The Biotech Rally has Legs—But Rising Tide Isn’t Lifting All Boats

Barbara Ryan is Founder, Barbara Ryan Advisors

The XBI, as of late last month, stood at $95, off the recent high of $103.52, but well above the low of $65 in October 2023 when the rally in the biotechnology sector began. In contrast, the number is still significantly below XBI’s all-time high of ~$141 in October 2020. Of course, as is the case with all rallies, progress is not reflected in a straight upward line. The index has traded inversely with interest rates since 2021 (tightly correlated with the economy and inflation, where conflicting reads continue). That said, investors have clearly decided that it is merely a question of when—not if—we will see rates decline, and are now accordingly focusing less on macro factors to assign valuation metrics and are leaning more decidedly on fundamentals.

While the XBI year to date (YTD) is underperforming the S&P 500 YTD, it has massively outperformed it versus the lows in October of last year. Since investors are now making money in the sector, sentiment is improving with an increasing appetite to put money to work in quality names. Evidence: the first quarter saw record financing activity of $15.4 billion raised in 86 secondary offerings, compared to $14.8 billion in 2021, $1.3 billion in 2022, and $4.4 billion in 2023. YTD, there have been 39 follow-on offerings, 30 PIPEs, 17 registered directs, and six IPOs. Biotech funds got off to a great start to the year, averaging gains of 10%, according to Brian Gleason, managing director at Raymond James. Tim Opler, managing director at Stifel, states “capital raised in the sector in 1Q ’24 hit record levels, up 49% versus last year.” But the number of deals in the secondary market, at 86, trails the 122 in 2021 as average deal size in rising, which likely reflects a higher bar for eligible companies, according to Gleason. He adds that the average deal size this year is $180 million, versus the prior four-year average of $120 million.

THE HAVES AND HAVE NOTS

This rising tide is not lifting all boats. Of the 200 companies who started out the year with less than 12 months of cash, only 10% been able to raise capital. Of the 155 companies with market caps of less than $100 million, only 5% have been able to raise money. This will mean that more organizations will be forced to make tough decisions, reprioritize, and restructure to extend their cash runways, liquidate, or merge.

According to Opler, the average value of a Phase III-stage biotech today is $967 million, which compares to $1.36 billion 27 months ago (at the height of the market). In stark contrast, the average preclinical-stage company value today is $237 million, which is less than half its value of $511 million 27 months ago.

But with the turn in sentiment, investors are seeing opportunity across companies with negative enterprise value (EV) and opportunistically buying these up. To cite Opler again, his count of negative-EV companies now stands at 123, down from a number of about 225.

INDEX REBALANCING WILL ADD TO MOMENTUM

Opler, again, makes a very important point in the reasons to believe in a sustained rally from here—the rebalancing of the Russell indexes based on April values, which will become effective in June. He states, “because the value of biotech in the market has nearly doubled, this means that the value for biotech in this index will also nearly double,” with index funds loading up accordingly—and increasing the appeal of the sector to generalists.

Last, but certainly not least, M&A continues to fuel positive performance and is running at a record pace, which places new cash into sector funds to redeploy into new investments into attractive companies. The large cap acquirers have $1.4 billion in Firepower to fund deals, according to EY’s Annual Firepower report. Those companies have a high sense of urgency to use this to fill their growth gaps created by the blow of their impending loss of exclusivity for blockbuster revenue products, with sales that exceed $350 billion

Barbara Ryan is Founder, Barbara Ryan Advisors, and a member of Pharm Exec's Editorial Advisory Board