November 1, 2011 (Vol. 31, No. 19)
Uncertainty Will Continue Until Policy Makers Find Path to Sustainable Global Economic Stability
Several macroeconomic concerns came to the forefront in the third quarter of 2011. Standard & Poor’s strapped on its dancing shoes and did the downgrade mambo, lowering its long-term sovereign credit rating on the U.S. to AA+ from AAA. Consumer spending began to show signs of stalling, and macroeconomists were prompted to lower their GDP estimates. Economic weakness in Europe continued, increasing the risk of austerity measures. Economists have become increasingly concerned that the slowdown in Europe, the U.S., and China will negatively impact corporate earnings and stock prices.
Global economic uncertainty along with biotechnology sector-specific disappointments contributed to the ongoing market volatility.
During the month of August, the S&P 500 Index had ten trading days where it moved more than 2% in a given session, and six days where moves exceeded 4% up or down. The Chicago Board Options Exchange’s Volatility Index (the VIX), often called the “fear gauge” by market commentators, spiked in early August and oscillated in an elevated range of about 35 to 45, closing out the quarter at 43. This is more than double its average level of 18 during the first two quarters of the year.
The healthcare sector is seen as defensive by investors and typically suffers less than the broader market during a sell-off. However, biotechnology company stocks performed in-line with the broader market in the quarter ending September 30, 2011. For the third quarter, the Nasdaq Biotech Index fell 12.5%.
Over this period, the Dow Jones Industrial Average, Nasdaq Composite, and S&P 500 Index dropped 12.1%, 12.9%, and 14.3%, respectively. The strong fund inflows experienced by healthcare equities through July of this year reversed in August, as macro concerns emerged. Healthcare equities along with the broader equity market saw a strong net outflow of funds in August and September.
Current market dynamics make it more difficult for biotechnology companies to raise capital, consummate strategic deals, and ultimately make progress toward bringing their therapeutic products to market. Stock market volatility will likely continue until European and Washington policy makers find a path toward sustainable global economic stability. Biotechnology companies should prepare to be nimble as windows of opportunity to raise capital in the public markets present themselves during the remainder of the year.
Given the biotech industry’s collective experience during the economic downturn of 2008, some industry pundits have predicted a near-term run-up in financing activity by biotech companies looking to shore-up their balance sheets. Several biotechs tapped the capital markets shortly after Labor day this year.
Raptor Pharmaceutical was first out of the gates with a $46 million follow-on equity offering. InterMune followed with a dual-tranche equity and convertible notes offering raising $231 million. Then, Zogenix completed a $60 million follow-on offering adding to the $30 million it raised in exchange for a portion of future revenue from Sumavel DosePro Zohydro and its $56 million IPO last year.
In the third quarter, companies cancelled or postponed approximately $9 billion in initial public offerings, globally, across all sectors. The value of withdrawn and delayed IPOs so far this year exceeds $34 billion, approaching the $40 billion pulled in 2010, the most since Bloomberg began compiling this data. Only one biopharma company IPO, Horizon Pharma, priced in the third quarter. Horizon Pharma raised $49.5 million in late July and closed the quarter at $6.99 per share. Some transactions are likely to slip into 2012, as issuers are being more patient and waiting for the right market window to open. The current reluctance of some investors to participate in deals could recede quickly as valuations get right-sized.
Alternative Financing Options
This summer’s challenging equity capital markets have prompted some biotech companies to explore alternative sources of funding. Royalty monetization funds represent one such alternative. The number of funds interested in buying current and future royalty streams from biotechs has recently increased. New funds have formed, and existing funds have raised capital dedicated to this type of investment, as some limited partners search for alternatives to the stock market.
For examples of private equity funds that do royalty monetization deals and an analysis of what’s working and what’s not, check it out here.
With royalty deals, biotechs typically get an up-front payment in exchange for a portion of the future revenue stream from a drug. While royalty investors have traditionally focused on marketed products to eliminate regulatory risk, some will provide funds secured by revenue or milestones for drugs still in development.
Other biotechs continue to seek partnership dollars to fund their pipeline development activities. If uncertainty and volatility continue to hamper capital markets activity, biotechs will be more likely to seek the maximum possible up-front payments at the expense of back-end dollars in their partnership deals.
According to data from Deloitte Recap, the average up-front payment of $60 million in the first half of this year was more than 27% of the total deal size. In 2010, up-front payments averaged $21 million and represented less than 6% of the deal value.
This trend of higher up-front payments may also be driven by increasing large pharma demand for later stage assets. These assets tend to be partially de-risked and tend to command larger up-front payments as compensation for their lower risk profiles.
Declining biotech company valuations may spur an increase in opportunistic merger and acquisition activity in the biotech sector. Paying a high premium becomes more palatable when the target’s stock price has been beaten down significantly.
Biotech Trick or Treat
Uncertainty will likely continue to be pervasive in the capital markets as elected officials and policy makers work through the issues impacting the global economy. Near-term market volatility will probably remain elevated, resulting in a higher degree of short-term stock price fluctuations across all major market sectors, including biotech. However, pending clinical trial outcomes, FDA decisions, and sales momentum of promising new therapies will ultimately dictate performance of individual companies and the biotech sector for the remainder of the year.
This Halloween, let’s hope some of the talking heads in Washington make like ghosts, and disappear from the scene for a while. But, that’s just wishful thinking with an election year approaching.
Eugene Rozelman ([email protected]) is a principal in the life sciences investment banking sector at Canaccord Genuity (CGI). CGI has received compensation from Raptor Pharmaceutical and Optimer Pharmaceuticals for investment banking activity in the past 12 months. For regulatory disclosures visit http://www.canaccordgenuity.com/EN/about/Pages/Disclosures.aspx
Market statistics and data obtained from Bloomberg.