A slew of milestones through
year end combined with last quarter's outperformance have investors hopeful
that the biotech sector can continue to fend off a dreary macroeconomic environment
and weakness in the broader markets.
Buysiders don't expect to see
anything catch the imagination of investors and strategic acquirers
quite the way HCV has in the last year. But they think positive Alzheimer's
Phase III data, as well as another obesity approval, could continue to generate
excitement within the sector.
The takeout of Amylin
Pharmaceuticals Inc. as 2Q drew to a close also could generate momentum
from investors who have been making bets on M&A.
Late last Friday, Bristol-Myers
Squibb Co. announced it will acquire the diabetes company for $31 per
share in cash, or about $5.3 billion in aggregate after a two-step process
involving $3.4 billion cash payment from BMS's diabetes partner AstraZeneca
The real drag on the group is
likely to come from forces outside biotech's control: the European crisis, the
normal summer doldrums, a renewed U.S. budget debate around mandatory cuts
slated for FY13, and the presidential election.
Investors also think these
externalities are likely to keep a damper on what had been a strong appetite
for follow-ons earlier this year.
Fortunately, many biotechs are
now well set for cash, having raised money in 4Q11 and 1Q12. Non-debt
financing in 2Q was at its lowest level in three years. Specialist investors
remain interested in conducting financings to get promising biotechs to an
important milestone. But they are more hesitant about buying shares in small
caps without enough cash.
Last quarter was particularly unattractive for IPOs, with
neurology play Supernus
Pharmaceuticals Inc. and cancer company Tesaro
Inc. the only biotechs to make it out. Wall Streeters have mixed views
on whether this will change as a result of the Jumpstart Our Business Startups
(JOBS) Act (see "IPO Performance").
In terms of stock performance,
investors say the larger mid-cap names are likely to remain among the sector's
top performers. Large caps have some major milestones in 2H12 and will have a
defensive appeal if economies and markets take a turn for the worse.
Micro- and small caps suffered
the most last quarter as some investors fled risk on market volatility.
Investors expect this will continue to be the case.
While the group has outperformed overall, investors don't
anticipate a correction anywhere near the magnitude of the one that occurred
last August when Dendreon
Corp. removed its annual revenue guidance for prostate cancer
immunotherapy Provenge sipuleucel-T and raised fundamental questions for
investors about biotech launch plays.
On the up and up
Buysiders were surprised that
biotech managed to add to its first quarter gains last quarter. Indeed, the
sector outperformed the broader markets and IT in 2Q.
The BioCentury 100 rose 5% on
the quarter, while the NASDAQ Biotechnology Index (NBI) and NYSE Arca
Biotechnology Index (BTK) each gained 4%.
By contrast, the S&P 500
and Dow Jones indices each shed 3%, while the tech-heavy NASDAQ lost 5% (see
"Biotech on Top").
"On a relative basis,
biotech did pretty well in the second quarter in a very weak market and a not
very good economic environment. That's pretty good, all things considered,"
said Miller Tabak's Les Funtleyder.
This half, "it will be
hard for the sector to have additional gains unless the macro environment is
improving. Companies with good products will do well, but they will do better
not fighting the headwinds of a weak macro environment," he added.
Overall, Funtleyder expects
biotech indices will range from "treading water to up single digits. I'm
not looking for double digits on the rest of the year. The best case is maybe
high single digits."
Small cap specialist Selena
Chaisson of Bailard was slightly more negative.
"Biotech in general has
held up surprisingly well - look at the Dow compared to the BTK. It's been
surprisingly strong. I was expecting a correction all quarter, given all the
volatility around the world," she said.
She added, "I don't think
we're out of the woods. Investors have gone to cash where they can. Maybe the
third quarter will be worse than the second quarter for small cap biotechs.
Sometimes there are catch-up corrections."
Still, Chaisson is among those
who don't expect anything on the order of last August.
"Eventually stocks will
have to consolidate, but I don't think we're in for a 30% sell-off," she
said. "I think a consolidation period will happen in the markets and last
three to four months, maybe a little longer. Then the markets will have a
stronger rally and take out the old highs."
Medical Strategy's Stefan Kraft
also thinks biotech could be in for a pullback.
"Prices have appreciated
since August last year; now they are relatively flat. A little correction could
come," he said. "Some companies are overvalued - that might make some
room for a little correction of about 10%."
Banker Annette Grimaldi of BMO
Capital Markets is similarly cautious.
"We don't see any reason
for a correction, but it's reasonable to assume that if some of the macro
issues remain in the forefront, there will be a correction along with the
overall market," she said.
LSP-Life Sciences Partners'
Joep Muijrers agreed, but noted the big milestone list could help.
"Macro issues will largely
determine what the sector looks like in the back half of the year. But there
are quite a few important milestones in the second half. If a few hit, it may
help biotech in a broader sense," he said.
Indeed, there are at least 34
PDUFA dates through year end, along with at least 40 Phase III data readouts.
The back half of last year, which resulted in strong biotech momentum, had 19
PDUFA dates and 46 sets of Phase III data (see "Miles of Milestones,"
Banker Peter Reikes of Stifel
Nicolaus Weisel also sees regulatory milestones as encouraging. "There is
more positive potential for a significant number of adcoms and PDUFA outcomes
than in recent quarters, maybe even in recent years," he said.
Reikes acknowledged missed
milestones could dampen interest, but noted "the market increasingly views
negative events as company specific."
David Pinniger of International
Biotechnology Trust was less sanguine, saying positive news will not be enough
to move the group up. "I expect the sector to remain pretty static through
end of year," he said.
The European crisis is weighing
heavily on European stocks, which is creating tempting bargains. But investors
are hesitant to actively pursue this as an investment thesis because they
continue to wonder how long it will take to resolve the EU's problems.
"The valuations of some
European biotechs are unreal they're so low. But it would be difficult to make
money even if you get the investment thesis right," said Behzad Aghazadeh
of venBio. "One could argue for a strategy that's long European biotech
and short U.S. biotech, but you might have to wait a very long time for that to
Kraft predicted valuations will
come up when Europe "announces that they have a plan or have built a
Specialist investors continue
to favor mid-cap biotechs, which outperformed their peers last quarter, while
the large caps are seen as a potential safe haven in an uncertain market.
"Growth strategies have
worked better than value strategies in this market," said IBT's Pinniger. "Investors
are funneling capital into names that have earnings growth. Money keeps getting
pumped into companies like Regeneron, Alexion and Questcor. That makes it tough
for small cap plays, since the money is sticking to mid-cap names."
Cancer, ophthalmic and inflammation company Regeneron
Pharmaceuticals Inc. is up 114% on the year, while Orphan disease play Alexion
Pharmaceuticals Inc. has added 39% and neurology, autoimmune and
inflammatory disorder company Questcor
Pharmaceuticals Inc. has gained 28%.
Pinniger noted he's been
sitting on 10% cash since April, waiting to buy on a pullback. But he hasn't
seen many opportunities.
"We're waiting for
blow-ups, situations where something big goes wrong and investors run for the
hills, where there's a chance that sentiment could return in 12-18 months. But
right now we're more comfortable holding on to cash than recycling back in,"
Funtleyder, who focuses on
biotechs worth more than $1 billion, has added to some positions on recent
market weakness. But he hasn't done much on the short side. He has been hedging
with options, but noted that this downside protection has gotten more expensive
in recent weeks.
In the small cap space,
selected names are generating interest, but recent volatility, low liquidity
and performance fears are pushing away some investors who might usually be more
receptive to this group. Buysiders said the ability to minimize financing risk
is crucial for these companies.
Pinniger noted liquidity in
some of his small cap names has dried up, with trading volumes consistently
below the 100-day moving average.
"Everything is grinding to
a halt. You can't tidy up or add to small cap positions," he said. "For
us it's difficult to make an investment decision because of liquidity and volatility.
Plus valuations aren't very cheap anywhere but big caps."
Conversely, Fidelity's Kaul is
embracing small caps, participating in financings for companies he sees as
fundamentally strong but currently out of favor.
"With the macro perception
of risk, a lot of the smaller biotechs are getting thrown out the window.
Everything that's risk-oriented and smaller cap have been suffering," he
said. "I'm looking for companies with good data that need cash and that
will do financings at very discounted prices."
He added: "This plays to
our strengths. We have a comparative advantage being a large long-term fund,
not a hedge fund that has to worry about investors pulling out on a poor
quarter. The small companies that I bought on the panic in 2008 have had very good
Kaul's conclusion: "Fundamental
investing is not working in the short term, but it does in the long term. The
macro environment is very bad, but biotech has never been better."
He singled out oncology,
antibiotics, cardiovascular and diagnostics as "good areas to be in.
Orphan diseases have been an ongoing theme for a while. These are areas where
drugs can add important value in terms of patient value or in terms of
Muijrers is investing in smaller cap companies if he can participate
in a financing to ensure the company is well capitalized, rather than buying
shares on the open market. Last quarter, he participated in financings for two
microcaps: gastrointestinal play Synergy
Pharmaceuticals Inc. and neurology company AcelRx
"There are a lot of
companies that trade close to cash and have an interesting pipeline," he
Aghazadeh sees small caps as
full of opportunities, but also worries about financing risk in this environment.
"We generally keep a long
bias and look for assets that are of strategic value to pharmas. With the
market volatility, that's not always easy to do, but we think that's the right
thing to do," he said.
No one expects financing
activity over the remainder of the year to hit the levels of the first quarter (see
"Financing in the Age of Volatility").
"The first quarter was
very, very active; a lot of people have filled up the gas tank," noted
Matthias Spaenle of Oppenheimer.
Rahul Chaudhary of Leerink
Swann agreed. "In the first quarter, companies that needed to finance or
had the ability to finance did so. A lot of supply got cleared out," he
Follow-ons, in particular, have
pulled back. Some biotechs have opted instead for convertible offerings, which
allow investors to take advantage of volatility while minimizing risk. Bankers
also see a lot of pent up demand for converts after a relative dearth of these
Another reason follow-ons have
dried up is that investors didn't like the prices biotech are seeking.
"A number of deals that
were out didn't get done because issuers didn't want to take the price. They
were a little more price sensitive, and the discounts that investors expected
were just too deep," Spaenle said. "I wouldn't like to invest at a
52-week high if I was an investor."
Reikes noted larger cap names
are actively financing, with the real pullback being among smaller caps.
"We've seen a visible
increase in financing by bigger cap, more established names, particularly those
that finance in the wake of positive news like BioMarin, Alkermes and Jazz,"
he said. "Against that backdrop, you've seen an obvious compression with
smaller cap and less well established names and unseasoned names like IPO
Orphan disease company BioMarin
Pharmaceutical Inc. raised $249 million at the end of May, after 1Q
earnings helped kick its share price to a 52-week high.
In March, CNS company Alkermes
plc sold $398 million in a secondary offering of 24.2 million shares
held by Elan
Corp. plc. The offering came after FDA's approval in January of Amylin's
once-weekly Bydureon exenatide to treat Type II diabetes, which uses drug
delivery technology from Alkermes.
Elan gained 31.9 million
shares, or a 25% stake, through the sale of its Elan Drug Technologies drug
delivery business to Alkermes last September.
In June, specialty pharma company Jazz
Pharmaceuticals plc garnered a $475 million loan and a $100 million
revolving credit facility. The former was to complete its $680 million
acquisition of EUSA Pharma Inc., while the latter was for general corporate
purposes. The biotech ran up late last year and early this year on earnings
expectations and better-than-expected 2012 guidance.
Reikes also expects the convert
market to revive.
"Interest rates are at
unprecedented lows and there's a heightened degree of volatility in the equity
market," he said. "Together these conspire to make terms for
convertible financings the most attractive they've been in years. Marry that
with an acute supply/demand imbalance in the market with the absence of new
product against a very cash-flush buyside marketplace and you've got all the
ingredients for a vibrant convert market."
BMO's Grimaldi noted there
haven't been a lot of convert deals, "but I think there's a receptive
market and there's just been a shortage of supply."
In 1H12, biotech companies
raised $2.1 billion in 29 converts compared to $1.4 billion in 20 offerings in
2H11. Almost all the convert money raised last half was by larger cap
companies; there were five deals that raised $1.8 billion for biotechs with a
market cap of at least $1 billion.
IPOs on JOBS
The JOBS Act has already
resulted in some tangible changes in how biotech IPOs are getting done.
Foremost are confidential IPO filings and the premarketing of IPOs to investors
immediately before a formal road show.
Still, it remains unclear if
any of the JOBS Act provisions will actually improve execution, pricing or
returns on biotech IPOs. Bankers have yet to implement some aspects of the law,
such as the integration of analysts and their reports into the IPO process, as
they await guidance from SEC and FINRA.
In early June, SEC said there
had been 30-32 confidential IPO filings. Bankers told BioCentury about
one-fifth to one-third of these filings were made by biotech companies.
Bankers think the new ability
to assess investor appetite during the confidential filing period could reduce
the filing-to-offer discount, and potentially shield companies from the
embarrassment of a withdrawn or postponed IPO.
"The JOBS Act is an
incredible positive in terms of allowing a company to test the market without
having the stigma of a busted IPO," said Edwin Gordon of Ladenburg
He noted that the reduced
compliance costs resulting from JOBS have translated into interest from foreign
issuers looking to list on U.S. markets.
Bozilenko thinks confidential
IPO filings could enable biotech companies to time IPOs better. "If they
have a prospectus on file, maybe they can hit an IPO window, because those
usually last only about three months," she said.
Oppenheimer's Spaenle praised
the premarketing provision in particular. "What's attractive is if you can
file an IPO and go on the market before you are actually on the road. It gives
investors more time to look at it, to understand and do their work," he
But he cautioned: "A good
quality company shouldn't need to file confidentially. If a client asked me to,
I would be a little worried."
Indeed, buysiders surveyed by
BioCentury so far are indifferent to confidential IPOs. A couple said the
practice may allow them more time to survey the deals, but they are still
unlikely to participate.
Gordon expects to see more Form
10 filings this year, which allow companies to become publicly traded through a
gradual process that replaces an IPO. After raising money and filing a Form 10,
these companies aim to list on the OTC Bulletin Board and finally move to a
"I think you'll see
further use of Form 10 filings. In the current circumstances, where you have
insider participation in IPOs that's at 50%, it just makes sense to consider
it," he said.
The most recent company to take advantage of the Form 10
process is fertility company OvaScience
Inc., which started the process in April. It raised $37 million in a
venture round and then the following week filed a Form 10 with SEC.
As always, M&A activity
remains a theme for specialist investors, who know high-premium biotech
acquisitions get the attention of generalist investors and generate momentum
for the sector.
The BMS agreement to acquire Amylin, which both boards have
approved, could test that thesis. The total value of the transaction is about
$7 billion, including Amylin's net debt and an obligation to its former partner
Lilly and Co. (see BioCentury, Nov. 14, 2011).
After the deal closes, BMS said
it will expand its existing diabetes partnership with AstraZeneca to include
Amylin's diabetes portfolio. AZ will pay BMS's Amylin subsidiary $3.4 billion
in cash, and the companies will split profits and losses.
The deal provided a strong finish to a quarter in which
M&A activity had otherwise slowed and investors were left smarting after
betting on sequencing and microarray company Illumina
The tool company's shares shed 23% after management fended off
a hostile takeover attempt by Roche.
Looking ahead, some buysiders and bankers expect Human
Genome Sciences Inc. will be acquired this year, but others aren't so
For example, a white knight hasn't emerged for HGS, which is
trying to fend off a $13 hostile bid from GlaxoSmithKline
"HGS had a disappointing
drug launch and has failed to get investors excited since then. Their main
objective now is to try and squeeze as much value as possible out of GSK.
Without M&A, it's difficult to see how you make money in the stock from
here," noted IBT's Ailsa Craig.
Kraft doesn't expect HGS to get
taken out until next year, after Phase III data for darapladib to treat
coronary heart disease from partner GSK.
He noted data for the compound
have been mixed.
"We think Human Genome's
strategy is to wait until Phase III data for this drug. After this data,
another bid could be made by GSK. We would say that $13 is not the last word in
this case," Kraft said.
BioMarin also is being tipped
as a takeout candidate. It remains unprofitable despite four marketed products,
as management has opted to keep investing in R&D. Investors are counting on
positive Phase III data in 4Q12 for GALNS to treat mucopolysaccharidosis IVA.
If the data are positive, this product is expected to push the biotech to cash
flow positive (see BioCentury, June 4).
"I think BioMarin could
come back into focus next year on the back of strong clinical data from their
late stage pipeline, but they still have a lot of work to be compared to the
likes of Alexion," said Craig.
Aghazadeh noted that stock pops
on M&A rumors helped to create a floor for the sector last quarter.
"The NBI is up on M&A
rumors. Amylin and Human Genome Sciences popped. These rumors have helped
create a bit of a bottom for the sector," he said. "We'll continue to
see that in the fall and later in the year."
"There's strong interest
in the relatively small number of companies with marketed products with
substantial upside. But there's really not a lot of supply," noted BMO's
She said the most desirable
companies for acquisitions have marketed products and are in the $1-$5 billion
market cap group. But there are only about 26 biotechs with that valuation with
products on the market or in registration.
Pharmaceuticals Inc. (NASDAQ:ACRX), Redwood City, Calif.
Pharmaceuticals Inc. (NASDAQ:ALXN), Cheshire, Conn.
plc (NASDAQ:ALKS), Dublin, Ireland
Pharmaceuticals Inc. (NASDAQ:AMLN), San Diego, Calif.
plc (LSE:AZN; NYSE:AZN), London, U.K.
Pharmaceutical Inc. (NASDAQ:BMRN), Novato, Calif.
Squibb Co. (NYSE:BMY), New York, N.Y.
Corp. (NASDAQ:DNDN), Seattle, Wash.
Corp. plc (NYSE:ELN), Dublin, Ireland
Lilly and Co. (NYSE:LLY), Indianapolis, Ind.
plc (LSE:GSK; NYSE:GSK), London, U.K.
Genome Sciences Inc. (NASDAQ:HGSI), Rockville, Md.
Inc. (NASDAQ:ILMN), San Diego, Calif.
Pharmaceuticals plc (NASDAQ:JAZZ), Dublin, Ireland
Inc., Boston, Mass.
Pharmaceuticals Inc. (NASDAQ:QCOR), Union City, Calif.
Pharmaceuticals Inc. (NASDAQ:REGN), Tarrytown, N.Y.
(SIX:ROG; OTCQX:RHHBY), Basel, Switzerland
Pharmaceuticals Inc. (NASDAQ:SUPN), Rockville, Md.
Pharmaceuticals Inc. (NASDAQ:SGYP), New York, N.Y.
Inc. (NASDAQ:TSRO), Boston, Mass.