5:03 PM
Jan 11, 2019
 |  BioCentury  |  Finance

Warning: cash needed

Why biotechs may need to seek alternative financing options in 2019

A near decade-long run of cheap money appears to be coming to a close, and most of the biotech sector isn’t well positioned for the new reality.

BioCentury’s analysis shows that two-thirds of biotech companies could be facing a cash crunch in 2019 if the markets remain difficult.

While investors don’t expect capital availability to be a problem, they think the rising cost of capital might mean employing alternative financing structures to help biotechs extend their runway.

According to 14 buysiders and bankers contacted by BioCentury, most of the financial market issues facing the biotech sector in 2019 have nothing to do with the fundamentals of the industry, as a confluence of macro-economic forces have driven a shift toward a risk-off sentiment. 4Q18 was one of the worst quarters for biotech indexes in over 16 years, and investors see little reason to think the sentiment will change in the near term.

“There’s been a perfect storm in having a crappy macro market, specialists re-trenching and short of cash, and the generalists are gone.”

Otello Stampacchia, Omega Funds

The only potential silver lining investors see is the string of M&A events that kicked off 2019 that could draw investors back to the sector, and they think the template is more like Eli Lilly and Co.’s $8 billion deal for Loxo Oncology Inc. than the $74 billion takeout of Celgene Corp. by Bristol-Myers Squibb Co. But short of an M&A spending spree, which is always hard to predict, buysiders expect cost of capital may be one of the most important areas of focus this year.

The top tier of companies have raised enough capital to weather nearly any storm. 2018 saw the biotech sector setting records in the total amount of money raised in venture and IPOs, while the amount raised through follow-ons is second behind 2015.

But most of the sector didn’t participate in the cash grab; BioCentury’s analysis of public biotech balance sheets shows that about 40% of loss-making companies have one year of cash or less.

“There’s been a perfect storm in having a crappy macro market, specialists re-trenching and short of cash, and the generalists are gone,” Omega Funds’ Otello Stampacchia told BioCentury. “Companies should have refinanced six months ago, minimum.”

That advice rings even more true as the U.S. government shutdown persists, meaning the SEC is unable to review or approve registration documents. The result is that there haven’t been any IPOs or follow-ons completed since the shutdown started on Dec. 22.

With straight equity follow-ons expected to be particularly punitive in a down market, investors said companies may need to consider alternative financing options, such as private investments in public equities (PIPEs) or other structured financings, as ways to extend their cash runway.

Crossover investors in particular may be looking to add positions through these options as their returns on private investments have shrunk.

And while there was little concern overall about capital availability, foreign private investment into U.S. biotechs -- in particular from Chinese investors -- could see a material reduction in 2019, as the expansion of CFIUS has caused them to reallocate their focus away from the U.S.

Down goes the market

Investors are holding a relatively bleak outlook for the sector in 2019, with enough reason to worry from the last three months, which saw biotech enter a bear market.

The fourth quarter was the third worst performance for biotech sector indexes on a percentage basis since 2002. In 4Q18, the NASDAQ Biotechnology Index (NBI) sank 21% as the continued U.S.-China trade war, increasing interest rates and worries about slowing economic growth pummeled the broader markets and installed what many buysiders characterized as an off-risk sentiment. Over the same period the BioCentury 100 and NYSE Arca Biotechnology Index (BTK) were similarly hammered, both falling 22% (see “Index Performance”).

The sector bottomed out on Dec. 24, down 27% for the quarter, before rallying in the final week of the year.

The previous lows for a quarter came in 2Q02, when the NBI dropped 34%, and in 1Q16, when the index fell 23% in a correction from the all-time highs reached the previous summer.

Buysiders see little reason to expect the new year will bring a change in the near-term outlook.

“I don’t see any reason why things are going to change that materially,” ClearBridge Investments’ Marshall Gordon told BioCentury. “I don’t make predictions about the broader markets, but I know to the extent that there is less appetite for risk, that’s never good for biotech.”

Stampacchia agreed. “I don’t expect a magical button to switch on January 1 and change the outlook,” he said. “I think the market is still digesting a bunch of things and I don’t think any of this is specific to biotech, it is more macro.”

“I would be very worried about the cost of capital in 2019.”

Peter Reikes, Stifel

Contributing to that macro pressure has been the U.S. government shutdown. The SEC said that during the shutdown, companies can still submit new registration or offering statements to the agency; however, with only emergency staff still operating, the SEC is unable to review or declare effective any registration or offering documents.

Thus while early January is typically a busy time of year for biotech financings -- biotechs raised nearly $3.8 billion in IPOs and follow-ons in January 2018 -- for 2019 it has been silent.

The worry is that as the shutdown persists, the backlog of SEC filings builds, which could create further delays beyond the end of the shutdown.

But two buysiders have no concerns about the shutdown negatively impacting biotech’s capital raising in 2019, with one welcoming the respite.

“I don’t think it’ll affect biotech much longer term,” Abingworth’s Kurt von Emster said. “It is probably more of an annoyance.”

“In my opinion this is welcome news for the sector,” OrbiMed’s Sven Borho told BioCentury. “In a...

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