More than Ever, Data Will Dictate Future Fortunes

Last month I wrote about some emerging green shoots in the biotech sector, suggesting a potential recovery in 2023 performance following the steepest and longest decline in the sector in its history. These green shoots included data suggesting an easing in inflation—thus, potentially a more dovish Fed and an easing in rate hikes. These were coupled with rising expectations for a recession and ultimately declining rates. If these come to pass, investors would likely have rotated out of value and back into growth stocks, specifically biotech.

Biotech’s valuations have been severely punished by the rapid and steep Fed-induced rise in interest rates to combat rising inflation. While the sector had a solid start to the year, it very recently has relinquished its gains, and the XBI is down by 1.8% (as of Feb. 26), still underperforming the S&P 500, which is ahead by 3.4%.

It is likely that an unexpected resurgence in inflation (still over 6%) and fears that the Fed will retaliate with continued rate hikes is responsible for the biotech sector’s most recent underperformance. The XBI continues to trade in a highly correlated inverse direction with interest rates. As in the past, the earliest-stage companies are the hardest hit, while later-stage companies have held up. According to some data from Tim Opler, partner at Torreya, “[H]alf of the value of the 451 US listed companies, R&D stage biotech companies is in a fortunate few (9%) that have a ‘very good’ Phase II or III dataset.”

In addition to being largely led by macro factors, biotech performance is now more than ever clearly data-driven, with the “haves” demonstrating positive clinical results and the “have-nots” falling further behind. The value of the sector is increasing concentration on the companies with strong late-stage data sets, as Opler notes. According to a recent note out to clients from Opler, the average value of late-stage US biotech companies is up slightly this year while the value of preclinical companies is down approximately 8%.

The number of companies with negative enterprise values had begun to decline but recently is modestly on the rise again.

Restructurings, pipeline prioritizations, shutdowns, reverse mergers, and mergers continue across this distressed sector, and this trend is not expected to slow down. These efforts are focused on extending the runway—in some cases, building the breadth of pipelines and competencies. Torreya has been relatively active in M&A this year, and Opler notes that companies are frequently opting for public/public deals over public/private deals, as the deal parties can avoid lengthy debates about the correct valuation level for a private company.

A near majority of companies in the sector have less than 12 months of cash—hence, we will continue to see more strategic transactions as well as companies falling into bankruptcy, as some are merely hanging on by their fingernails.

That said, the IPO market does have a pulse this year and high-quality companies with good or upcoming proof-of-concept data and credentialed investors supporting the transactions are getting public. The follow-on market continues to look healthy but remains highly selective, led by data and the investor base.

While 2023 thus far has not seen the sector outperform, I still see reasons for optimism as we move through 2023. But the potential rising tide will not float all boats, and the disparity between the haves and have-nots will continue to widen. The following are some reasons for optimism this year:

• M&A remains a tailwind. Large pharma is flush with cash, and according to EY’s most recent annual Firepower report, they have more than $1.4 trillion to fund M&A and strategic partnerships and collaborations. M&A has always been a core pillar of the leading companies’ growth strategies, and the emerging biotech innovators are their targets. The need has never been greater. They will face LOEs for products with total revenues of $225 billion beginning in 2025. Expect a strong year of M&A and dealmaking in 2023.
• Innovation is alive and well, and good data for programs that offer an advantage over the standard of care will continue to be rewarded.
• There is lots of money on the sidelines ready to invest.
• Macro factors may reverse and drive investor rotation out of value and into growth sectors like biotech. Rates will also stabilize at some point, and the economy will likely fall into recession. Rates may even decline. Each of these things should drive outperformance for the biotech sector.

Barbara Ryan is the founder of Barbara Ryan Advisors and a member of Pharm Exec’s Editorial Advisory Board.