12:00 AM
Jul 11, 2016
 |  BioCentury  |  Finance

Ground up

How biotech stocks may navigate post-Brexit, pre-election waters

As the third quarter gets under way, biotech is shaking off the hangover of the Brexit vote while facing the overhang of the November election in the U.S. Fifteen bankers and investors contacted by BioCentury agree neither macro event will affect biotech's still-solid underlying science, but nevertheless are going to have effects on the sector's access to the capital markets.

While worries that Brexit would wreak havoc on global markets did not pan out in the first week of the third quarter, the investor expectation of important new modalities driving the sector next year also might need to be tempered. The reason is the new questions surrounding chimeric antigen receptor (CAR) T cell therapies that arose after Juno Therapeutics Inc. disclosed a clinical hold on a Phase II trial of its lead cancer product due to two patient deaths.

In any case, risk appetite among generalists is at best diminished and at worst non-existent. Compounding the problem is a loss of big cap biotech leadership and a less than robust list of companies with key 3Q16 milestones.

Against this backdrop, some biotech specialists are rebuilding from the ground up - selectively picking small- and mid-cap names. The first step is adding to positions in existing portfolio companies deemed excessively punished during the first half. A harder ask is putting money to work in new names.

In all cases, companies looking to court bargain hunters should be prepared to offer financing terms that are much sweeter than before. Gone are the days where investors took a basket approach and bought as many follow-ons or IPOs as possible.

Bankers are telling their companies to avoid publicly marketed deals at all costs, as many of the companies that tapped the markets in that manner were soundly beaten down in the second quarter. Instead, the advice is to be ready to finance at a moment's notice. At least one banker thinks this could require careful navigation of the summer holiday and the narrow window this fall before the U.S. election completely takes over the conversation.

Pounded, briefly

The June 23 Brexit vote hit biotech hard, but the effects were short-lived. After a two-day hosing following the vote, biotech was testing its February nadir and the sector's small gains on the quarter had been erased. But both biotech and the broader markets ended the second quarter on an upswing.

The fact that biotech is gradually recovering from a miserable first quarter - and remains the only sector with any appreciable IPO activity - has some investors and bankers thinking the darkest days are in the rearview mirror.

The BioCentury 100 index ended 2Q up 2%; however, it's still down 21% year-to-date. The NASDAQ Composite was off 1% in 2Q and the Dow Jones Industrial Average closed up 1% (see "Index Performance," page 14).

The DJIA started the third quarter up 1% and the NASDAQ Composite is up 2%. The BioCentury 100 is up 5%.

The BioCentury London index and the BioCentury Europe index were actually the best of the bunch in 2Q16. The BioCentury Europe advanced 9%, and the London index gained 7% last quarter. In both cases, the reason for the gain was strong performance by the biggest constituents of the market cap-weighted indices (see "London vs. Europe," page 14).

"I think there's zero connection between biotech and what happens to Britain in terms of fundamentals," said Brookside Capital's Daniel Krizek. "But in the overall market there's a huge connection. It's all about people's willingness to be invested and have money at risk. Whenever there's uncertainty, biotech goes down."

"Uncertainty weighs on a risk-on sector like biotech," said Oleg Nodelman of EcoR1 Capital. "The big question now is whether the Brexit is contagious. We always like to say that the best type of risk for us is macro risk that isn't correlated to what's happening to our companies."

Joep Muijrers of LSP agreed the main effect of Brexit was to completely flip investor mentality to risk avoidance, or what he called risk-off behavior.

"At the end of the day my feeling is the impact fundamentally is not that big. The U.K. market isn't that big, and I don't expect anything from the EMA regulatory process to go haywire," he said. "But it is something biotech has to deal with, because sentiment-wise we're now in a big risk-off trading environment."

The first trading day after the Brexit vote, Muijrers said he combed through his portfolio looking for European biotechs that were getting punished.

"It was Armageddon in the morning. It reminded me of 2008 when Lehman Brothers failed," he said. "I'm not calling a bottom, but when you have well-capitalized European names going down more than 10% it's an opportunity."

For the U.K.'s biotech industry, one...

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