8:02 PM
Jun 29, 2018
 |  BioCentury  |  Finance

Smitten by SMID-caps

Why biotech buysiders are still bullish on small- and mid-caps

Risk is pervasive heading into the third quarter and choppy waters are expected, but 13 buysiders told BioCentury they’re not afraid to stay the course.

A politically charged environment is likely to intensify as the midterm elections approach in the U.S., and investors fully expect rhetoric around drug pricing to amplify as well.

Juxtaposed against this are persistent macroeconomic fears of a trade war, rising interest rates and increasingly chaotic geopolitics, which are expected to feed a new wave of market volatility.

An unusually light catalyst calendar means biotech sector indexes could see limited upside support as well (see “Eyes on Launches”).

Despite this, buysiders aren’t going to play defense. Instead, they are sticking with the thesis that has served them well thus far in 2018: overweight small- and mid-caps and steer clear of the big caps.

A minority believe the large caps could close the performance gap starting in the back half of the year, but the argument is technical, not fundamental.

But that doesn’t change the view that small- and mid-caps are going to continue to create value through clinical, regulatory and commercial execution.

This market bifurcation should keep biotech indexes weighed down by the big caps, benefiting stock pickers by allowing them to generate “alpha” by topping their benchmarks.

Bolstering the small- and mid-cap thesis is a continued belief by investors that M&A will pick up in the second half.

Buysiders were perplexed by the lack of deal flow in 2Q18 -- especially after robust takeout activity to start the year -- but they see the possible hurdles easing starting in 3Q18, such as valuation disparities between buyers and sellers.

Weathering the storm

Another U.S. election cycle means political rhetoric on drug pricing is bound to rear its head again.

While the White House’s June 18 statement announcing $50 billion in new tariffs on imports from China caused global market volatility, the impact on biotechs isn’t yet clear, given other conflicting messages coming from the Trump administration.

On June 25 Trump officials said the administration is considering restrictions on foreign investments in U.S. companies. Two days later the president said his administration may use the Committee on Foreign Investment in the United States (CFIUS) as a vehicle to protect U.S. inventions. The proposals could present additional barriers for Chinese investors looking to back U.S. biotechs.

Renewed drug pricing fears are the icing on the volatility cake for investors looking for an excuse to dump biotech stocks.

Buysiders expect Democrats running in the upcoming U.S. congressional elections to use drug prices as a convenient talking point, and there’s no guarantee the Republicans won’t pile on, too.

In a May 30 speech, President Donald Trump said he expected drug companies to voluntarily announce “massive” cuts to drug prices, confounding investors given the lack of details and follow-up.

More concrete movement on the drug pricing front came from HHS Secretary Alex Azar, formerly U.S. president of Eli Lilly and Co.

“Most large caps are still in the...

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