Billionaire Seth Klarman’s Favorite Healthcare Stocks

BAUPOST GROUPThe Baupost Group, managed by value investor Seth Klarman (author of Margin of Safety), is one of the largest hedge funds in the world. It invests in a range of industries, but in the fund’s 13F filing for the second quarter of 2012 we noticed a number of healthcare companies in prime positions in its portfolio (see other stocks the Baupost Group owns). It can be difficult to evaluate some healthcare companies, so investors may want to take the fund’s investment as a seal of approval and give that some consideration as they buy stocks themselves. Here are the Baupost Group’s three largest healthcare positions as of the end of June:

Theravance Inc (NASDAQ:THRX) was Bauposts’s top healthcare holding, with the fund disclosing a position of 14.6 million shares. This was unchanged from the previous quarter. Theravance researches and develops medications, with its primary products treating bacterial infections and chronic obstructive pulmonary disease. At the moment its drugs are still in development mode and the company is expected to take net losses for both this year and next year. So far in 2012 the stock is up 31% bringing the company’s market capitalization to $2.6 billion. Iridian Asset Management also had a position in the stock as of the end of June.

Klarman and his team increased Baupost’s stake in Idenix Pharmaceuticals Inc (NASDAQ:IDIX) to 10 million shares, placing it just a bit behind Bain Capital’s Brookside Capital in our database of major hedge fund positions. Idenix’s primary product is an attempt to treat the hepatitis C virus, and has an agreement to work with Novartis to develop and produce drugs. As their product is still in development, they have the same situation as Theravance: Idenix is not expected to turn a profit in 2012 or 2013. It should also be noted that Baupost and Brookside combined own about 16% of the company’s shares outstanding.

AVEO Pharmaceuticals (NASDAQ:AVEO), fitting the pattern, is another top Baupost pick in the healthcare sector which is not expected to turn a profit any time soon. It’s also another stock that the fund owns a large piece of: its 5.1 million shares from the end of the second quarter, unchanged since the end of March, mean that it owns about 12% of AVEO’s shares outstanding. AVEO is researching a variety of cancer drugs, including an oral cancer drug that limits tumor growth and is currently in Phase III clinical trials. The stock is down 31% this year, with much of that loss coming in early August after the company reported that the previously mentioned drug will require additional data analysis before an FDA decision. Baupost is mostly on its own on this one with respect to the hedge fund community: no other fund tracked by Insider Monkey had a position worth over $5 million.

All three of these cases are speculative pharmaceutical companies. They are currently unprofitable and therefore depend on seeing their drugs in development become successful and marketable at a reasonable price. It is difficult for many investors to evaluate the likelihood that these products will end up succeeding, so it might be helpful to start by limiting the universe of emerging pharmaceutical stocks to those where fund managers with a track record of success have committed capital to the company. Klarman’s track record is good enough that we think Baupost is such a fund whose activities in the pharmaceutical industry should be watched. Of course, it’s also interesting to note that despite its value background Baupost prefers these stocks to more established healthcare companies including major drug manufacturers and direct care providers.

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