Biotech 2016: Now Starts the Hangover
January 27, 2016
By Karl Thiel for BioSpace.com
Not that you need to be reminded of this, but...
For the stock market, this has been the worst kickoff ever to a new year. And for biotech, it has been much, much worse. The Nasdaq Biotech Index plummeted over 17 percent in the first eight trading days of 2016, with some industry-specific ETFs doing significantly worse. It has continued to drift lower since then, although it has at least stopped underperforming the broader markets for now.
It's fair for investors, executives, employees, job seekers and anyone else with a connection to the industry to wonder why this is happening. And more importantly, it makes sense to wonder if what we've seen in January presages more trouble ahead.
The mood at the annual J.P. Morgan Healthcare Conference (JPM) this month—the traditional barometer for the new year in biotech—was fairly sour. The meeting didn't offer up much in the way of buzz, excitement or headline news. True, there wasn't any notable bad news out of the conference, but positive surprises were thin on the ground. And in the absence of new helium, the balloon that has kept biotech rising over the past few years has been drifting earthward.
Sheer gravity has something to do with that, but there are more reasons why things have been tough for the biotech market. And just as many reasons to expect improvement in the months ahead.
1. Some reversion to the mean is to be expected after a long period of strong outperformance.
With so much of biotech valuation relying on projections of future events, there's a lot of room for interpretation, making it easy to under, or overshoot reality. If the markets were overshooting at the highs of 2015—or even if investors only fear they were—it's not surprising to see an outperforming sector become an underperforming one.
BUT...
That's a temporary issue that's arguably already been addressed. There is, of course, no definitive answer to what stocks are worth, particularly in the short term. But with the Nasdaq Biotech Index well below its 200-day and even 500-day moving averages, you could certainly argue that a lot of the excess has been burned off. That leaves the market to weigh up more fundamental factors, where the industry still looks pretty strong overall.
2. People sell risk in volatile times: Biotech is the poster child for high-risk, high reward investing.
Volatility is rising, investors are growing increasingly fearful and hence the sector has seen, and will continue to see, outsized selling.
BUT...
That's more about perception than reality.
The industry is too diverse to be lumped into a single high-risk category. To the extent the current sell-off being is being driven by oil prices and China's economy, biotech looks more like a safe haven. Yes, it is impacted by these things, but comparatively modestly. Long-term demographic factors, meanwhile, remain tailwinds for the industry.
3. Fear about capital availability is on the rise.
Some CEOs used part of their JPM presentations to reassure investors that they have sufficient resources to get them through a dry spell. Perversely, this may have the effect of making investors more nervous. Biotech is famously capital-intensive, and the idea of hunkering down through a financial drought brings back memories of the bad old days of 2001-2003, 2008-2012, or....well, actually it might be easier to highlight the booms than to point out when money was tight. The idea that we could be entering another period of dilutive capital raises or death spiral convertibles is not enticing.
BUT...
Balance sheets really are strong!
The thing is, many companies are absolutely right when they point out that they're in great financial shape. The last several three years have been a great time for companies—at least those with competent management and a modicum of luck—to build strong cash balances. Most companies can go a long while without needing to raise more money. The situation is fundamentally different than it was in, say, 2001 or 2008, when a lot of overleveraged companies saw the rug pulled out from under them.
4. There have been lots of approvals, but few huge launches:
In 2013, we saw the launch of huge blockbusters like Sovaldi, Tecfidera and Imbruvica. In 2014 we had Harvoni, Opdivo and Keytruda. But in 2015, there was a dearth of fast-ramping blockbusters. Some of the most highly anticipated drugs, like Praluent and Repatha, don't look as strong out of the gate as hoped for. Many other new drugs have relatively modest markets.
BUT...
2015 was a great year for approvals.
It was a near-record year in terms of the number of new drugs approved, better than 2014 and 2013, which were each strong years in their own rights. Some drugs, like the PCSK9 drugs or Orkambi, still have huge potential—they just need time to ramp. But other approvals simply illustrate that the industry has been successful in moving toward a long-term goal: More personalized medicines, deliberately aimed at distinct populations. Not only are the numbers of approvals high, but the impact of these drugs on patient outcomes is arguably much greater than what we saw from the drugs of decades past. More approvals of more-focused drugs is not a bad thing.
5. Outperformance was driven to a significant extent by M&A.
Nothing tells investors a company is undervalued like an acquirer being willing to pay a huge premium for it. Smoking hot M&A in the sector over the past several years of buoyed valuations. And 2015 was the best-ever year for M&A, with the healthcare sector one of the leading drivers. But the JPM meeting had a dearth of related big-deal news, leading some to wonder if dealmaking may slow significantly. Moreover, a few mega-mergers from last year—Time Warner/Comcast, Staples/Office Depot, GE/Electrolux—have failed. Could that put the brakes on some ambitious pairings? Could Pfizer 's inversion deal with Allergan be in jeopardy?
BUT...
This is going to be another strong year for M&A.
While everything is subject to change, nobody at this point is predicting that deal-making slows to a trickle in 2016, or that much of last year's momentum won't carry forward. A few juicy deals in the biotech sector will likely pique investor interest again as the year moves forward.
6. Drug prices will be under scrutiny in the election cycle.
The healthcare industry has enjoyed unfettered pricing power for decades, and clear cases of abuse that have captured a lot of attention. It's become increasingly apparent that the party can't go on forever, but stocks have been priced like it can.
BUT...
That's unlikely to make a difference in the foreseeable future.
As much as I think the industry should do some self-policing on drug pricing before they face eventual regulation, that day is unlikely to come anytime soon. A hypothetical Democratic president in 2017 is still likely to face a Republican Congress. A hypothetical Republican president is unlikely to champion the issue. A wild card might be a Trump presidency, but that would be so disastrous for so many reasons that we'll have far worse things to worry about.
7. The hype machine has broken down.
New miracle drugs have proven to be as risky and fraught as the technologies that came before them. "Cures" like the gene therapies from Bluebird Bio and immunotherapies from Juno Therapeutics , Kite Pharma , and others whipped up unrealistic expectations, and they've been dashed by clinical disappointment.
BUT...
It has always been thus.
Last year gave us a lot of breathless enthusiasm, and a few reality checks as well. There is, on balance, tremendous reason to be optimistic about the scientific progress of the industry. Anyone expecting a straight march to victory is simply unrealistic; investors who study the industry carefully and diversify their bets can still find great opportunity.
We're off to a rocky start, and 2016 is unlikely to lift virtually every boat in the sector, as we saw over the last couple years. Nevertheless, this will be a year of great progress from the best companies out there. Good luck to all!
-Karl Thiel
Read the BioPharm Executive online newsletter January 27, 2016.
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