12:00 AM
Jan 04, 2016
 |  BioCentury  |  Finance

Curbed enthusiasm

Why tempered investor enthusiasm doesn't mean the biotech bull is over

Following three years of investor exuberance manifested in gains of at least 115% in biotech indices, buysiders say a good 2016 would see biotech merely keeping pace with the broader markets.

Nobody is calling an end to the biotech bull market, but volatility is the key word due to election year politics that will feature drug pricing as a central talking point, the sour performance of biotechs that tapped the markets in 2015, and an exodus of crossover investors that helped about 20 companies go public.

The consensus remains that biotech is still the best and perhaps only growth sector. As a result, many generalists will invest in biotech almost by default, even though momentum players - and their froth - are absent.

Expectations are for the generalists to remain in large cap biotech names until specialist investors show convincing wins in smaller cap companies. Specialists will have ample opportunities to build positions early in the year, as a glut of paper will be on offer in January.

The full year is likely to see fewer financings, in part because 908 companies stuffed their coffers with $109.7 billion in 2015, making it the biggest year in the sector's history.

Another reason is that bankers don't think many financings will happen from August to year end, when the election will become a distraction. Face time with buysiders will therefore be hard to come by, and companies will need to heed bankers' advice to cast as broad a net as possible when courting investors.

Even if stump speeches about drug pricing lead to periods of volatility and an associated chilling of generalist interest, specialist investors still have no concerns about the pricing power of companies with innovative medicines that deliver measurable benefits to patients.

Big ending

Biotech beat the broader markets in 4Q15 and FY15, but not by as wide a margin as last year.

The NASDAQ Biotechnology Index (NBI) was up 12%, the NYSE Arca Biotechnology Index (BTK) gained 11% and the BioCentury 100 index advanced 8% in 4Q15. The NASDAQ Composite added 8% and the Dow Jones Industrial Average advanced 7% in 4Q15.

For the year, the NBI and BTK were up 11% and the BioCentury 100 was up 5%. The NASDAQ gained 6% and the DJIA finished in the red with a 2% decline.

In 2014 the BioCentury 100 advanced 28%, the NASDAQ added 13% and the DJIA brought up the rear with a gain of 8%.

Biotech's 2015 performance was on pace to match 2014 until the sector lost 23% in 3Q15. Afterwards, investors put their money into big cap biotechs, which posted a 16% gain in 4Q15 (see "Results by Market Cap," page 10).

In Europe, the preference for big names propelled the market cap-weighted BioCentury Europe index to a 40% gain in 2015 (see "London vs. Europe," page 11).

Even though companies valued at $5 billion or more were up 7% for 2015 after climbing more than 100% over 2012-14, buysiders say big cap biotech still does not look expensive. The average P/E for the group was 24, up from a nadir of 20.2 at the end of the third quarter and just above where it began the year (see "Price-to-Earnings: BT vs. RX," page 10).

The average P/E to growth (PEG) ratio was 1.6 for big biotech based on 2015 EPS estimates, below telecommunications (2.2) and just above IT (1.4).

"From where valuations stand, just on pure price-earnings values, we are back to where we were three years ago," said Daniel Koller of BB Biotech.

Linden Thomson of AXA Framlington noted that her generalist colleagues "are paying much higher multiples for lower growth elsewhere."

LSP's Joep Muijrers said if big biotechs report another quarter of strong earnings, the sector will be impossible for generalists to ignore. In 3Q15 almost every large cap company beat consensus estimates and raised guidance.

"I think that generalists will not shy away from the sector, but remain invested in large cap companies," said Mario Linimeier of Medical Strategy. "They will definitely avoid small and mid-cap stocks."

If he's right, the proposed IPOs and follow-ons that bankers and buysiders expect this month will need to be taken up by an increasingly discerning group of specialists.

Andrew Bogan of Bogan Associates is unlikely to be among the buyers. "When the equity market is not generally booming, euphoric biotech buying of preapproval, non-profitable companies tends to disappear in a drastic and horrific way. I don't know that 2016 will be when that happens, but it wouldn't surprise me," he said.

"I'm not itching to sell some of the younger, successful companies that we currently own, but I'm not necessarily expecting them to outperform," Bogan added.

Bogan's macro concerns include unemployment numbers that he thinks are worse than people expect, weakness in the semiconductor industry and the poor economies of Japan and Brazil.

He said demand for big biotech does not tend to fall off during weak economic times.

Marshall Gordon of ClearBridge Investments also is not expecting biotech indices to leave the broader markets in the dust. But, he added, "I'm planning on specific stocks doing well based on approvals or launches or milestones. I don't think the sector will be off to the races, but there are still very few secular growth opportunities elsewhere."

Carl Gordon of OrbiMed Advisors was perhaps the most sanguine. "Even with a pullback the biotech market remains strong...

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