By Wayne Koberstein, executive editor
Yes, 2013 was a great year for biotechs, with 65 small-cap IPOs in the sector globally (52 in the United States), along with new interest from both generalist and venture-capital investors. A late surge in IPOs toward the end of the year silenced the doomsayers who predicted a fall-off. But what did all the positive action mean for the industry’s long-term future, and where is it headed in 2014? For answers, we spoke with an experienced hand in life science investment, Dennis Purcell, senior managing partner at Aisling Capital.
Purcell discusses the boom-and-bust dynamics of biotech, including the difficulties in small-cap valuation in the sector. He offers strategic and historical context for the biotech’s spectacular gains last year. And he shares some sage advice, sobering cautions, and provocative thoughts for the coming year — and beyond.
LSL: How would you characterize the small-cap life sciences/biotech sector peformance as a whole in 2013, especially in contrast to previous years?
PURCELL: In 2013, Wall Street opened up to biotechology again. Companies were raising capital, and their stocks were going up, so there was good momentum, and many more generalist investors came into the sector. Consequently, a lot of new capital flowed into biotech from sources we didn’t have before. In the past, only the venture-capital community and the pharmaceutical industry funded those companies, and the new investor interest began after a long drought of seven to eight years, during which the science continued to get better and better, but Wall Street wasn’t recognizing it.
LSL: How are all the new IPOs doing now in company and stock performance?
We were pleasantly surprised some earlier-stage companies were able to go public and raise capital and that the pharmaceutical industry was also willing to acquire or do deals with some of the companies at an earlier stage than they did before. We also found a whole new set of buyers in the bigger biotech companies, such as Gilead and Celgene. The biotech sector has gone through a big boom-and-bust cycle over the past 25 years — now the question is, how do we “capitalize” on what’s going on, and what should the companies be doing to make sure that they remain stable?
LSL: Do you think one of the reasons biotech historically follows a boom-and-bust cycle is that the bigger the boom, the more volatile the stocks and market caps thereafter?
Yes, I believe that’s true. The biotech sector is one of the really hard ones for doing traditional valuations, so you see these wild swings either on the upside or on the downside, even for minor news. Companies now have an obligation to manage their cash better, to make sure that they have enough reserves if the industry goes into a bust cycle. They need to reassess governance, because a company just getting started has different governance needs than a company that’s about to launch a product. We have to get better at not duplicating infrastructure; in other words, outsource whenever we can. If someone else has the expertise, let them do it. And given where stock prices are now, it’s a good time for biotechs to be somewhat bold and figure out whether they can build their businesses either by acquisition, licensing, or other means. Whenever a company has only six months of cash left, as was too common in the past, it has few options and is just trying to stay alive. Companies are in a position now where they can really think about shaping their own future.
LSL: Do small companies have trouble managing information and expectations?
Sometimes the story a company develops about itself can catch up to it later when things don’t go according to plan. I can’t think of a single company that has traveled a straight line to accomplish what it thought it was going to accomplish. When Amgen went public, the company listed Epogen and Neupogen as number seven or eight in its pipeline, but they became two of the biggest-selling drugs in the world. This is complicated science; you’re learning as you go, and every company that I know has had to make midcourse corrections.
LSL: Two interesting companies riding the stock waves are Ariad and Sarepta. What do their examples tell us?
One of the good things about 2013 is, on average, the IPOs are up about 40 percent; on the other hand, we’ve had some recent IPOs that have disappointed, for example, Ariad and Sarepta, which hopefully will not drive generalist investors too far out of the sector. Did Ariad get out ahead of itself with a $4 billion market valuation? Probably. But it’s a real challenge to keep investors’ expectations in check because, in a booming market, any little bit of good news drives the stocks significantly, and any bit of bad news gets the stock killed. That is where we have boom-and -bust cycles.
An interesting exception to this cycle is Regeneron, where the pipeline is deep enough so that any one piece of information does not materially have a significant impact on the stock.
LSL: Have regulators played a positive or negative role with small biotechs?
Ariad actually had an accelerated approval, and for the past couple of years, the FDA has been acting pretty well toward these companies. In 2013, the FDA did a very good job of approving new drugs, particularly on the oncology side. We had 27 approvals last year, which was down from 39 approvals in 2012, but was still a very good year on the regulatory front.
Investment regulation is catching up as well; for example, the new GAIN [Generating Antibiotics Incentives Now] Act will help get new anti-infectives to the market. So the science is moving quickly, and the federal lawmakers and regulators are trying to keep up with it. The press about 23andMe later in the year is an interesting story in the sense of, “Do I have the right to know what’s in my genome or not?” The FDA is trying to figure out how it should regulate the personal genome business, so we’re in new territory, but investors are giving the companies the benefit of the doubt. In gene therapy, which has been a real problem for years, bluebird got public.
LSL: Any advice for the large pharma and bigger biotech companies in light of the small-cap boom of 2013?
Given the new interest on Wall Street, the biotechs gained a little more negotiating leverage on the big pharmas, because if biotechs don’t get the deals that they want, they will try to go to Wall Street and raise the money. But Big Pharma is doing interesting stuff in the many new collaborations they are forming with academic institutions. Just in New York, Takeda has an alliance with Sloan Kettering, Rockefeller, and Cornell. Big Pharma companies are trying to adapt, and clearly the large majority of drugs in their pipelines are coming from outside their R&D, not inside. You see more innovation coming out of pharma in dealing with academics, who themselves are entering deals where the venture community funds Phase 3 projects and the Big Pharma companies can buy them back later.
But the pharma companies face the same issues as the biotechs: once you have a little more cash on the balance sheet, should you stick to your knitting, like Regeneron or Acorda, or do you go out and acquire other companies, as Cephalon or Alkermes has done? When I say it is a chance for the biotechs to be bold, I mean it’s a real chance for them to reassess what they want to become as they mature. The following is an interesting question I heard posed the other day: Is it better to own 50 percent of four products or to own 100 percent of two products? That is the kind of fundamental question that biotech companies will have to answer.
LSL: Does the investment climate for small biotechs look as good going into 2014, and what investment trends do you see?
We had a really good run in 2013, and we can’t expect to have the same kind of gains in 2014. We must deal with three issues for the industry to continue to do well, and I call them “The Three O’s.” First is “output,” or how we can use our capital more efficiently to generate better output. Second is “outcomes,” which is about sharing clinical data. Right now, half of all clinical trials are not reported, but we need to learn from each other’s mistakes — not only from the positive outcomes, but also the negative outcomes. Third is “originality.” We will see biotech companies develop new kinds of business plans, because the time-worn business plan of doing your Series A, Series B, and so on is not the best way for everybody to make money, so consequently we’re starting to see Series A rounds that are $100 million or more.
2014 will be a year of transition as we build on the success of 2013. Take a step back and look: There is about $30 trillion in the world right now that’s earning less than 2 percent a year, so as an industry, we don’t need to give people a 10X return — there are not a lot of other places for them to put their money. If we can show investors a more stable way to make money and money starts flowing into the industry, so much the better.
Companies now have an obligation to manage their cash better, to make sure that they have enough reserves if the industry goes into a bust cycle.
Dennis Purcell, Senior Managing Partner at Aisling Capital
LSL: Are there issues that concern you about the industry in 2014?
We have to concern ourselves about funding for the NIH and the FDA. The NIH, really over the last decade has lost about 25 percent of its purchasing power to budget cuts and inflation and now faces even worse cuts in the future. FDA’s budget sits in limbo, and the agency is dealing not only with past cuts, but also continued uncertainty. So the cuts are disturbing because they hurt the NIH’s ability to put out research money and the FDA’s ability to keep up with the science and its increasing responsibilities.
If this industry had not figured out a way to make AIDS a chronic rather than a fatal disease, most hospital beds in New York City would be filled with AIDS patients. And if we don’t make progress on brain disorders like Alzheimer’s and dementia, 20 years from now most of the beds in New York City and across the country will be filled with Alzheimer’s and dementia patients. So, it’s really important that we invest government dollars to help keep innovation going.
LSL: It seems the biotech industry has a twin burden to bear — innovation on one hand and economic stimulus on the other.
I agree. The industry has the burden of innovation, but the people who actually fund the industry — by and large, endowments, state pension plans, and teachers’ retirement systems — have their own issues. They need to fund their retirees or endowments. So we rely greatly on people who sometimes need a quicker return than biotech can give them.
LSL: What other, larger issues in the industry will affect its fortunes this year and beyond?
I would emphasize three big issues: personalized medicine, biotech business models and infrastructure, and public perception of our industry. Regarding personalized medicine, look at cancer treatment: We really treat cancer as a problem at the molecular level, and it’s now targeted at specific patient groups, so we’ve done a good job of moving that ball along in cancer. But companies must think about their business models. In the past, if your drug was safe and effective, you were okay — now it must be safe, effective, differentiated, and reimbursed. Also, immunotherapy may be the next wave in cancer, but if you’re going to do autologous cell transfer, that’s a very expensive proposition. As for infrastructure, I believe we must avoid too much duplication of efforts in biotech. In Boston, just as we have three hospitals within a mile of each other all doing heart transplants, we now have almost 200 biotech companies in the area, many of them working in the same areas. Finally, in the pharma/biopharma industry as a whole, we need to be more sensitive about how we’re perceived in the public. For example, Forbes put out its list of the 100 most valuable brands, and there was not one drug on the list.
I’ll leave you with two last thoughts. One, if you took the U.S. healthcare system and made it a country, it would be the fifth largest country in the world — after the United States, China, Japan, and Germany. And my final thought is this: Every 12 years, we’re adding one billion more people to the planet.