of the alphabet, right? I think that if we go down the road and if Google does have to break out certain components of their business, those certain components of their business are going to almost by necessity be independent. Well, we'll have to stay tuned and see what happens with this one.

Thanks for your time today, Bill. Hey, thank you, Deidre. We've got even more Monopoly discussion up next. Ricky Mulvey and Motley Fool analyst Kirsten Guerra dive into a biotech company that owns a virtual monopoly for a life-changing treatment. You can innovate and generate solid free cashflow. Joining us now to talk about a company doing just that, it's Motley Fool analyst Kirsten Guerra. Good to see you again. Thanks for having me on, Ricky. I want to talk about Vertex Pharmaceuticals, ticker VRTX. To set the table, what does this

company do? Vertex Pharmaceuticals, as you can probably tell by the name, they are a biopharmaceuticals company. They have a whole commercial drug development program. Their bread and butter, really, that drives their cash flows right now is a suite of cystic fibrosis drugs. In this space specifically, they have a virtual monopoly at this point. They sell those drugs under several different names. You may have I've heard of Trikafta, Symdeco, or Combi, Calideco. These different titles or these different names serve different mutations. They're kind of approved for various different age groups, but they all target the cystic

fibrosis patient population. So they're all really in that area. So let me back up for a second. If there's anyone unfamiliar with cystic fibrosis, it is a genetic condition that just deals with sort of the fluids of the lungs and digestive system, where those fluids become too viscous, essentially. It causes a lot of mucus buildup, and it can impact quality of life. This area for Vertex, they've been very successful in this area.

As I said, they have a virtual monopoly here. It provides the dominant cash flow for the company. But, of course, being a biopharmaceuticals company, they also have a pretty extensive drug pipeline as well, with different drugs for different conditions in various stages of that pipeline. I'm sure that we'll get into that. Yeah, Trikafta is the big cash cow for Vertex, but is this something that could be disrupted by a generic treatment or competitors working on something similar? Yeah, definitely. I mean, there are other ways to treat cystic fibrosis, first of all.

You can take simple things like antibiotics just to prevent lung infection, or you can take medicines that will thin the mucus that's building up. There's also vests that have these high-frequency oscillations that physically break up the mucus from this condition. But all of those things are kind of Band-Aids or they're more like Band-Aids, whereas the Vertex cystic fibrosis suite, they all really treat the underlying condition. They actually go in and correct the misshapen protein that causes cystic fibrosis. So to be clear, it's not a cure. This still requires that patients take daily tablets, but it's way better than all of those Band-Aid options. So could a generic treatment come in and disrupt that? Absolutely. Based on the,

When I call it a near monopoly, that's sort of based on the quality of life that's offered. Like I said, there are all of these other treatments you can do, but the quality of life here is much higher with this drug suite. It's been shown to those who take Trikafta have shown significantly lower levels of anxiety and depression than non-Trikafta patients. So because of that, it is definitely priced for monopoly status, right? And so any threat to that would potentially drive down the price, whether it's a generic or even a comparable branded drug that's able to come to market.

With all that said, it's easier said than done, right? It's not as if competitors aren't out here trying. They are. Competing development pipelines exist in this space. AbbVie, for example, just recently canceled their development program for cystic fibrosis. They did make it to phase two, but their chief scientific officer came out recently and said that it simply, quote, does not work. And so, again, it's easier said than done to actually compete with a drug like this.

So, approval process is very difficult for these drug companies, and they're working on some bleeding-edge stuff, like a non-opioid painkiller, CRISPR treatment for sickle cell. How do you think about regulatory risk for investors in Vertex, or investors considering it? Yeah, they have a substantial pipeline going on here, focusing on a lot more specialty markets, All of those are in various stages of the regulatory process that you mentioned. For example, there's some under development for sickle cell disease, beta thalassemia, muscular dystrophy, type 1 diabetes, among others. As I said, they're all in various stages, some as early as just being researched, some

that have moved into phases one, two, three. The way to think about those phases is that realistically, any of these drugs can and will fail at any point. The higher the phase the drug makes it into, the more likely it will come to market, but the likelihood is still quite low. This is still very risky. To think about that regulatory framework, I think you just have to be aware upfront and accept the fact that this is an industry where a lot of the future cash flows that you might be excited for on the horizon potentially just won't come to pass. That's why a substantial pipeline is key. Maybe of

10 treatments, if that's what's in development, maybe only one of them comes to pass. And that's kind of how these things are priced out. You mentioned CRISPR. Let's talk about it. What's going on with the work with CRISPR Therapeutics? Yeah. So, CRISPR, some of their more advanced stage pipeline development programs actually are with CRISPR Therapeutics using the CRISPR gene editing technology. So, they're trying to develop one-time treatments here that focus on the partnership with CRISPR is specifically towards blood disorders, sickle cell disease, and beta thalassemia. Right now with CRISPR, those studies are ongoing in phase three, which as I mentioned is one of the later stages, but they have already

filed their biologics license applications to the FDA, including a request for priority review. So typically the review process is around 12 months and they're trying to do that even quicker. that's not yet approved, to be clear. But in this space, anything like that is a positive sign, right? This management here knows far more about the success or failure of the trial at this point. So, any indication we get of how they're communicating that with the FDA is going to be a positive sign. Yeah. In the human trials that have been going on for years now, there were 31 sickle cell patients that were all freed from symptoms, even though they had all been previously diagnosed with severe cases. Good NPR story about it.

I'm hopeful for those people with this new treatment. Anything else in the development pipeline you want to chat about? I would say that for anyone interested in seeing more that is in the pipeline, I would just search up Google Vertex Pharmaceuticals Pipeline. They have a great visual. The first result that comes up should be their website. They have a great visual of everything they have in the pipeline, what stage it's at, what they're trying to treat, what they're after. Acute pain, they have had a pretty widely publicized effort into acute pain, a non-opioid pain drug.

Last March was when it was announced that phase two resulted in outperformance of placebo, an important early first step in that development program. Phase three should have started late 2022. That's expected to come with results in late 2023 or early 2024. four. Still behind the scenes, a lot of times with these drugs, you just sort of assume that progress is being made until suddenly you are informed whether that is true or whether something has ended. But that's kind of where that one is. Again, as I said, it's widely publicized. I think

a lot of people are excited for the opportunity there. The person driving the ship is Reshma Kewal Romani. That's the CEO. Is leadership something you focus on with this kind of company, or do you want to make sure that the CEO is not Martin Shkreli and then you just move on to the development pipeline. Yeah, a little bit. The Shkreli background is interesting because his background is just business. Kewal Rahmani, she does have a business background, general management program grad from Harvard, but she also has graduated from the med program at Boston University, went through residency, nephrology fellowship. She was a physician before joining Vertex. She has a clear proven interest in the field

beyond just that business acumen. If you look at the insider holdings of this company, it's quite low, less than 1%. That's very standard across the industry. Maybe not for every company, but it's pretty standard that most shares tend to be held by institutional investors. This is just a space where biotech is very tough. It requires tons of cash upfront, really long timelines and they really need that alignment with their investors. It's best for them to have institutional investors that are really willing to fund and hold for longer terms, not a retail investor that's in and out. The bigger thing that I would be concerned about in this space that I would look for is if you're looking at biotechs that are

smaller cap, have single product pipelines instead of Vertex's mini irons in the fire high retail ownership might be something that concerns me. It could be a sign that they went to institutional investors and couldn't get a lot of backing, so they're just trying to market themselves in another venue. It may be an unsafe way for retail investors, so I would just look in that area if they're doing a lot of clear marketing. If they're speaking to you with a lot of marketing language or they're boasting about every unimportant advancement along the the way, anything they can possibly spin as positive, I'd look out for that. But when you look at how Kewal Romani speaks or read the transcripts, she always speaks with a

very long-term focus for the company. She's very measured in how she presents results moving forward. It does not sound like marketing jargon or a hype cycle. That's what I look for and I don't see a lot of concern here with Vertex. On to valuation, Vertex does have a higher sticker price than many other biotech pharma companies like Gilead, Amgen, Biogen. Do you think the growth story for this company warrants that higher sticker price? I definitely do. There's a couple ways to think about valuation. If you look at forward price-to-earnings ratio, for example, Gilead is somewhere around 10 or 11. Amgen is around 13. Vertex right now is around 22.

So the first thing you notice about that, of course, is that it's higher. I think maybe what's more interesting is that if you look at the trend over the past year or so, where Gilead, like I said, 10 or 11, it's very flat around that area. Amgen, again, also pretty flat around 13. Vertex, 22 now, but was 17 just over a year ago. So, you actually see a pretty clear rise there. And so, what does that mean? It can be a number of things. Many things influence the market, of course. But I think biotech analysts' consensus seems to be rising on the progressive updates that we're getting in this pipeline. This is one of the more advanced pipelines in the space. So, you just see that rising interest based on continued positive feedback coming from the

company. My preference in thinking about valuation here is to do more of an expectations investing approach to take the current price that it's at and then back that out into, okay, what are the revenue and operating margins that are really expected here based on that price? And if you do that, there's a number of ways to do this. You can come up with different numbers. I came up with something around 5% revenue growth, 50% operating margins, which is where in terms of operating margins, that's where Vertex operates right at about right now. And then I dropped that to 40% in perpetuity. Given that outcome, I think that that's where Vertex is today. That's pretty reasonable in terms of expectations. It is dragged down, I think,

largely over concerns that we talked about, the potential for competitors to enter the space or generics. But I think it also is not factoring in a lot of expectation for the pipeline. It's a balance of those two things, the uncertainty of generics, and in my opinion, maybe not weighing the potential of their advanced pipeline quite enough. That's how I think about valuation. But there's definite risk here. I don't mean to say that there's not. Most pipelines, again, do not work out. It's very possible that most of the things in their pipeline don't work out. But if even one or two does, that could be a very substantial contribution to the company going forward for their cash flows. Kirsten Guerra, thank you for your time

and your insight. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow. Thanks for watching!