The biotech ecosystem looks
healthy moving into 2013. With the space above $1 billion more than replenished
in 2012, mid-cap names have money to create their own tier-jumping stories this
year, while investors see natural selection plucking winners from the small and
Fund managers suggest the
run-up in large caps could lead to a rotation of investment into lower market
cap tiers, fueling the cycle of replenishment necessitated by take-outs like
Amylin Pharmaceuticals Inc. and Human Genome Sciences Inc.
Of the 85 companies that began
last year in the $200-$499 million market cap tier, more than half had at least
three years of cash at the end of 3Q12. By the start of 2013, 25 had jumped one
or more tiers.
This year, 80 companies are
starting out in this small cap space; 44 have development programs in key areas
of buysider interest, while only 14 are operating in no-fly zones shunned by
public investors (see BioCentury, Jan. 7).
Buysiders also expect to see
larger sums of money targeted at a few small and micro-cap names. This would
continue a pattern that emerged in 2012, when specialists provided funds needed
to get well beyond important inflection points to a select list of companies
while subjecting others to Darwinian forces.
As for the IPO market, the
reemergence of crossover investors, a strong performance in the after-market by
last year's class of new public entrants, and implementation of the JOBS Act could
help improve prospects for private biotechs looking for a public exit in 2013.
Biotech's big run
Biotech had an impressive run
in 2012. Despite a sector-wide slowdown in 4Q12, on the year the NASDAQ
Biotechnology Index gained 32% and the BioCentury 100 gained 26%, handily
outperforming both the NASDAQ Composite (up 16%) and S&P 500 (up 13%).
Much of this performance was
driven by companies valued above $5 billion, which as a group have been the
best-performing market cap tier for two quarters running. In fact, the big caps
were the only biotech tier to finish last quarter in the black (see "Raised
by Market Cap").
Ladenburg Thalmann's Edwin
Gordon suggested last quarter's selloff was motivated by uncertainty about how
capital gains would be taxed as politicians dealt with the fiscal cliff.
"There was a decided
preference for selling winners rather than getting out of losers last quarter,
indicating fear about capital gains was driving much of the selloff," he
said. "That means there is a lot of cash on the sidelines, setting us up
for lots of activity in the first quarter."
The standout performers last year were bellwether Gilead
Sciences Inc. and rising star Regeneron
Last year, Gilead tacked on
$23.5 billion in valuation, a 76% increase, thanks to continued clinical
success with its HCV portfolio. The company ended 2012 with a market cap of
Regeneron, which crossed into
the $5 billion-plus tier in 1H11, rode the commercial success of Eylea
aflibercept for wet age-related macular degeneration (AMD) to a valuation of
$16.5 billion at YE12. That was up 213% from $5.1 billion at the end of
Buysiders offered several
reasons, both fundamental and psychological, for why they think biotech's lower
tiers are in position to play catch-up in the near term.
Rajiv Kaul, who manages the
Fidelity Select Biotechnology Fund, said large caps have gotten expensive.
"The valuations of the big
caps are certainly less compelling now than they were a year ago," he
Indeed, biotech's healthy P/E
ratio of 18.4 is down 24% from 3Q12. But it is still up 11% from the end of
2011 and matches up favorably against 11.7 for big pharma (see BioCentury,
Kaul said he may look more
aggressively at smaller cap names in 2013, though the size and liquidity
requirements of his fund means companies valued at $200 million are the
smallest he can consider.
The top three holdings in Kaul's fund are Gilead, Amgen
Inc. and Biogen
Idec Inc. The only one of his top 10 holdings valued under $5 billion
is cancer company Medivation
Inc., which closed 2012 with a market cap of $3.8 billion, up 125% from
$1.6 billion at the end of 2011.
Gordon also noted the Chicago
Board Options Exchange Volatility Index (VIX) suggests volatility will be low.
VIX is a measure of implied volatility of S&P 500 index options for the
following 30 days.
"Financing in life
sciences falls off anytime the VIX rises above 25, but right now we're at
around 14 or 15, so we should be in pretty good shape" as far as investor
willingness to rotate out of the safe haven of big caps and into the riskier
mid- and small cap arenas in search of stronger returns, he said.
Harald Schwarz, managing director
at healthcare investment consultancy Medical Strategy GmbH, also expects
investor appetite for beta will increase, which he said should be good news for
the smaller caps.
"We anticipate investors
will take on additional risk with small cap investments, especially as the
overall stock market rally continues and as fixed-income yields remain anemic,"
There is recent precedent for
expecting some rotation out of the larger caps and into smaller names. The
large caps outperformed the other segments in consecutive quarters beginning in
1Q11 and running through 4Q11.
Then, in 1Q12, the $200-$499
million group took the leadership role with a 16.4% gain, followed by the large
caps at 14.6%. The micro-cap group of companies valued under $200 million was close
behind at 14.3%.
Re-cycle of life
The number of companies that
jumped tiers last year suggests the healthy cycle of replenishment continues,
and many companies in the $200-$499 million group appear particularly well
positioned to graduate in 2013.
Five biotechs disappeared from the $1 billion-plus tier last
year, including four via M&A and one - Dendreon
Corp. - due to a loss of market cap.
Among the biggest biotech takeouts of 2012, Bristol-Myers
Squibb Co. paid $2.5 billion for HCV play Inhibitex Inc. in February
and plunked down even more in August - $7 billion - to take out diabetes
Autoimmune, cancer and infectious disease play Human Genome
Sciences was taken out by GlaxoSmithKline
plc for $2.9 billion.
The fourth company to exit by way of M&A was Gen-Probe
Inc., which was acquired by fellow molecular diagnostics company Hologic
Inc. for $3.8 billion in August.
Dendreon closed 2012 off 30% to
$5.29, valuing it at $791.3 million, as punishment for disappointing sales of
prostate cancer immunotherapy product Provenge sipuleucel-T.
Twelve companies moved up to
take their place (see "Biotech Restocks").
Among companies crossing the $1 billion threshold were three
that jumped two tiers, starting 2012 in the $200-$499 million group: Arena
Pharmaceuticals Inc.; Infinity
Pharmaceuticals Inc. and Synageva
Arena's obesity drug Belviq
lorcaserin received FDA approval in June (see BioCentury, July 9).
Infinity has two compounds in
Phase II testing: IPI-145, an oral inhibitor of phosphoinositide-3-kinase
(PI3K) delta and gamma for asthma; and retaspimycin (IPI-504), a small molecule
heat shock protein 90 (Hsp90) chaperone inhibitor for non-small cell lung
Orphan disease company Synageva's
lead compound is sebelipase alfa (formerly SBC-102), a recombinant human
lysosomal acid lipase (LAL) enzyme replacement therapy. The product is in Phase
II/III testing in infants with early onset LAL deficiency, also called Wolman
An analysis of the 39 biotechs
that began 2012 with a market cap of $500-$999 million suggests the group had
ample access to capital, as virtually every unprofitable company with less than
three years of cash was able to raise money over the past 12 months.
In fact, 2012 turned out to be
one of the strongest years for follow-ons on record. A total of $6.3 billion
was raised in 111 follow-ons last year. In the mid-cap group, 30 companies took
in $2.3 billion (see "Follow-on performance," A4).
One exception was Aveo
Pharmaceuticals Inc., which stumbled in August after FDA expressed
concerns about the overall survival trend in a Phase III trial of Tivopath
tivozanib to treat renal cell carcinoma (RCC). The company, saying it had
addressed the agency's concern, submitted an NDA for the inhibitor of VEGF
receptors 1, 2 and 3 in September.
Tivopath, which has a July 28 PDUFA date, is partnered with Astellas
Aveo subsequently reduced
headcount by 45 (17%) to 235 and scaled back investment on research programs in
October. At the time, it said the $189.7 million in cash at Sept. 30 would
provide it with runway through 2013.
The company lost 62% of its
valuation over the course of 2012, opening the year with a market cap of $741.8
million and closing at $281.9 million.
Next in line
Among companies valued below
$500 million, the sentiment among buysiders is nearly unanimous: selectivity is
the new normal. As a result, many of these companies are going to struggle to
raise the capital needed to reach the next inflection point. But the ones that
do raise money will get more.
Indeed, in total, small and
micro-cap groups each raised more money in 2012 than in 2011 (see "Raised
by Market Cap," A2).
Roth Capital's John Chambers
noted investors channeled the money into almost the same number of companies.
He believes this trend will continue as investors pick out a smaller set of
companies to fund beyond important inflection points.
"More selective investors
are going to invest more dollars into fewer companies," he said. "Companies
achieving institutional support will garner ample funds to bring them through
and beyond milestones, thus removing the financial overhang, while those that
do not are at risk of a Darwinian process in which it may no longer be viable
to remain a stand-alone entity."
RA Capital's Peter Kolchinsky
said capital always will be available for small companies based on sound
science with competent management to guide it.
"The sector is a pyramid
with maybe a few dozen notable large companies," noted Kolchinsky. "But
there are many more companies in the $100-$300 million range, many of which
have the capital to generate Phase II data that might cause them to rocket into
the next segment."
The good news is there is a
strong concordance between what investors want and what the small cap universe
is working on.
In BioCentury's 21st Annual
Buyside View, money managers said cancer, antibiotics and Orphan diseases are
areas of high interest heading into 2013 (see BioCentury, Jan. 7).
Among the 80 companies that
began 2013 in the $200-$499 million space, 28 are in cancer, 11 each in
infectious and Orphan diseases, and six in diagnostics.
In the latter space, Ladenburg's
Gordon, Baird's Selena Chaisson and Eli Casdin of Casdin Capital argued there
will be an expanding role for diagnostics in the context of personalized
medicine, which makes them an interesting investment option.
According to Gordon, that's
particularly true in light of valuations that have recently contracted "due
to the questions around reimbursement and thus their value proposition."
He predicted "CMS will
come around to paying for diagnostics that can be tied to efficacy or lack
thereof in specific patient populations. This would result in an upward
revaluation of this group from 2x revenue."
Gordon said it may take two or
three years for this to play out.
As to the unpopular spaces, 10
of the 2013 group of small caps are working in neurology, where buysiders said
they are less willing to deploy significant funds due to the unpredictable
nature of clinical trials and a dearth of knowledge about the physiopathology
of many diseases.
Three of the small caps are
working on gastrointestinal disorders, which several buysiders noted often
require large and expensive clinical trials and sales forces.
Following a modest uptick in
IPOs last year, buysiders are looking to three positive trends that could
grease the wheels going forward.
Last year, 24 companies went
public compared to 19 in 2011, although most took haircuts in the double-digit
percent range to get the deal done.
"The IPO market remained
challenging in 2012," said Cowen's George Milstein. "The mean
file-to-offer discount was in the low 20s, so pricing has been difficult."
The amount of insider
participation also has increased as investors seek to help companies out the
door. "We seem to have reached a new normal on insider participation, with
insiders picking up around 30% of an initial public offering," Milstein
One thing buysiders think will
improve the IPO market this year is the Jumpstart Our Business Startups (JOBS)
Act, which was enacted in April 2012 to help small companies access public
"Companies are now allowed
to file silently with the SEC," said Marina Bozilenko of William Blair. "This
allows more flexibility for picking your time and is important because IPO
windows don't say open for long."
Perhaps more importantly,
according to Bozilenko, is the change to SEC policy that now allows companies
to speak with investors "to help familiarize them with the complexities of
their story rather than having one 45-minute discussion and expecting the
investor to make a decision."
Gordon said more communication
should help manage expectations, "since companies will now have a better
feel for where their shares should price."
The banker did note one
downside. "The ability of companies to file silently means there is less
clarity about who and how many candidates are in the queue," said Gordon.
A second factor that could fuel
the IPO market is the larger role crossover public investors have played in
late-stage private financings, providing an additional source of capital
to help shepherd companies to reach a stage where other public investors
will take notice.
Two examples from 2012 were a $60 million series D round by
gene therapy company bluebird
bio Inc. in July and a $210 million equity and debt raise by diabetes
Therapeutics Inc. in November.
"These two deals included
a virtual who's who of crossover investors," said Milstein. "If you
look at these types of transactions, it's a new financing paradigm where
companies are reaching directly into public financing institutions for later-
and last-stage rounds" that should help see a company out the door.
A third positive indicator was
the strong after-market performance of last year's IPOs.
The class of 2012 finished the
year up 22% compared to the BioCentury 100's 26% gain. What's more, the 4Q IPOs
ended the quarter up 24%, while the BioCentury 100 was off 4% (see "IPO
In contrast, the IPO class of
2011 lost a median of 13% of their value six months after going public.
"What you are clearly
seeing is an appetite for new issuance," said Milstein. "There were
certain times during the year that were more fluid than others, but it is clear
that for the right story" the public markets are accessible.
Chambers noted the lack of
access to the public markets over the past few years has resulted in a build-up
of mature candidates waiting for the right opportunity (see "IPO Queue,"
"Many private companies
are further along in the clinic, and the more mature and advanced they become,
the more attractive they will appear versus their public comparables," he
Milstein agreed: "I expect
that more companies will look to go public next year and, if the market
dynamics mirror 2012, then we should have a bigger class this year."
COMPANIES AND INSTITUTIONS
Inc. (NASDAQ:AMGN), Thousand Oaks, Calif.
Pharmaceuticals Inc. (NASDAQ:ARNA), San Diego, Calif.
Pharma Inc. (Tokyo:4503), Tokyo, Japan
Pharmaceuticals Inc. (NASDAQ:AVEO), Cambridge, Mass.
Idec Inc. (NASDAQ:BIIB), Cambridge, Mass.
bio Inc., Cambridge, Mass.
Squibb Co. (NYSE:BMY), New York, N.Y.
Corp. (NASDAQ:DNDN), Seattle, Wash.
Sciences Inc. (NASDAQ:GILD), Foster City, Calif.
plc (LSE:GSK; NYSE:GSK), London, U.K.
Inc. (NASDAQ:HOLX), Bedford, Mass.
Pharmaceuticals Inc. (NASDAQ:INFI), Cambridge, Mass.
Therapeutics Inc., Hayward, Calif.
Inc. (NASDAQ:MDVN), San Francisco, Calif.
Pharmaceuticals Inc. (NASDAQ:REGN), Tarrytown, N.Y.
BioPharma Corp. (NASDAQ:GEVA), Lexington, Mass.