This fall, during the weeks following the great Turing-ignited clash over drug pricing and the consequential plunge in biopharma stocks and valuations, we captured the thoughts of six leaders in life science investment capital, which fuels drug development by hundreds of new companies every year. We asked them to look ahead to the new year and tell us, did the downturn signal an end to the boom times in biotech funding, as many believe — or if not, what sort of future for the industry does the changing financing climate forebode?
Our six investment leaders represent a broad complement of firms, varying considerably in size and type, focus, and experience. (See sidebar “The Forecasters.”) Each of the participating individuals also has a unique history and viewpoint of the funding landscape, yet all often agree on the big issues affecting the changing climate.
Doomsayers may be surprised. In a word, no — not one of the experts believes the good times for life science funding are coming to an end, even though every one expresses concern for the fate of industry innovation in the longer term. It is in the details that their views diverge and often complement each other.
We first asked the experts for their general assessment of what would follow in 2016 from the October plunge that seemed to erupt with a CEO’s defiant pricing strategies and continued with new pressures from political and economic forces. All of them agreed on this point: Despite all, the life sciences space remains strong, resilient, and resistant to prolonged, destructive downturns that would signal another burst bubble.
Where do you believe the funding/ investment environment — from angels to VCs to the stock market — is heading in 2016? Will the “boom times” in biotech financing finally end?
“The idea that we would have unlimited pricing power forever might become more difficult to maintain over time,” says Carl Goldfischer of Bay City Capital, a bimodal firm that handles both startup and late-stage pre-IPO investing. Goldfischer assesses the downturn’s long- and short-term effects:
"The correction we’ve seen is an ending of a certain type of boom in the sense of multibillion dollar valuations for nonclinical-stage companies. The core bullishness that drove this remains: the thesis that there are too few high-quality, breakthrough novel therapeutic assets to meet the demand. The larger biopharmaceutical and pharma companies still do not generate enough new drugs in their core R&D operations to satisfy the pipeline needs, and to the extent that people like us invest in companies that do make a real difference in disease outcomes, we will still be rewarded handsomely for our work.
Coming six months later, when many IPOs are planned, the downturn could have had an even more depressive effect on the sector. IPOs are slowing down, many of them are being pulled, and I believe that environment will carry through for some time. Still, many venture funds have made a ton of money in this space and are flush with capital, but the capital will be pricier and harder to come by. If you’re a buyer of assets, you will probably get better entry points, but all the companies with assets to sell will be private companies. If your company is trying to sell a very novel technology at a high price, but at an early stage without much clinical proof, it will be harder to do now."
Along with the others participating in this article, Goldfischer points to the flight of the generalist investors from life science stocks in the hoopla over pricing in October. Generalists, essentially industry neophytes, were in fact important drivers of the IPO “good times” in recent years. But for the time being, they have largely exited the market via the simple act of selling their bio stocks. Veteran investor Dennis Purcell of the large New York-based firm Aisling Capital, offers a more sanguine take on the sell-off:
"The recent correction is not that big a deal. It comes after we had five or six great runs, companies are much better capitalized, and we should not see the kind of crisis we had in former downturns. Having said that, we lost about $125 billion in market value during September and October. People say the generalists are leaving, and there’s truth to that. I look at the ETFs [exchange-traded funds], securities traded separately but usually rising or falling in parallel to the stock market, and primarily owned by individuals. There were about $20 billion in ETFs, and that went down to between $14 billion and $15 billion in October, meaning individuals were leaving the market. Investors also held off buying on the dips, waiting for more momentum to build. In late August through September, almost two-thirds of bio IPOs were priced below the range, and almost two-thirds declined in value. Most companies were able to raise money during recent years because the market was so good. Now, the early-stage, proof-of- concept model is becoming even more important because Big Pharma is tending to make deals and acquisitions sooner rather than later."
Factoring in the Big Pharma viewpoint, a corporate venture capitalist shares some useful points on how to prepare for the investment climate in the new year — Isai Peimer of MedImmune Ventures:
"It helps to deconstruct the situation and recognize how early-stage biotech investing is different from later-stage biotech investing in the types of investors. Close to $8 billion annualized investment goes into the biotech sector, around double the normal fund rate, and a lot of it is generalist investors in IPOs as well as mezzanine and even earlier-stage rounds. It is important to recognize the source of capital, because that determines how “sticky” it is.
In late-stage investing, there are very legitimate reasons why the sector has attracted capital. Of course, investment flew out of declining sectors like energy, so it had to go somewhere, and luckily, biotech has experienced some constructive forces. The novelty and quality of science has greatly improved, and many new approaches are panning out with clinical data and new drugs on the market that provide a step-function benefit in treatment and care. The FDA has become a lot more constructive with its new regulations expanding accelerated approvals in our sector. For the past five years, we have had a steady stream of great companies appropriately going public and understandably creating great returns for investors.
But if we continue to kind of go through turbulence, that will be painful. I worry about companies that have accepted money from investors who were counting on a constructive IPO market and may not have the time horizon flexibility to stick it out to the end. The fundamentals are still good, but I also recognize that there’s been such an over-representation of generalist money, and I wonder where the generalist money will go. It will not go into the energy sector, not for a while.
On the early-stage side, I don’t believe much has actually changed. It’s the same 100 or so companies being started every year. It’s the same sources of capital, the same couple of dozen or so funds that do most of the early-stage investing. That hasn’t changed."
Greg Brown of Healthcare Royalty Partners outlines several factors that will likely make life science investment “flatter and more volatile” in 2016:
"Capital markets tend to be cyclical, creating discontinuity in access to capital. The new year will be interesting for three reasons. Number one is the presidential election, and we’ve already seen that drug pricing will be a very attractive and compelling political football, so that will increase volatility in our sector.
Reason two: When the Fed eventually raises rates, it will probably draw people out of the equity markets and back into fixed-income capital, which always has an impact. The nadir in both the Dow and the BTK (Amex Biotechnology Index) was on Feb. 1, 2009. The Dow is up 143 percent above what it was then, but the BTK is up 615 percent. So that was great — the Dow delivered a 2.5-times return, but the BTK delivered more than a 6-times return. That’s pretty cool.
But it also leads to the third reason for a less-stellar market in 2016. When the generalist money flowed out, the BTK dropped off of its peak of 4,262 in July and was down just shy of 4,000 in mid-October. So it will not be a great funding environment, particularly in the equity capital markets. Of course, VCs had unparalleled exit opportunities during the past few years in the IPO markets and M&A activity. Now they will likely be more cautious about the valuations — because they can be. But it still will be an environment where good science can be funded and good technologies can get capital."
Another New York-based veteran, John Chambers of ROTH Capital Partners, steps back to take in a larger perspective on bio investment in the new year:
"There has been a marked change in the nature of how investors looked at biotech during the past 15 years. We now have real earnings-driven, metrics-focused companies at the top of the pyramid — Celgene, Gilead, Biogen — that we can value and trade at a market multiple, which is quite attractive based on their growth profile. There are more than 500 publically traded companies in this sector. Before the past several years, there were approximately 300 companies at any given time, as M&A volume tended to offset the number of IPOs over this period. If the capital markets are functioning well, there will be fundamental investor interest. The market returned about 35 to 45 percent a year for the past four years, mainly because the larger players performed exceedingly well on their true metrics. When investors wanted to add value and punch to their portfolios, they would take the liquidity risk and go downstream to smaller cap names and hopefully, on a milestone-driven basis, get a higher return.
Many of the companies that have gone public haven’t done a subsequent follow-on offering, so there is a large amount of pent-up supply on the issuer side. Yet funding tends to become more difficult late in the year; investors take on a risk-averse posture, especially with vagaries such as the current pricing debate. Going into 2016, companies will obviously look to the new issuance market again, but the fund managers will be much more discriminating. It’s not going to be an exercise in getting a little capital to a lot of names. It is now more Darwinian — fund managers will say, “We’ve gone from roughly 300 companies to more than 500 companies; how many of them are delivering at a level where we want to continue funding them?”
Karl Handelsman of the startup-focused Bay Area firm, Codon Capital, foresees a continuing demand for novel bio assets in 2016, though with a higher bar of therapeutic impact and proof-of-concept.
"If and when the boom times do end, there will be an even stronger need for a stable of very strong, especially early-stage projects that deserve to be moved forward into the clinic, as in cancer immunotherapy. The enthusiasm for cancer immunotherapy is driven by its ability to modify the course of a disease in an incredibly dramatic way. That experience was formerly limited mostly to people involved in treatments for rare diseases, where there is often a clear mechanism of action and where you can have some dramatic impact or it wouldn’t be a rare disease. Cancer immunotherapy has caused so much excitement because people realize it is a gamechanger, and it’s a principle that can be exploited in many kinds of cancer.
There is always a high-risk profile at the preclinical stage for novel approaches, and people always talk about clinical proof-of-concept in go/ no-go decisions. But I think much more about whether an approach has a higher probability of success relative to others at this stage — and if it does work, does it really modify the disease in a head-turning, 'Oh wow, this is fantastic' way?"
How can companies and investors manage the risk of drug discovery and development in the more “Darwinian” climate of the coming year?
Dennis Purcell puts risk-management into the context of the 2016 investment climate:
"In the past, when generalist investors withdrew, it really created problems for the life science sector, but this time I don’t believe it will, because the sector has matured. In relation to risk, a lot of money is now being poured into the venture capital world, so our job is to take on more risk. With the continued risk-taking by the VCs, the foundations looking for good early-stage technologies, the health systems entering the equation, and Big Pharma making deals earlier and earlier, we will continue to see a good level of investment at an early stage."
Isai Peimer advises caution toward some new early-stage technologies but greater optimism toward the resurgence of others:
"There are some therapeutic areas, such as immuno-oncology and gene therapy, where there’s a broad conviction, maybe ahead of convincing data in the clinic. In those cases, a fantastic amount of investing occurs for anything and everything in the tool box, which is worrisome. That said, there is now a lot of good data for specific approaches. In gene therapy, recent trials show it is a great tool for monogenetic diseases, perhaps even transformative, with the potential of being curative. We invested in a company that entered gene therapy 10 years ago, when it was very unpopular. We IPO’d the company about a year ago, but we refocused it from diseases that were probably unsuitable for the technology into other areas, such as ophthalmic disease, where it is working out."
Karl Handelsman sees new promise at the preclinical stage for earlier proof-of-concept and target validation:
"It is perennially true what really matters is what we see in the clinic, but the animal models are getting better — more predictive of how to use a small molecule, protein, or antibody in the clinic, how it could fit into the standard of care, and whether a strong signal will emerge early in the clinic, validating the drug’s mechanism of action and ability to modify the disease. We are quickly accumulating better tools and data to make preclinical models more predictive. CRISPR is a tool that will greatly accelerate discovery of different pathways and ways to fight diseases. We now also have a pool of talented professionals who have moved drugs forward into and through the clinic."
John Chambers recommends companies make the most of the remaining momentum in the public market:
"Four IPOs were done within a month and a half after the pricing and reimbursement issue arose. Yes, they were done at a 20 to 30 percent discount to the midpoint of filings, but they indicate an IPO market still exists. They largely traded up, so there is a positive after-market, and maybe a few more will get done this year. There are investors looking for risk-mitigated companies, something that won’t hurt them before the end of the year. If your company delivers on clinical data between now and the end of the year and wants to access the capital markets — even though your stock price might not reflect its de-risked value, it’s your ticket to enter the market and gain access to the capital. You have a ticket to ride!"
Carl Goldfischer emphasizes creative, early-stage funding:
"One of the benefits of having a really flush capital market cycle for bio is giving companies more leeway in funding earlier-stage, riskier assets. There is now a host of alternative financing structures being contemplated for early-stage assets, from the little companies that partner with a pharmaceutical company at startup, to universities that, with reduced NIH funding, want to be more creative about how they partner with VCs and pharmaceutical companies. A whole myriad of new structures and financings are arising at all of the major medical centers in cooperation with the market participants."
Greg Brown sees more alternative funding models emerging:
"Companies have become more adept at finding additional ways to fund new technologies. That puts a lot more focus on critical milestones, proof-of-concept, and being more careful with capital — a pattern I would expect to increase, not decrease, during the next year or so. That means more credit products, royalty financings, grant funding, and other non-dilutive, nontraditional forms of capital. The need for capital is so inelastic, but access to capital is sporadic, and that’s a bad combination. When the equity markets grow more parsimonious, we can enjoy more opportunities in the alternative-funding markets."
What other issues, events, or trends could affect the life science funding/investment environment significantly in 2016?
A quick wrap-up initiated by Dennis Purcell:
"Compared to most industries, the pricing and reimbursement issue will be a steady drumbeat. I don’t think the election in 2016 will particularly change things, but the payers such as Express Scripts and United Health are being much more difficult, and we will be paying much more attention to them. Express Scripts writes a billion prescriptions a year and covers 85 million people. It will have a huge impact on our sector going forward. About 40 nonprofit health systems now have their own VC funds, so we will see more of the hospital systems act as the payer on the one hand, the provider of healthcare on the other hand, and an investor in these companies on yet another hand."
"Companies should reach out to advocacy groups early on. There will be points when the groups are supportive, and other points when they look at pricing, and hopefully it will not lead to confrontation. But if you have these relationships, the advocates can educate you about the patients’ treatment experience and help you come to a rational, but return-oriented pricing. Beyond the enormous cost of developing a new drug, companies have to be able to price within that IP-protected window to get a return; otherwise shareholders won’t let the capital flow into the sector to pay for the innovation. The logic is a little circular, but when people realize what the R&D they and their insurers pay for accomplishes, they are much less likely to challenge every high price. Still, it is preferable that companies take guidance from the patients’ expectations, rather than merely announcing a price and effectively saying “Take it or leave it.”
The other experts echo the thoughts in this “anything to add?” section, and the group as a whole offers more thoughts and experiences than we have space to share here. But rest assured — none of it will go to waste. Look for additional material from our exchange in our online “cutting-room floor” section and future editorial features in Life Science Leader.
Read more on life science funding: Startups & Outsourcing — Opposite Poles or Virtual Partners?
THE FORECASTERS — LIFE SCIENCE FUNDING 2016
A broad sample of financing experts from a variety of firms answered our call to envision the funding environment for innovative life sciences companies in the coming year. Two members of the following group rejoin us from the “Strategic Options In Financing Your Biotech” roundtable (October 2015 issue), held at BIO’s annual meeting last summer; the others appear here for the first time in Life Science Leader.