Last year we highlighted in our February blog post the strategic factors driving the long-term growth of biotechnology share prices and the behavioural factors shaping short-term share price cycles.
The ageing population and an acceleration in scientific innovation provide a stable long-term growth trend, but over the short-term, sentiment drives exaggerated highs and lows in share prices – which investors can exploit.
IBT’s portfolio managers have identified five stages in this investment cycle, illustrated below. They are despair, recovery, equilibrium, euphoria and correction.
The most recent loop around this cycle was exaggerated by the Covid-19 pandemic, which increased focus on the biotech industry and led to a rise in retail trading over lockdown. However, the comedown in the Spring of 2021 was equally sharp and the biotechnology sector has now lagged the market as a whole for two years.
At the moment, we think the market is currently on the cusp between stage two – recovery – and stage three – equilibrium. Over the first quarter of this year, valuations in the biotechnology sector have appeared to begin to stabilise.
M&A and IPOs returning
There are several signs experienced fund managers will be looking out for to give them confidence in a genuine recovery. During 2022, mergers and acquisitions (M&A) in the sector picked up, with appetite driven by the combination of impending patent expiries and large cash positions at the big pharmaceutical companies. This has continued into 2023, although the US Federal Trade Commission (FTC) is now thought to be obstructing Amgen’s $28bn takeover of Horizon Therapeutics, which may have implications for other announced and planned M&A transactions.
The reopening of the initial private offering (IPO) window is another positive sign we could be moving from the recovery phase to the equilibrium phase of the investment cycle. In early May, J&J successfully spun off its consumer healthcare arm Kenvue, raising $3.8bn, and immunology company Acelyrin raised $540m in its May 2023 IPO. These sizeable capital raisings, combined with two other $150m+ development-stage IPOs in February, were well received by the market and indicate investors are feeling more confident about investing in biotech. This is key to establishing an equilibrium in the valuation cycle.
As the biotechnology sector moves out of recovery and into equilibrium, there also tends to be an uptick in shareholder activism.
We believe shareholders become more assertive during this period because they are frustrated with the lack of activity and lacklustre returns during a protracted downturn, so they start to rattle the cage in order to extract returns on their investments.
Investors may feel the market recovery is taking too long and they need to take steps to accelerate the next phase. They might also think management at individual companies are failing to live up to expectations. There has been an uptick in such shareholder activism in recent months.
Last month, the hedge fund Farallon Capital sent a letter to the board of Exelixis announcing its nomination of three directors to the board. The hedge fund said the biotech firm should focus its research and development efforts, communicate a differentiated and coherent strategy and commit to ongoing distributions of excess capital to shareholders.
April also saw activist investor Carl Icahn call for Illumina’s CEO, Francis deSouza, to be voted off the board for his efforts to acquire cancer blood test developer Grail, which has been rejected by international regulators.
As well as shareholders agitating for better management of biotechnology companies in order to improve share price performance, they will also start to pressure biotechnology companies to be sold. For example, in April, MKT Capital wrote to fellow shareholders of Aurinia Pharmaceuticals asserting the company was worth over 190% more than the prevailing share price, urging them to join MKT in withdrawing support for the current board and pushing for the company to be put up for sale.
The recent move by the FTC to obstruct the largest M&A deal of 2022 is a concern and may have a wider-ranging impact on investor confidence in biotech investing, but at the time of writing this blog, it is unclear exactly what the outcome of this will be. With this aside, there remains strong evidence to indicate the biotechnology market is on the cusp of moving from recovery to equilibrium, and IBT’s portfolio managers are cautiously optimistic about its trajectory.