Will Strong Early-Year Vibes Translate to More Stabilization Ahead?

Barbara Ryan
Founder
Barbara Ryan Advisors

Will the positive sentiment and performance the industry left with following J.P. Morgan’s annual Healthcare Conference in early January prove—yet again—to presage what investors should expect for the year? Let’s review some recent financial and stock signals that could help answer that question.

• In the fourth quarter of 2023, the XBI soared by a staggering 38% off its lows set in October to actually finish the year in the green—up 7.8%. This spared investors in the sector a third straight year of losses.
• The rally was led first and foremost by a drop in interest rates and fueled by expectations for more of the same in 2024. It was complemented as well by strong M&A activity and underpinned by continued gains on the innovation front, which were overruled by the macro environment.
• As has been the case for the past two years, biotech stocks have been inexorably tightly and inversely correlated with interest rates and have been the victim of an epic—and historic—climb over the period. But now, the pivot to lower rates has had the expected result—a long anticipated and welcome significant outperformance for biotech and a refocus on fundamentals.

As should be no surprise, M&A activity is also at a giddy pace, reaching record levels in 2023. Last year, 38 publicly traded biotechs were acquired—which far exceeds the record of 25 in any prior year. Importantly, 20 of the 38 were deals valued at greater than $1 billion—the previous record was 14 in 2022 and 2019, respectively, according to Brian Gleason, managing director, Raymond James Investment Banking.

As EY cites in its annual Firepower report, the story is not just the volume of deals—at 116 in 2023 compared to 126 in 2022— but in the average deal size, which has increased by 77%, as Big Pharma multinationals have begun to dominate industry dealmaking once again.

There is every reason to expect this activity to continue and accelerate, as despite the surging number of deals, Big Pharma retains close to $1.4 trillion in “firepower” available to fund future M&A, EY reports. This accompanies a decided urgency to transact as the industry approaches the much-anticipated steep “patent cliff,” which creates a huge growth gap to be filled by revenue declines for leading products losing exclusivity.

The dealmaking imperative will certainly continue to gain urgency and there is plenty of ammunition to fund it.

Adding fuel to reasons to be optimistic about the sector’s potential for outperformance this year, Tim Opler, managing director at Stifel Investment Banking, calculates that 43 specialist funds have picked up nearly $20 billion in gains since the AbbVie-ImmunoGen deal was announced on Nov. 30; so there is an unusually large amount of money on the sidelines that will get reinvested into the sector, likely sooner than later. The snapback in the sector in the fourth quarter of 2023 is an indication of how significantly and substantially things could get a whole lot better for biotech investors.

Due to the unbreakable correlation of the sector’s performance with interest rates, volatility should be expected to continue and the recent backup in rates is a reminder of just that. So, despite a strong start to the year for biotech, the XBI is now essentially flat (as I write this on Jan. 22) due to a backup in rates.

The capital markets for biotech kicked off the year with a bang; in fact, we saw the largest amount of capital raised for public companies in the week before the JPM confab in over 10 years, with $2 billion raised across nine deals. As of late January, there were four biotech IPOs publicly on file and the deepest IPO p ipeline w e h ave h ad s ince 2 021. M omentum i n t he follow-on market continues, with December being the most active month since the July summer rally. Given that ~50% of the public universe have less than 18 months of cash, it is likely that the capital markets will be very active in 2024, assuming the macro environment is conducive.

To sum up, the reasons to believe in a positive 2024 include:

• Rate declines on tap.
• Record M&A pace to continue with urgency, as cash-rich buyers seek to fill the growth gap driven by patent losses.
• Innovation wins continue.
• As cash-rich biotech investors make money, they are more anxious to reinvest.