Despite the apparent turn of market fortunes more recently, by virtually any measure it would appear that the life science industry may be poised for a period of profound structural transformation. Declines in equity values and their implications paint a sobering picture for the future.
While off their March lows, equity values have dropped precipitously—the BTK is off 29.3% and the NBI is off 26.6% from their respective August 2008 highs. And while the decline from the highs has not been as pronounced as the drop in either the DJIA or NASDAQ, given that the biotech sector highs lagged these broader indices by 10 months, might the bottom possibly lag as well?
Lost on no one is that the current market turmoil has significantly constrained the industry’s access to capital. As reported by Burrill & Co., public funding of the sector through IPO, PIPE, and follow-on equity transactions declined nearly 80% in the fourth quarter of 2008, with slightly over $200 million raised compared to the prior three months when over $1 billion was raised. Similarly, private financing witnessed a fourth quarter drop, declining $500 million from the $1.2 billion raised in the third quarter of 2008. New investment activity has been sharply curtailed, and portfolios have been trimmed as investors take more defensive investing postures.
As a result of this lack of access to capital, the industry faces severe financial constraints. Of the 400 biotech firm that are public, nearly 50% have less than 12 months’ cash, and more than 30% have less than 6 months’ worth. The situation is similarly dire among the privately held companies, with an estimated 40% of the 800 or so companies possessing less than a year’s cash. Virtually all are early development-stage companies with promising technologies yet limited near-term revenue opportunities.
The severity of this market retrenchment is even more pronounced when placed in context. For nearly six consecutive quarters, the IPO window for life science companies has been completely closed. The life science IPO drought was similar in duration during the market downturn following the dot.com bubble earlier in the decade.
A key distinction, however, was that during the previous lull the overall new-issue market remained relatively accessible—226 nonlife science companies still managed to become public. Since the beginning of 2008 only 36 companies have debuted. Effective last September, the entire new-issue market has been at a virtual standstill.
That companies in this industry find themselves financially overextended is not unusual. These companies often plan a funding effort to coincide with a valuation inflection point, such as the release of clinical trial results, despite a painfully short financial runway. The underlying premise behind this financing strategy is that at some price the financing would get done, and that the only uncertainty was the market-clearing price for the offer.
Historically, this reasoning has, by-and-large, held. Today, however, that assumption appears to be a thing of the past. For many companies, it is quite likely no market-clearing price will emerge, no matter how low, and they will find themselves without the financial wherewithal to continue operating.
Ominously, even with a rebound in the broader market, it may be the case that the life sciences will not witness a similar rebound. Investors may reflect more closely on their investment experience and recognize that of the 223 life science IPOs since the beginning of the decade, less than one-third are currently above their IPO offering price per share.
And no particular category of issue, be it biopharma, medical device, diagnostic, or discovery, has faired appreciably better than another. More striking would be the realization that an investment in one share of each of these IPOs at their IPO price would today be worth nearly 25% less than the amount originally invested.
Even before the current market collapse and the contraction in access to capital, investor enthusiasm has increasingly displayed a bias for more mature companies offering late-stage pipelines if not marketed products. This trend is exemplified by the changing profile of biopharma companies to come public. In 2000, only 38% of biopharma IPOs involved companies with drugs in clinical development. By 2007 that percentage had risen to 100%. Half of the companies had either lead compounds in Phase III trials or approved products.
Current market conditions have only exacerbated the situation. The public market bias for more mature companies is now even more pronounced. As a result, early-stage companies—the vast majority of the industry—do not have access to funding through the capital markets to advance their development. Should this situation become further protracted, there undoubtedly will be a pronounced change in how the industry conducts business.