Did capitulation hit the sector in 2023 paving the way for future outperformance?
While the huge outperformance in the last two months of 2023 was certainly not neglectable, 2023 still marked a temporarily low point on some of those factors we typically discuss when we evaluate the status of the BioTech and Life Science sector:
- Historically, even when BioTech and Life Science companies stop their operation when the financing challenges becomes too big, their pipeline projects typically ‘find a new home’ one way or the other, but in 2023 pipeline projects were shut down or de-prioritized in much larger scale that we have seen for long. The number of BioTech and Life Science companies stopping to operate, voluntarily or through bankruptcy, was almost four times as high in 2023 compared to 2022 according to consultancy and research company, Fierce BioTech.
- The shutdowns and generally downsizing and re-prioritization in the sector, was also reflected in the number of BioTech and Life Science companies announcing bigger lay-off programs which rose almost 60 percent compared to 2023.
- The opportunity for private BioTech and Life Science companies to finance their development and raise capital through IPO listings remained under pressure, illustrated as the number of IPOs in the US stayed at a very low level from 2022 of approximately 20, nearly one-fifth of the number in the record year in 2021. According to the investment bank Leerink, the ‘IPO backlog’ of BioTech and Life Science companies waiting to go to the market has continued to grow from around 80 a couple of years ago to 129 by the end of the third quarter in 2023. Adding to this is a 35 percent drop of approximately USD 13 billion in capital provided by venture capital in BioTech in 2023, also reflecting the lower activity in the BioTech and Life Science sector at a time when the venture capital funds combined actually have record high level of funds available for investments as these funds continue to raise capital for future investments.
- As share prices have come down, the ability of listed BioTech and Life science companies to raise capital in the market without diluting shareholders has been increasingly difficult. This has forced many BioTech and Life Science companies to engage in liquidity demanding and very expensive bridge-financing loan schemes, ultimately just adding to the financing challenges the companies face.
The above examples illustrate a BioTech and Life Science sector in dire straits, where it is difficult to see the light at the end of the tunnel. Following the two negative years in 2021 and 2022, hopes were high that 2023 would mark a turning point in the beginning of 2023. It didn’t, although there were positive signs towards the end of the year and in the beginning of the new year:
- The reversal of the interest rate direction has certainly had some effect, at least from a short-term perspective. But as frequent readers of this BioSnack newsletter will know, while it is acknowledged that changes in interest rates can have an effect, the basic attitude is that the ability to predict changes in interest rates is extremely difficult and, therefore, generally not a recommendable method on which, investment decisions should be made. This is not to say that changes in interest rates cannot have a huge influence on the behavior of the typical ‘generalist’ investor, who would certainly consider moving into BioTech and Life Science stocks when interest rates go down. But as we know, due to the nature of BioTech and Life Science business models, investors in the sector are required to be long-term and patient, which is often not compatible with the short-term behavior of the generalist investor as he or she frequently moves in and out of sectors and asset classes as interest rates and other economic indicators fluctuate.
- What should be of greater importance and have a more lasting effect is the valuation aspect of BioTech and Life Science companies. Valuing BioTech and Life Science companies is not easy, but to illustrate, the following example should be considered. As the market value on many companies within the sector has come down for three years in a row by an average total of approximately 35-40 percent, and assuming that the medical advancement in the pipelines in these companies has moved forward more or less as planned, the investor has in principle come three years closer to the same expected future cash flow of which an industry standard of 15 percent discount rate per year would be applied. Combining the effect of an asset value that has come down approximately 35-40 percent but should, in principle, have increased by 15 percent per year for three years makes a strong valuation argument – all things being equal. This argument is increasingly being put forward by venture capital funds, but as they are still not investing a larger part of their available funds, they are probably still considering whether BioTech and Life Science stocks will become even cheaper before they put their money to work. But once they start to invest, a ‘herd effect’ among venture capital funds is not unlikely.
- While venture capital funds are sitting on their hands, Big Pharma has been on a buying spree in the last couple of weeks into 2024. For 2023 the M&A activity was also up a massive almost 40 percent in value from 2022, but the number of deals was down 8 percent, illustrating that deals were bigger on average, although Pfizer’s acquisition of Seagen of USD 43 billion at the beginning of 2013 had a big effect on the total value number. On a side note, anecdotal evidence suggests that deal activity often increases up to and during the annual industry-leading JP Morgan Healthcare conference taking place one of the first two weeks of the year. This year, the CEO of Eli Lilly raised expectations of more deals to come as he publicly addressed the participating BioTech companies, saying that Eli Lilly is open for business! The increased M&A activity could be interpreted as a confirmation of the valuation of BioTech and Life Science companies being very attractive. But in the current environment, it is probably more of a sign of different Big Pharma trying not to be left behind as a gold rush is starting to take place within AI-related technology platform companies and, in particular, within obesity-related companies. All major Big Pharma are making acquisitions within obesity, and with respect to AI-related companies, it should be noted that traditional Information Technology companies like Google, Apple, and Nvidia are currently entering the AI-medical related areas, indicating what could become the next big area within drug development – together with further development of obesity drugs. It is an important prerequisite for increased medical development and increased M&A activity when these big waves of a new class of drugs emerge, so it could potentially be a positive trigger for the BioTech and Life Science sector when it happens. Just as it did 4 years ago with Corona.
Whether this is the time for BioTech and Life Science stocks to come out of three years of doldrum, is difficult to say. The companies are still extremely challenged financially. In this context, it will be interesting to see if contrarian investors will take notice of the ‘capitulation’-like comments being associated with BioTech and Life Science fundamentals through most of 2023, as these investors know capitulation-sentiment concerning an asset class or sector has historically been a good time to start accumulating the asset class or sector from a long-term perspective. Combined with Big Pharma’s likely continued buying spree and Venture Capital funds potentially putting their money to work, conditions are in place for BioTech and Life Science stocks to finally start outperforming.