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Is there still value in the biotech boom?

The biotech boom of the early 2000s left investors with their fingers burnt and a lack of positive sentiment has plagued the sector ever since. But a rush in biotech IPOs on the US market in 2013-14 has prompted investors to ask if there's still value to be found in these high-risk innovative stocks
November 7, 2014

The prospect of investing in biotechnology is still daunting. In the early 2000s the sector was plagued with clinical failures which often meant investors lost out. Confidence in the sector paled, and small innovative companies - often listed on junior markets - struggled to drum up much-needed funds.

Perverse as it may seem, the onset of the financial crisis actually improved prospects for the biotechnology sector. For one, their relationship with their big pharma cousins became much closer. With global drugs giants forced to streamline their in-house research and development (R&D) divisions, management teams were forced to look beyond their in-house resources to find the next big blockbuster drug. In healthcare, product portfolios are a key indicator of a company's value, and biotechnology companies offered big pharma a cost-efficient way to build a stack of future medicines. The benefits of these R&D tie-ups flowed both ways. Biotechnology companies that established effective patented technology platforms were able to strike up lucrative licence or royalty deals with big pharma partners, or were occasionally bought out at a hefty premium.

 

Renewed confidence

As this changing relationship evolved, confidence in the sector started to build. Over the last 18 months, there's been a veritable 'biotech boom' in the number of companies seeking a listing on public markets - more often than not on Wall Street, where they are usually granted a warmer reception from investors. Fierce Biotech - the sector's leading publication - recorded 45 biotech IPOs in the US in 2013, which raised a collective $3bn (£1.87bn) to support their ongoing drug development programmes. Forbes magazine noted in September 2013 (when 30 biotechs had already listed in the US) that 2013 marked the second most successful year for biotechnology IPOs in the industry's 30-year history.

But why did last year mark a change in the fortunes of biotechnology stocks? If investors were wary of the sector, what caused the sudden surge of optimism? Bruce Booth, a life sciences commentator at Forbes magazine, said that confidence was driven upwards by the return of generalist fund managers, who were intent on chasing the sector's outperformance. Biotech, and in particular the Nasdaq Biotech Index, had significantly outperformed other investment sectors since 2010. Put simply, the superior rates of returns outweighed any lingering anxieties.

 

Biotech bounds ahead

 

Success breeds success

A domino effect also came into play, with one successful biotech IPO often precipitating another. In fact, analysts said the effect was so widespread, it boosted the London floats of companies such as Circassia Pharmaceuticals (CIR), Horizon Discovery (HZD) and Cambian (CMBN) Generally, the improved sentiment meant that the IPO market performed well in 2013 and through the early part of this year, before trailing away during the second quarter. IPO fatigue eventually fed into global markets in mid-2014 and plenty of big names had to alter their plans. But in healthcare, the IPO trend was supplemented by a surge in M&A activity driven by attractive tax inversion opportunities for US companies looking to repatriate assets. Examples of this included Pfizer's (PFE) approach for AstraZeneca (AZN), Valeant's (CA:VRX) hot pursuit for Allergan (US:AGN) and Abbvie's (US:ABBV) recently failed takeover of Ireland-domiciled Shire (SHP). But confidence in biotech is still humming under the radar of these headline-grabbing deals: Dialogic data shows US biotech companies raising $4bn in 43 initial public offerings and follow-on fundraisings this year. In Europe, 28 companies have generated $1.4bn.

Swiss group Novartis has gone one step further. In early October, the drugs giant agreed to take a stake in Oxford BioMedica (OXB) as part of a deal to work together on a promising new cancer drug. Oncology is biotech's cash cow, promising big profits to big pharma if companies can successfully commercialise effective, long-lasting cancer treatments. Oxford BioMedica will receive up to $90m from Novartis over the next three years in return for helping it develop its CART-19 leukaemia drug. Novartis will get a 2.8 per cent stake in Oxford BioMedica while the British company will earn royalties from any future sales of the medicine. Accordingly shares in Oxford BioMedica rose on the back of the news, and the share price has doubled since July. Long-standing investors in OXB (which joined Aim in 1996 before moving to London's main market in 2001) have been rewarded.

 

Biotech's chequered past

OXB also serves as a reminder of the sector's chequered past, particularly as its share price peaked shortly into the new millennium. Although the company has evolved significantly in recent years, shares in OXB took a sizeable hit back in 2008, when its lead cancer treatment TroVax failed a major clinical test for kidney cancer treatment. Like many companies in the sector, it is reliant on raising new money to fund its annual cash-burn rate. That said, at the time of the IPO in the mid-1990s it raised just £5m. In a placing and open offer in December 2010, it managed to raise closer to £20m, thus indicating improved confidence in the company's abilities.

And it's not just OXB: the latest data shows fundraising in UK life sciences is at a seven-year high of £734m in the first half of 2014. Adaptimmune, another Oxford-based biotech company, struck a $350m deal with GlaxoSmithKline (GSK) earlier this year to develop new cancer drugs. Subsequently, it has raised over $100m from US venture capital funds. It shows American investors are looking as far as Europe for further opportunities following the surge in US biotech valuations last year.

Immunotherapy, and particularly immuno-oncology, is biotech's biggest opportunity. Treatments are effectively developed using the body's own immune system to fight off cancers. Illustrating the value of such treatments, and the cash-cow biotechnology companies have on their hands, are US biotech companies Juno Therapeutics and Kite Pharma (KITE). Juno, (which is backed by Amazon founder Jeff Bezos) has raised $300m over the past year while Kite raised $128m at its debut on the US Nasdaq market in June.

 

IC VIEW:

There are real opportunities for biotech investors in London at the moment. But we urge investors to look at the sector broadly and incorporate 'medtech' and bio-pharma companies into their portfolios. It's often the case that these start-up companies are difficult to value. An absence of profits, sometimes even sales, makes valuation a tricky business in biotech. Therefore, understanding the product portfolio, the main trends in the sector, and near-term term catalysts for the shares is vital. But if investors are looking for speculative stocks to fulfil the riskier end of their portfolio, now is a good time for biotech buyers.

 

Favourites

Since the deal with Novartis, the outlook for Oxford BioMedica (OXB) is much improved and after years of underperformance, the company has renewed momentum. Cold and cough specialist Vernalis (VER) also caught our attention in August as it gears up for a game-chaning product approval next April. Tissue Regenix (TRX) has also rewarded shareholders this year: the shares rose 150 per cent in nine months to May ahead of the launch of its Dermapure product in the US. Finally ReNeuron (RENE) still gets the nod from us, as the group continues to develop a number of stem-cell based therapies.

 

Outsiders

Outsiders in a biotech are difficult to call, because essentially every stock carries with it an enormous amount of risk. At any point, clinical trials could fail, safety issues could arise or manufacturing delays could impinge upon a successful commercial product launch. That said, continual fundraisings are often a warning sign. Earlier this year, Silence Therapeutics (SLN) raised £11m to fund its ongoing clinical programme, as costs rose 86 per cent to £3.9m in the six months to 30 June. This throws into doubt how long cash reserves will hold out, and to what extent investors should expect dilution on their investment.