By Alex Castelli, technology and life sciences industry practice leader, CohnReznick LLP
Even though the U.S. economy continued to strengthen in 2015, many public investors sat on the sidelines grappling with global economic and political concerns and uncertainty surrounding the Fed’s policy concerning interest rates. Because of these and other factors, middle-market IPO transaction activity (IPOs completed by companies with market caps between $10 million and $2 billion) in 2015 decreased versus the previous year. Contributing to the downward pressure on IPO activity was the availability of capital and high valuations from private financial and strategic investors.
In 2015, IPO transaction activity for middle-market life sciences companies followed the pattern of broader middlemarket IPO activity. The number of life sciences companies that accessed capital by issuing an IPO was down 39 percent in 2015 when compared to 2014. When examining overall middle-market IPO activity in 2015, there was a 43 percent drop when compared to 2014.
While middle-market life sciences IPO transactions decreased in 2015, one positive sign is that the proportion of life sciences IPOs compared to total middlemarket IPOs increased. In 2015, life sciences issues represented 34 percent of middle-market IPOs compared to 32 percent in 2014. Additionally, 41 percent more public middle-market life sciences companies raised additional capital through follow-on transactions. In 2015, a full 42 percent of all middle-market follow-on transactions involved a life sciences company (compared to just 24 percent in 2014) — an indication that investors see promise in the future of these growing companies.
Although the decrease in life sciences IPOs could lead one to believe that there was less investor interest in the industry, the decrease may be more a function of broader market volatility than lack of interest in the industry as a whole. From an investment perspective, when comparing biotechnology and pharmaceutical company investments to investments in other industries, investors can measure the progress of these companies by milestones achieved through the discovery, preclinical, and clinical trials.
As life sciences companies achieve milestones and move closer to regulatory approval, valuations tend to increase, as does the continued need for capital. This industry-specific dynamic is attractive to investors as it helps when evaluating the risks and rewards of a prospective investment. Also, the achievement of milestones helps investors establish a prospective timeline to commercialization, which could help build investor comfort and confidence. The development process is unique to the life sciences industry, but can be an attractive tool to investors when making investment decisions.
Communicating timely and transparent information relative to the achievement of scientific milestones and relative to the growth and development of the company may support pharmaceutical companies seeking higher valuations. Disseminating such information helps to build relationships with the investment community, leading to greater investor confidence, which is critical to successful fundraising.
REASONS FOR OPTIMISM IN 2016
Despite 2015’s lag in IPO activity, life sciences companies in need of raising capital should have reason for some optimism in 2016, with several options to consider. For many of these companies, the IPO will remain a viable form of capital. In addition, strategic acquirers with cash on their balance sheets and pressure to grow will be aggressively searching for new acquisitions.
In 2016, the IPO window will be open, but to an increasingly selective group of issuers. As was the case in the second half of 2015, we are likely to see increasing public investor scrutiny before new issues come to market, resulting in moderating valuations and careful pricing. Those companies with a proven track record of achieving milestones and that are further along in the development and approval processes may find a greater opening of the IPO window. A valuation premium will be placed on those companies whose management teams have successfully commercialized their products and services.
In the near term, private financial and strategic investors will continue to woo some companies once destined to become public. Capital from venture capital and strategic investors should remain plentiful in 2016, as will their appetite for quality investment opportunities. Some life sciences companies should be well-positioned to negotiate a private capital raise that includes many of the benefits associated with an IPO.