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The Digest #163

Corporate taxes, Berkshire’s clean energy investments, Isaacson’s biography of Elon Musk, ESPN’s future, Nvidia, AI, Interpreting medical studies, Why…

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Corporate Tax Headwinds

The Tax Cuts and Jobs Act of 2017 was the result of a political process constrained by anticipated effects on the long-run fiscal condition of the federal government. In order to bring the projected cost of the overall package down to politically acceptable levels, many of the tax cuts have an expiration date at the end of 2025. If Congress does not act, an array of taxes will automatically increase in 2026.

Perhaps it is a sign of the relative power of various constituencies, but the steep cut in the corporate tax rate is one of the few that do not expire in 2025. The corporate tax rate was cut from 35% to 21% and this was advertised as a “permanent” change. If Congress is gridlocked in 2025, the corporate tax will remain at 21%.

When it comes to tax policy, it is dangerous to consider anything to be “permanent” when the fiscal condition of the United States is in disarray. The pandemic brought about massive deficit spending and debt as a percentage of GDP has skyrocketed, as we can see from the charts below. The first chart shows the federal budget deficit as a percentage of GDP since 1940. The second chart shows total public debt as a percentage of GDP since 1966, the first year in the data series.

Source: St. Louis Fed
Source: St. Louis Fed

The Congressional Budget Office (CBO) projections for deficits and debt in the years to come are extremely disturbing, even with optimistic assumptions regarding the interest rates paid on the national debt. There is a massive gap between projected revenues and spending as far as the eye can see. The pandemic spending spree does not appear to be transitory; instead, it established a new and much higher baseline.

I should emphasize that the CBO is assuming that the “temporary” tax cuts will expire on schedule in 2025. If Congress wishes to extend any of those cuts, the outlook will be even worse than the chart indicates. One can observe that we have a spending problem, not a revenue problem, given that revenues are on trend while outlays have risen far above trend, but few politicians seem willing to even propose serious cuts.

I do not regard the “permanent” status of the corporate tax rate to be of much comfort because it will be politically difficult to maintain a 21% rate if the other provisions of the 2017 legislation are allowed to expire in 2025. Most investors seem oblivious to this potential headwind that could start blowing with a vengeance in the near future. Markets are forward looking and if it looks like the corporate tax rate might rise in 2026, markets will reflect this well ahead of time, perhaps starting next year.

Many companies experienced a strong tailwind when the corporate tax cut went into effect in 2018. For example, look at the effective tax rate of Dollar General, the subject of an article I wrote earlier this week:

Source: Dollar General 10-Q and 10-K Reports

It is obvious that Dollar General benefited from the 14% cut in the federal tax rate and would be harmed by a tax increase. It is unlikely that the corporate tax rate will return to 35% but we should note that President Biden’s fiscal 2024 budget called for the rate to rise to 28%. Obviously, this will not happen with the current composition of Congress, but it indicates that there could be upward pressure in the future.

The political landscape is constantly evolving. One unmistakable shift in recent years is that the Republican Party has moved in a “populist” direction, a major change from the party’s traditional “pro business” philosophy. From a political perspective, the GOP could very well be amenable to an increase in the corporate tax rate in exchange for retaining tax cuts that have more populist appeal. Therefore, I think that the corporate tax rate is not just a function of which party is in power.

Investors have mostly shrugged off the strong headwinds of rising interest rates over the past year which seems odd given that it is now possible to purchase a ten year treasury note yielding 4.3% or a ten year TIPS yielding 2% + CPI. As Warren Buffett has said on more than one occasion, interest rates act like “financial gravity” when it comes to the valuation of all assets. If Uncle Sam, our “silent partner” as investors, decides that he will claim an additional 7% of corporate profits in a few years, that will represent yet another headwind that investors must account for.

The stereotype of value investors is that we are not supposed to consider the macroeconomy. It’s one thing to avoid making investments based on projections of the CPI in September or GDP in the third quarter. But we should be aware of longer term trends related to taxes and interest rates, particularly when it comes to our central expectation for the returns of stocks over the next decade.


Articles

Warren Buffett’s Green Cash Washes Over Coal Country by Scott Patterson, September 5, 2023. The “Inflation Reduction Act” included major incentives for clean energy projects. Berkshire Hathaway Energy has a long history of responding to tax incentives. This article reports on a project in West Virginia involving BHE as well as Precision Castparts, another Berkshire subsidiary. These projects apparently came together without Warren Buffett’s direct involvement. “I’m glad it worked out,” Buffett told The Wall Street Journal. “I can claim no personal credit.” (WSJ)

The Real Story of Elon Musk’s Twitter Takeover by Walter Isaacson, September 2, 2023. In an excerpt from his biography of Elon Musk to be released next week, Walter Isaacson provides some behind-the-scenes reporting on the Twitter acquisition. “The way that Musk blustered into buying Twitter and renaming it X was a harbinger of the way he now runs it: impulsively and irreverently. It is an addictive playground for him. It has many of the attributes of a school yard, including taunting and bullying. But in the case of Twitter, the clever kids win followers; they don’t get pushed down the steps and beaten, like Musk was as a kid. Owning it would allow him to become king of the school yard.” (WSJ)

The Rise and Fall of ESPN’s Leverage by Ben Thompson, September 5, 2023. Disney’s stock has been beaten down severely in recent months. One of the difficulties in analyzing the company has to do with the long term future of ESPN, a crown jewel that has seen its moat slowly erode in recent years. I found this article’s discussion of ESPN’s history and current competitive position very useful. (Stratechery)

Initial estimates point to Hurricane Idalia insured loss of below $10 billion by Saumya Jain, August 31, 2023. “The Big Bend area of the Florida coast where Idalia made landfall is far less densely populated than the region devastated by Hurricane Ian last year. In contrast to Hurricane Idalia, there were approximately 1 million people within 30 miles of landfall for Ian, while there were about 38,000 people within that distance for Idalia, according to an AccuWeather report.” (Reinsurance News)

Warren Buffett: “I am a better investor because I am a businessman and a better businessman because I am an investor.” by Kingswell, September 5, 2023. This article contains excerpts from the 1993 Forbes 400 issue when Warren Buffett edged out Bill Gates for the #1 spot on the list. It’s easy to picture him making many of the same statements today. One of the hallmarks of Warren Buffett’s approach to business and life is his consistency over very long periods of time. (Kingswell)

These 38 Reading Rules Changed My Life by Ryan Holiday, September 6, 2023. I agree with almost everything in this article, especially the benefits of reading older books, taking notes, and turning to books rather than the mainstream media to better understand current events. I continue to have trouble abandoning “bad” books before I finish them. Hope springs eternal, I suppose. (RyanHoliday.net)

Never Look Down the Road Not Taken by Nick Maggiulli, September 5, 2023. Attempting to replay history is an exercise fraught with peril. This article reminds me of the article I wrote about selling Apple stock in 2001. (Of Dollars and Data)

Respect and Admiration by Morgan Housel, September 6, 2023. This is a good reminder that buying expensive things to impress people is pointless vanity. Respect is not driven by showy displays but by innate qualities. (Collaborative Fund)


Podcasts

Nvidia: The Dawn of the AI Era, September 5, 2023. 2 hours, 54 minutes. This is an interesting overview of the development of AI over the past decade. “Over the past 18 months Nvidia has weathered one of the steepest stock crashes in history ($500B+ market cap wiped away peak-to-trough!). And, it has of course also experienced an even more fantastical rise — becoming the platform that’s powering the emergence of perhaps a new form of intelligence itself… and in the process becoming a trillion-dollar company.” (Acquired)

Where Does Your Return Come From: Yield, Growth, and Multiple Expansion, September 4, 2023, 32 minutes. This discussion breaks down the sources of returns on an investment. It’s important to understand where you expect your returns to come from when considering a new investment as well as where your returns have actually come from when evaluating current and past investments. (Focused Compounding)

Good vs. bad science: how to read and understand scientific studies, September 4, 2023. 1 hour, 50 minutes. Mainstream media articles covering scientific studies cannot possibly discuss all of the complexities that one needs to understand in order to separate signal from noise. In this long and detailed podcast, Peter Attia explains his process for reading scientific papers, focusing on how studies and clinical trials work. He delves into topics including differentiating relative risk from absolute risk and how to determine the statistical significance of study results. (The Drive)

Berkshire’s Beginnings w/Jacob McDonough, August 31, 2023. 1 hour, 25 minutes. “In 1962, Warren Buffett began purchasing shares in Berkshire Hathaway, a struggling textile maker in the midst of a decline. Ironically, in hindsight, Buffett has said that purchasing Berkshire Hathaway in the first place was one of his worst decisions ever. In this episode, you’ll learn how Buffett was able to turn the business around and make its way to eventually becoming worth nearly $800 billion in 2023.” (We Study Billionaires)

Why Doomberg left Twitter (okay, X) to go all in on Substack, September 4, 2023. “If the new owner of Twitter had not specifically and proactively throttled all Substack authors, we would almost certainly still be on the platform. It’s his private property. He can run his property in any way that he sees fit… but the primary driver and the motivation to leave the platform was because of the impact on all of our friends.” (On Substack)

The Lifecycle of Greed and Fear, August 31, 2012. 12 minutes. “All greed starts with an innocent idea: that you are right, deserve to be right, and are owed something for the efforts you put into establishing your beliefs and opinions. It’s a reasonable feeling. But it sets off a chain reaction that leads to an inevitable boom-and-bust cycle. This episode explores one of the most important topics in investing: the lifecycle of greed and fear, and why it cannot, and will not, ever go away.” (The Morgan Housel Podcast)


Jimmy Buffett

No matter the weather outside, you can always get a virtual ticket to the tropics. Jimmy Buffett, who died on September 1, invented his own tropical sound that transcended country and rock and earned the loyalty of generations of fans. 

Jimmy Buffett and Warren Buffett were not related but they were friends who referred to each other as “Cousin Warren” and “Cousin Jimmy”. Jimmy Buffett was a Berkshire Hathaway shareholder for many decades and was known to appear at annual meetings and hold impromptu performances for shareholders.

I don’t think that Fruitcakes is one of Jimmy Buffett’s best known hits but I’ve always liked it because it says something about our flawed human condition. RIP.


Evolution Valley, Kings Canyon National Park, September 7, 2013

Copyright, Disclosures, and Privacy Information

Nothing in this article constitutes investment advice and all content is subject to the copyright and disclaimer policy of The Rational Walk LLC. The Rational Walk is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

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Glimpse Of Sanity: Dartmouth Returns Standardized Testing For Admission After Failed Experiment

Glimpse Of Sanity: Dartmouth Returns Standardized Testing For Admission After Failed Experiment

In response to the virus pandemic and nationwide…

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Glimpse Of Sanity: Dartmouth Returns Standardized Testing For Admission After Failed Experiment

In response to the virus pandemic and nationwide Black Lives Matter riots in the summer of 2020, some elite colleges and universities shredded testing requirements for admission. Several years later, the test-optional admission has yet to produce the promising results for racial and class-based equity that many woke academic institutions wished.

The failure of test-optional admission policies has forced Dartmouth College to reinstate standardized test scores for admission starting next year. This should never have been eliminated, as merit will always prevail. 

"Nearly four years later, having studied the role of testing in our admissions process as well as its value as a predictor of student success at Dartmouth, we are removing the extended pause and reactivating the standardized testing requirement for undergraduate admission, effective with the Class of 2029," Dartmouth wrote in a press release Monday morning. 

"For Dartmouth, the evidence supporting our reactivation of a required testing policy is clear. Our bottom line is simple: we believe a standardized testing requirement will improve—not detract from—our ability to bring the most promising and diverse students to our campus," the elite college said. 

Who would've thought eliminating standardized tests for admission because a fringe minority said they were instruments of racism and a biased system was ever a good idea? 

Also, it doesn't take a rocket scientist to figure this out. More from Dartmouth, who commissioned the research: 

They also found that test scores represent an especially valuable tool to identify high-achieving applicants from low and middle-income backgrounds; who are first-generation college-bound; as well as students from urban and rural backgrounds.

All the colleges and universities that quickly adopted test-optional admissions in 2020 experienced a surge in applications. Perhaps the push for test-optional was under the guise of woke equality but was nothing more than protecting the bottom line for these institutions. 

A glimpse of sanity returns to woke schools: Admit qualified kids. Next up is corporate America and all tiers of the US government. 

Tyler Durden Mon, 02/05/2024 - 17:20

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International

Four burning questions about the future of the $16.5B Novo-Catalent deal

To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.
Beyond spending billions of dollars to expand…

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To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.

Beyond spending billions of dollars to expand its own production capacity for its weight loss drugs, the Danish drugmaker said Monday it will pay $11 billion to acquire three manufacturing plants from Catalent. It’s part of a broader $16.5 billion deal with Novo Holdings, the investment arm of the pharma’s parent group, which agreed to acquire the contract manufacturer and take it private.

It’s a big deal for all parties, with potential ripple effects across the biotech ecosystem. Here’s a look at some of the most pressing questions to watch after Monday’s announcement.

Why did Novo do this?

Novo Holdings isn’t the most obvious buyer for Catalent, particularly after last year’s on-and-off M&A interest from the serial acquirer Danaher. But the deal could benefit both Novo Holdings and Novo Nordisk.

Novo Nordisk’s biggest challenge has been simply making enough of the weight loss drug Wegovy and diabetes therapy Ozempic. On last week’s earnings call, Novo Nordisk CEO Lars Fruergaard Jørgensen said the company isn’t constrained by capital in its efforts to boost manufacturing. Rather, the main challenge is the limited amount of capabilities out there, he said.

“Most pharmaceutical companies in the world would be shopping among the same manufacturers,” he said. “There’s not an unlimited amount of machinery and people to build it.”

While Novo was already one of Catalent’s major customers, the manufacturer has been hamstrung by its own balance sheet. With roughly $5 billion in debt on its books, it’s had to juggle paying down debt with sufficiently investing in its facilities. That’s been particularly challenging in keeping pace with soaring demand for GLP-1 drugs.

Novo, on the other hand, has the balance sheet to funnel as much money as needed into the plants in Italy, Belgium, and Indiana. It’s also struggled to make enough of its popular GLP-1 drugs to meet their soaring demand, with documented shortages of both Ozempic and Wegovy.

The impact won’t be immediate. The parties expect the deal to close near the end of 2024. Novo Nordisk said it expects the three new sites to “gradually increase Novo Nordisk’s filling capacity from 2026 and onwards.”

As for the rest of Catalent — nearly 50 other sites employing thousands of workers — Novo Holdings will take control. The group previously acquired Altasciences in 2021 and Ritedose in 2022, so the Catalent deal builds on a core investing interest in biopharma services, Novo Holdings CEO Kasim Kutay told Endpoints News.

Kasim Kutay

When asked about possible site closures or layoffs, Kutay said the team hasn’t thought about that.

“That’s not our track record. Our track record is to invest in quality businesses and help them grow,” he said. “There’s always stuff to do with any asset you own, but we haven’t bought this company to do some of the stuff you’re talking about.”

What does it mean for Catalent’s customers? 

Until the deal closes, Catalent will operate as a standalone business. After it closes, Novo Nordisk said it will honor its customer obligations at the three sites, a spokesperson said. But they didn’t answer a question about what happens when those contracts expire.

The wrinkle is the long-term future of the three plants that Novo Nordisk is paying for. Those sites don’t exclusively pump out Wegovy, but that could be the logical long-term aim for the Danish drugmaker.

The ideal scenario is that pricing and timelines remain the same for customers, said Nicole Paulk, CEO of the gene therapy startup Siren Biotechnology.

Nicole Paulk

“The name of the group that you’re going to send your check to is now going to be Novo Holdings instead of Catalent, but otherwise everything remains the same,” Paulk told Endpoints. “That’s the best-case scenario.”

In a worst case, Paulk said she feared the new owners could wind up closing sites or laying off Catalent groups. That could create some uncertainty for customers looking for a long-term manufacturing partner.

Are shareholders and regulators happy? 

The pandemic was a wild ride for Catalent’s stock, with shares surging from about $40 to $140 and then crashing back to earth. The $63.50 share price for the takeover is a happy ending depending on the investor.

On that point, the investing giant Elliott Investment Management is satisfied. Marc Steinberg, a partner at Elliott, called the agreement “an outstanding outcome” that “clearly maximizes value for Catalent stockholders” in a statement.

Elliott helped kick off a strategic review last August that culminated in the sale agreement. Compared to Catalent’s stock price before that review started, the deal pays a nearly 40% premium.

Alessandro Maselli

But this is hardly a victory lap for CEO Alessandro Maselli, who took over in July 2022 when Catalent’s stock price was north of $100. Novo’s takeover is a tacit acknowledgment that Maselli could never fully right the ship, as operational problems plagued the company throughout 2023 while it was limited by its debt.

Additional regulatory filings in the next few weeks could give insight into just how competitive the sale process was. William Blair analysts said they don’t expect a competing bidder “given the organic investments already being pursued at other leading CDMOs and the breadth and scale of Catalent’s operations.”

The Blair analysts also noted the companies likely “expect to spend some time educating relevant government agencies” about the deal, given the lengthy closing timeline. Given Novo Nordisk’s ascent — it’s now one of Europe’s most valuable companies — paired with the limited number of large contract manufacturers, antitrust regulators could be interested in taking a close look.

Are Catalent’s problems finally a thing of the past?

Catalent ran into a mix of financial and operational problems over the past year that played no small part in attracting the interest of an activist like Elliott.

Now with a deal in place, how quickly can Novo rectify those problems? Some of the challenges were driven by the demands of being a publicly traded company, like failing to meet investors’ revenue expectations or even filing earnings reports on time.

But Catalent also struggled with its business at times, with a range of manufacturing delays, inspection reports and occasionally writing down acquisitions that didn’t pan out. Novo’s deep pockets will go a long way to a turnaround, but only the future will tell if all these issues are fixed.

Kutay said his team is excited by the opportunity and was satisfied with the due diligence it did on the company.

“We believe we’re buying a strong company with a good management team and good prospects,” Kutay said. “If that wasn’t the case, I don’t think we’d be here.”

Amber Tong and Reynald Castañeda contributed reporting.

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Petrina Kamya, Ph.D., Head of AI Platforms at Insilico Medicine, presents at BIO CEO & Investor Conference

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb….

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Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

Credit: Insilico Medicine

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

The session will look at how the latest artificial intelligence (AI) tools – including generative AI and large language models – are currently being used to advance the discovery and design of new drugs, and which technologies are still in development. 

The BIO CEO & Investor Conference brings together over 1,000 attendees and more than 700 companies across industry and institutional investment to discuss the future investment landscape of biotechnology. Sessions focus on topics such as therapeutic advancements, market outlook, and policy priorities.

Insilico Medicine is a leading, clinical stage AI-driven drug discovery company that has raised over $400m in investments since it was founded in 2014. Dr. Kamya leads the development of the Company’s end-to-end generative AI platform, Pharma.AI from Insilico’s AI R&D Center in Montreal. Using modern machine learning techniques in the context of chemistry and biology, the platform has driven the discovery and design of 30+ new therapies, with five in clinical stages – for cancer, fibrosis, inflammatory bowel disease (IBD), and COVID-19. The Company’s lead drug, for the chronic, rare lung condition idiopathic pulmonary fibrosis, is the first AI-designed drug for an AI-discovered target to reach Phase II clinical trials with patients. Nine of the top 20 pharmaceutical companies have used Insilico’s AI platform to advance their programs, and the Company has a number of major strategic licensing deals around its AI-designed therapeutic assets, including with Sanofi, Exelixis and Menarini. 

 

About Insilico Medicine

Insilico Medicine, a global clinical stage biotechnology company powered by generative AI, is connecting biology, chemistry, and clinical trials analysis using next-generation AI systems. The company has developed AI platforms that utilize deep generative models, reinforcement learning, transformers, and other modern machine learning techniques for novel target discovery and the generation of novel molecular structures with desired properties. Insilico Medicine is developing breakthrough solutions to discover and develop innovative drugs for cancer, fibrosis, immunity, central nervous system diseases, infectious diseases, autoimmune diseases, and aging-related diseases. www.insilico.com 


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