2021 - a year of two halves, optimistic for a recovery in 2022

At the start of a third year in which the Covid pandemic will undoubtedly play a major role, we revisit 2021 which was disappointing for the biotech sector with a marked underperformance against the broader market, and look forward optimistically for a strong recovery for the sector in 2022.

2021 – a year of two halves

First half – Exuberance and frothiness: 2021 for biotech started at a furious pace, with sky high valuations and hot IPOs in volumes previously not seen since the dot com era of the late 90s. As we pointed out in our February blog (https://ibtplc.com/investor/blog/meme-theme-and-the-ark-innovation-momentum-machine), our view was that valuations for the smaller, riskier and interest rate sensitive biotech stocks had become overheated and disconnected from company fundamentals. We also highlighted the short to medium term risk of inflation, which was proven correct as the global supply chain failed to keep pace with the global economic recovery which created bottlenecks and consequential inflation pressures leading to increased interest rates. Additionally, the execution of sizeable M&A deals nearly ground to a halt thanks to the spike in valuations and the impracticality of face-to-face interactions needed to conclude all but the most essential deals. These concerns led us to focus on the larger cap names of the sector, characterised by proven sales and revenue track records, which was validated by relative performance. The graph below shows the Nasdaq Biotech Index (NBI) which is market cap weighted and dominated by the large cap biotech companies vs the S&P Biotech ETF (XBI) which is an equal weighted biotech ETF which therefore gives greater prominence to the smaller cap companies in the sector.

Second half – Correction creating opportunities: After a peak in the spring, sentiment appeared to cool off and the biotech indices retrenched considerably. The IPO market moderated, with the number of deals and valuations tailing off. Market corrections create opportunities and we saw companies with great science, interesting projects and potential future cures reach more attractive valuation levels in the second half of the year. We weren’t alone in our valuation sensitive approach; big pharma and big biotech companies were also attracted to exciting science at what appeared to be reasonable valuations in their quests to expand and replenish their internal pipe-lines. We predicted in our August blog (https://ibtplc.com/investor/blog/pandemic-provides-launchpad-for-multi-year-biotech-boom) that following a stark reduction in sizeable deals in 2020 and 2021, major M&A deals would return to the sector. Eventually in the final months of 2021, several large deals were announced, including three names we owned in the Trust - Acceleron was acquired by Merck, Vifor by CSL Pharma and Arena by Pfizer.

2022 – we are optimistic, and geared

Performance of the sector during 2021 as a whole was disappointing relative to the broader market.

We believe that 2022 therefore represents an interesting entry point and, while our gearing facility of £55m remains conservative as a proportion of our NAV, we have increased our borrowing to a level higher than at any other point during the past ten years, reflecting our conviction that the sector is ripe for recovery. Taking the XBI index as a proxy for the biotech sector, it is currently trading pretty much back where it was in 2015 and 2018, in spite of the value creating events over that period characterised by significant scientific advancements and new drug approvals. This leaves us to conclude that valuations are not, on the whole, currently expensive and makes us optimistic about M&A on top of our expectation of continued innovation in the sector and demand for the sector’s products.

Before covering the outlook, we highlight some IBT-specific developments.

Vaccine producing companies – IBT’s restrictions now lifted

We would like to thank Kate Bingham for her contribution to the UK Government’s Vaccine Taskforce, which made it possible to accelerate the roll-out of vaccines in the UK and thus mitigated some of the effects of the Covid-19 pandemic. As a consequence of Kate’s role, to ensure that neither SV nor its clients were seen to benefit from her privileged access to information, we at IBT were restricted from investing in the highly successful vaccine producing companies which during 2021 outperformed hugely the average of the other biotechnology stocks contained within the NBI.

As of 1^st January 2022 this restriction has been lifted. Following the rebalancing of the NBI Index in December 2021, vaccine producing companies account for around 8.8% of the NBI as at 31 December 2021 (with Moderna accounting for around 6%) and the segment therefore merits careful consideration. We note the less grievous nature and the higher contagion of the Omicron variant which may lead to higher natural immunity among society thereby potentially reducing reliance on vaccines for the majority of the population going forward, but also are aware that this could change quickly should a more virulent variant emerge. We also note the rise of potential treatments for Covid and other viruses such as the recently approved antivirals which may also ultimately be a complement to vaccines.

We consider that in the light of those factors there is some doubt that Moderna’s COVID vaccine portfolio alone can justify its current valuation. However, we recognise its broader business plan and we very much like mRNA technology. Indeed we have exposure to mRNA already through our portfolio companies Ionis, PTC, Alnylam and Dyne. The first data from Moderna’s flu vaccine trial released in December 2021 showed similar efficacy to existing flu vaccines, but did not yet provide a full picture on safety data. We note Moderna’s significant positive cash balance, underpinned by the pandemic windfall, and we expect to see it participate in the M&A in the sector which could propel the company to being an even more successful biotech company. Due to Moderna’s wide following gained during its extraordinary rise in value during 2021, it performs somewhat unpredictably as moves are at times based more on sentiment than fundamentals which lends it a more volatile profile.

Whatever decision we make with regards to investing in companies, including Moderna, involved in combatting Covid and other viruses, it’s something that we will update you on in February and will regularly review in line with our active fund management ethos.

Unquoted portfolio update

IBT’s investment in SV Fund VI is maturing and the venture fund has paid out several distributions such that it now accounts for only 5% of IBT’s NAV. In accordance with the Trust’s strategy to maintain its exposure to unquoted companies within a 5-15% of NAV range, the Board of IBT has made the decision to investing SV Health Investors’ forthcoming biotechnology focussed private fund, SV Biotech Crossover Opportunities Fund LP.

Dividend for January 2022

The Trust held its AGM in December and confirmed the January dividend payment of 15.7p, the first of two bi-annual dividends for 2022. This represents an increase of 10.6% over the 14.2p dividends paid in January and August 2021, and for 2022 as a whole would represent a dividend yield of 4.75% on the shares at last Fridays market price.

Outlook

Looking into the crystal ball, we are confident that the sector is on a solid footing for a bounce back, but we are also wary that the ride may not be smooth with the anticipated recovery potentially being affected by US mid-term elections, inflationary pressures and other events.

Fundamentals intact: Science is expanding in an exponential fashion and this pace of innovation has been largely unfettered by the pandemic. The number of ongoing clinical trials (as measured by clinicaltrials.gov) is continuing to grow and has surpassed pre-pandemic levels. Despite challenging clinical trial recruitments and approval processes due to the pandemic, the US Food and Drug Administration still managed to approve 50 new drugs in 2021, illustrating the continued productivity, resilience and adaptability of the sector, despite moving to a virtual world. On the demand side, the expected doubling of over 65s over the next fifty years combined with the developing world insisting on better access to healthcare underpins demand for the sector’s products going forward.

Biotech-led return to normal: We are hopeful that Omicron will raise immunity through the world without a corresponding rise in severe disease and deaths, that combined with ongoing vaccination programmes and improved treatment options provided by the biotech sector, could lead to a reduction in Covid related restrictions on our lives.

Clinical breakthroughs expected: 2022 could become a year of several clinical break-throughs in the sector. We anticipate data from gene editing companies providing us with potential new ways to treat diseases by changing our genomes in ever more precise ways. Cell therapy treatments are also getting better and better at every iteration, and it has been by these incremental improvements that progress has been made over recent decades.

Important catalysts due in Q1: There are several exciting events within the sector expected during the first quarter of 2022. IBT’s portfolio holding, Mirati Therapeutics, is expected to file its drug for KRAS-mutated lung cancer with hopes to be the best-in-class therapy, competing with Amgen. We also expect to see the final read out of Trodelvy, an asset acquired by Gilead, in a large sub-set population of breast cancer patients. Oncology remains very much an area of unmet medical need and it will be great to see progress in these disease areas that should benefit a large population of patients.

M&A set to rebound: The flurry of deals announced in December reinforces our expectation of a resurgence in M&A activity in the sector as the big pharma and big biotech companies take advantage of the retraction in valuations and relaxation of Covid restrictions to use their strong cash balances to seek to replenish their pipelines, responding to the constant pressure of patent expiries on the horizon and driven by the demographic pull underpinning the biotech industry.

We look forward with excitement to 2022 and want to thank our readers and investors for supporting us.