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Volume 35, Issue 9
Pharm Exec sits down with prominent biotech investment strategist, Tony Gibney, to better gauge today’s state of play in this critically innovative segment of the life sciences industry.
With indications that the long bubble in biotech valuations may be primed for adjustment, Pharm Exec sits down with one of the investment community’s leading biotech strategists, Tony Gibney, Managing Partner of Leerink Partners LLC, to better understand today’s state of play in this critically innovative segment of the life sciences industry. In our Q&A, Gibney highlights key elements of a successful IPO and addresses the growing sensitivity of payers to the soaring biotech product cost curve. Gibney offers one novel solution-to raise the industry’s profile with fresh R&D commitments around an “underfunded” primary care disease pipeline, where evidence shows such products can have a disproportionate impact in lowering healthcare costs overall.
-William Looney, Editor-in-Chief
PE: We’ve seen continued growth in biopharma M&A activity in the first half of 2015, with a near-record of $250 billion worth of transactions. What’s behind the market’s continued momentum-is it great science, flexibility in pricing, or simple process efficiencies? Has the windfall been spread evenly between traditional big Pharma and start-up biotech?
GIBNEY: The industry is in a very healthy cycle overall; it’s arguably the most productive environment that I have seen in my 23 years servicing the industry. Consolidation in the biopharma industry continues at an exceptional pace, and the transactions are driven by a wide variety
of motivations for the acquirers: filling pipelines, commercial expansions, accessing R&D platforms, etc. Consolidators are looking for true innovation and products that can provide clear benefits to patients. Whether they come from large biotechs, smaller biotechs, or specialty pharma companies is less important.
Knowledge of the biologic origins of disease continues to increase. Clinical trials can be made “smarter,” and this, in turn, provides increased confidence in the technologies helping patients. And, perhaps most important, the regulatory process has been more consistent. When you take all these factors together, it is no surprise that we see the surge in M&A, higher valuations, and more risk being shouldered by the buyers. However, the high valuations have certainly created a competitive environment where only a select few bidders ultimately get there at the end of the process and financial buyers are finding it harder to compete.
PE: The cost of capital is low relative to the historic trend-is this also a factor? Might it also be true that the surge in M&A and licensing activity derives from financial engineering-exploiting incentives built into our taxation, banking and accounting systems-rather than superior science?
GIBNEY: The low cost of capital and liquidity of the capital markets have played a role. Moreover, in specialty pharma in particular, recently (tax) inverted companies have moved aggressively and decisively to grow through acquisitions. More deals are accretive and regardless of accretion, strategically compelling transactions have been supported. The bottom line is in today’s market, most transactions are working even when the valuations are considered rich.
PE: Has the surge in deal activity been influenced by biopharma’s embrace of globalization? Do we see an equivalent upswing in deals and M&A in the two other major global markets-Europe and Japan-compared to the US?
GIBNEY: Globalization became a priority for the pharma majors five to 10 years ago. We saw deals initiated by companies to acquire an international infrastructure and extend their reach into regions where they were under capacity. Today, virtually all the big players in the industry have the global reach that they desire; however, the majority of the profits are still derived from the US market. The objective now is to feed this expanded infrastructure with the right assets that can be profitable in different regions, especially in the US.
PE: The big US biopharma companies are cash rich, but a significant portion of this wealth is parked overseas and cannot easily be repatriated due to disincentives in US corporate tax rules. You might conclude from that all this cash is not being employed as productively as it could be. Does this pose a threat to the good times in biopharma -or has the threat been overplayed?
GIBNEY: The most direct impact that trapped overseas cash has had on the industry is to make ex-US domiciled companies incrementally more attractive as targets relative to their US-domiciled peers. However, this remains a secondary priority for buyers, most of whom are able to borrow capital to fund US-based deals. In these situations, companies take on debt or raise equity to finance an acquisition instead of repatriating their cash.
PE: Can you identify the headwinds affecting the small biotech segment? Does political pressure to slow the cost curve and limit prices for new innovations influence this group disproportionately?
GIBNEY: The biotech arena is more competitive now than it has ever been with a large array of companies seeking to develop breakthrough drugs that can transform the patient experience. Competitive advantages are often brief. Moreover, biotechs are owned by highly sophisticated investor syndicates that probe well beyond clinical data, and expect biotechs to understand the reimbursement, manufacturing, and commercial challenges and opportunities of their portfolio companies. The payers, in particular, continue to wield tremendous influence, which requires biotechs to offer treatments that pose compelling pharmacoeconomic benefits.
PE: Are there any other environmental or market factors that carry disproportionate weight for the smaller biotech players in the industry?
GIBNEY: Many stakeholders express concern regarding the sustainability of drug pricing. In particular, there is elevated concern regarding the potential cost to the healthcare system of multiple expensive drugs being used in combination to treat large populations of patients. Often, the pricing strategies of the individual drugs were (or will be) established as monotherapies before they are combined. In orphan diseases, where the overall burden to the health system is relatively modest, this is of lower concern. However, in larger indications or where the prices are particularly high, biotechs will face heightened external pressures if they cannot justify the value of their product.
I am also concerned about the relatively modest levels of investment being deployed in primary care indications, even though the scientific rationale to proceed is understood. Diseases such as diabetes, women’s health,
cardiovascular, pain, and certain anti-infective categories are particularly underfunded despite tremendous societal need for better medicines. If the industry allocated more of its efforts to these diseases, then more lives could be improved and the cost of healthcare could be impacted more proactively. The regulatory environment in these diseases is improving but there is more to be done to make these areas more cost-effective and attractive for investment.
PE: Leerink is heavily engaged in strategy and execution on IPOs. How has the IPO environment changed over the past decade-are the ingredients of a successful IPO still the same? Where are the pressure points?
GIBNEY: The level of IPO activity today is the highest since 1999-2000. Based on the positive industry trends that we discussed previously, capital has flowed into the biopharma sector aggressively over the last two or three years. We now have more investors with substantial capital to deploy and we benefit from a more streamlined IPO preparation and execution process, courtesy of the Jumpstart our Business Start-Ups (JOBS) Act. Moreover, as the biotech industry has matured, the experience level of management teams has increased. Better management, smarter science, and a more predicable regulatory environment have translated into an accommodating IPO environment.
PE: Is the private VC segment still hanging back?
GIBNEY: Quite the contrary. Most biotech VCs are back in full force. They have larger funds, are led by deeply experienced personnel, and are capitalizing their companies so that corners aren’t cut. Moreover, traditionally public investors are increasingly crossing over into pre-IPO rounds, which, in turn, is providing solid footing for companies when they go public. In 2015, the vast majority of companies that successfully completed IPOs had traditional public investors in their syndicates prior to the IPO. It is not uncommon for pre-IPO rounds to raise $60+ million and include multiple mutual funds and hedge funds. Leerink is very active in assisting clients with these cross-over rounds.
PE: Has the average size of a biopharma IPO increased?
GIBNEY: Yes. It has been about $80-90 million on average over the last two years, which is higher than in the 2012-2013 time period. In fact, it is not uncommon to see a biotech company raise in excess of $200 million in an IPO. Moreover, companies are able to go public earlier in their clinical life cycles than has been required in previous IPO markets. It is typical of the pre-IPO investor syndicate to continue to fund the companies in the IPO, as well, often taking upwards of 30-50% of the deal.
PE: What are the positives for the company seeking to go public?
GIBNEY: Some of the most successful recent IPOs have funded breakthrough discovery platforms with the potential to disrupt the status quo. These are big ideas that are backed by well-regarded leaders/founders/owners with strong reputations. Investors are particularly attracted to companies that offer the potential to dramatically impact diseases with first-in-class or best-in-class programs. For these companies, the IPO further increases their visibility, provides more financial flexibility, and provides near-term valuation recognition. Moreover, they can use public market valuations to negotiate more attractive partnerships or to acquire other assets of interest.
Of course, being public has its challenges, including the time demands for management, additional public company costs, and the need to disclose assets and set expectations publicly.
PE: Can you identify the most important metrics for certifying a successful IPO? Many analysts cite the market appeal of the therapeutic area; coherence of the regulatory package, including quality of clinical data; level of VC support; and a strong external focus through partnerships. Do you agree-are their other factors to consider?
GIBNEY: These metrics are important-solid data is always helpful. Some technologies, however, are able to attract investors at compelling valuations prior to having clinical data. Regarding partnering, I take the view that the appeal of having these alliances is a bit oversold unless the biotech is leveraging a particular operational asset or capability that provides additional value. Investors, today, are extremely sophisticated and have extensive networks to due diligence opportunities. They rarely rely on corporate partnerships to validate assets; instead, they look to the economics of partnerships and determine if they are value-creating or value-diminishing. Lastly, beyond the technologies and clinical assets, confidence in management still plays a fundamental role in garnering robust investor support.
PE: You appear to endorse the sustainability of the current IPO process-but are there any significant gaps in IPO positioning that need to be addressed?
GIBNEY: Companies are often slow to recognize the vital importance of positioning their assets against the competition in a balanced manner that is constructive, even supportive, of the competition. Many IPO investors bet on the category and not on one company. Investors want to see the sector work whether it is a platform technology or an indication domain, and they often have a detailed understanding of, and a positive bias towards, the competition. Be confident about what differentiates your value proposition, but be careful at the same time.
Lastly, the best management teams focus intently on cultivating relationships with the buy side over years instead of just during the IPO process itself. Striking the balance between informing and over-inundating accounts is a critical skill that the most successful management teams get right.
PE: Are there other elements in the current IPO environment that indicates potential market problems in the future? Is the IPO the optimal tool to reconcile innovation with societal needs?
GIBNEY: Fund flows into or out of the sector have a substantial short-term impact on IPO performance. Fund flow trends impact the breadth of participation and the amount of capital that investors want to put to work, which influence the level of over-subscription (or demand), valuation, and aftermarket trading. The capital markets professionals are invaluable when they can have trusted conversations with leading investors, can anticipate the impact that fund flow volatility will have on a particular new issue and can help the issuer to optimize the IPO timing and marketing strategy.
I should note that the strength of the IPO market is currently confined largely to the US, however. More companies outside of the US are accessing US investors and listing on US exchanges. They are following the money and the optimism, which are substantially driven from the US, even for ex-US issuers.
PE: What’s new regarding federal regulation of IPOs?
GIBNEY: The JOBS Act enacted by Congress in 2012 has had an overall positive impact on biopharma IPOs. Among other benefits, the JOBS Act allows a qualifying start-up company to file its prospectus confidentially with the Securities Exchange Commission (SEC), while enabling them to test the waters with investors during the SEC review period. This marketing window allows investors more time to due diligence the opportunity and provides important input to the underwriters and the issuer that influences the marketing strategy when the IPO commences.
PE: Can you hazard a guess on the future of the biopharma bull market? Is the market bubble primed to burst?
GIBNEY: Market timing in this industry is notoriously tough to predict. The one constant is surprise-it’s usually an unanticipated external event that pulls back the stock market and the biotech market can often take the brunt of the pull back. Even though market fundamentals in biotech are good and getting even better, biopharma is still a high-risk sector that relies on product approvals to create value. Right now, however, I see little on the horizon that will durably impact the current M&A and IPO markets in the US. The continuation of constructive actions of companies, regulatory authorities, and payers are critically important to the durability of the market.
PE: Overall, are you optimistic about what’s ahead?
GIBNEY: Yes. I am increasingly impressed with the quality of the innovation, the leadership and the optimism that healthcare stakeholders show in the face of an industry that is taking bigger bets to try to make a difference in market segments that were considered untouchable in the recent past. Areas such as gene therapy, gene editing, cell therapy, and immuno-oncology were barely investable just two years ago; now they are among the more promising areas in biotechnology. Of course, they will experience challenges going forward, and arguably those challenges are under-appreciated today. However, the biotech ecosystem is primed to give them a try and to ask: What’s next?
William Looney is Pharm Exec’s Editor-in-Chief. He can be reached at firstname.lastname@example.org. Anthony Gibney is Managing Director, Leerink Partners LLC. He can be reached at email@example.com.