Finding investment opportunities in a bleak biotech stock market

July 21, 2022 - 7 minutes
Image/Sofinnova

The situation remains difficult in public markets as biotech stocks struggle to recover from a 50% decline over the past year. However, the venture capital (VC) firm Sofinnova Partners is no stranger to downturns, and partner Joe Anderson explains how the industry is shifting in favor of life sciences investors.

It’s a tough time to be a public biotech company right now. Public stocks in Nasdaq-listed mid-sized biotech companies — measured by the S&P Biotech index (XBI) — have declined by more than 50% since their last high in February 2021. While the index is showing recent signs of a recovery, the situation remains precarious for many public biotech companies struggling to raise cash. 

According to Joe Anderson, partner at Sofinnova Partners, the downturn is in part caused by macroeconomic factors, including high worldwide inflation, the war in Ukraine, and ongoing disruption caused by the COVID-19 pandemic.

“What is completely unpredictable is how long this downturn lasts. It feels quite deep to me,” said Anderson. “My sense is it’s not going to recover quickly because we have to take a step back and look at what the drivers are for what this selloff is all about. In my view, principally the macroeconomic environment is causing a flight from risk in the public markets. So any risk assets at all, frankly, whether it’s tech or biotech or any speculative aspect of the economy, are out of favor.”

Anderson joined Sofinnova in 2020 as part of its Crossover Strategy, which often invests in late-stage biotech companies. Prior to this, he was co-founder and CEO of the VC firm Arix Bioscience, and spent 12 years as a partner at Abingworth. He’s seen several biotech stock selloffs over the past few decades. One occurred when the tech bubble burst in the year 2000, and when the life sciences was still a nascent industry. Another selloff took place during the financial crisis of 2008 and 2009, which Anderson remembers as feeling very deep at the time.

“You can typically measure a downturn by the number of public companies trading with a market capitalization below the amount of cash the company holds,” added Anderson. This is a phenomenon that sometimes happens in times of so-called bear markets, when stocks tend to lose their value. “There were many, many companies at that stage [in 2008 and 2009].”

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The downturn of the last year has seen roughly 150 small public biotech companies trading below cash, according to Anderson. There has also been a big drop in initial public offerings from biotech companies and a general reluctance on the part of big pharma to splash out in merger and acquisition deals in spite of reduced stock prices. The main difference from previous cycles is that it comes immediately after a very strong fundraising environment for a lot of small biotech companies. This left a high watermark for biotech stocks, giving them even farther to fall than in previous downturns.

“You can always tell the tone of the market by the stage of the company at the point it went public,” explained Anderson. “There were record numbers of firms in the year 2020 that went public with clinical assets in phase 1 and preclinical; a lot of concept stories out there that were selling gene therapy and gene editing. They were the most exposed, but many of them raised a lot of cash.”

A lot of companies have large cash reserves this time and may be able to weather the dry season for a while. Nevertheless, many are cutting costs, laying off staff, and securing non-dilutive sources of cash such as debt to extend their cash runway.

Sofinnova is accustomed to taking a long-term view on biotech markets as its funds tend to span 10 years. Unlike many VC funds, the investment firm’s crossover fund has the flexibility to invest in private companies and public companies, which increases the chance of finding a bargain investment as markets oscillate.

“When [public] markets are depressed as they are today, it’s much more interesting for us to go hunting,” remarked Anderson. The investor continues to perform the same due diligence on all prospective portfolio companies, but if a target “ticks the boxes, fulfills all those operational and strategic areas of interest for us, and it’s trading 80 percent cheaper than it was a year ago, that’s of interest to us.”

There are other reasons for VC investors to be excited with the current direction of the biotech industry. For example, private equity funds are moving into the VC domain as evidenced by merger deals between EQT and LSP, Carlyle and Abingworth, and a landmark collaboration between Apollo and Sofinnova.

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“Private equity is seeing the value in our sector,” Anderson explained. “But it’s very difficult for the big private equity funds to access what we do. Because we are in the nitty gritty, we help build operational improvements in our companies and it’s a lot of heavy lifting. Whereas private equity is more about financial leverage and going into service-based companies and generating profits.”

Additionally, life sciences VC firms in Europe raised record cash in 2021, heralding a growing maturity in the space. Many nations including the U.K. and France aim to be life sciences innovation powerhouses in the coming decade. As fund sizes swell in the region, more companies are launching and more entrepreneurs are circulating in the space.

“What’s been missing in Europe systematically for a very long time is the depth of capital and management talent,” Anderson added. “It’s been a lag phase between the U.S. and where we are in Europe. However, that is changing pretty rapidly.”

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In spite of the cyclical nature of the biotech markets, Anderson sees a sea change in the works with big pharma companies. The top 20 pharma companies gain about $800 billion in revenues a year, but $180 billion of that is going away over the next five years as patents expire on blockbuster drugs. That leaves a gaping hole that they must fill with new innovations, and smaller biotech companies are a prime source.

“We know the pharma industry has got the cash, it’s got the need and it is going to move into the sort of companies that we are backing,” said Anderson. “So taking a long-term view — I’m talking about a two to five-year view — we are feeling very excited by what’s ahead.”

Some of the innovations that VC investors have their eye on include vaccines and RNA technology. As adoptive cell therapies such as CAR-T cell therapies begin to saturate the blood cancer market, the focus will move to off-the-shelf cell therapies and candidates capable of tackling solid tumors. The pressure to get new products to the market also shines the spotlight on enabling technologies — solutions that improve the efficiency of life sciences research including lab automation, artificial intelligence and single-cell analysis.

One particular arena that Sofinnova is keen to be part of is cell engineering that can be used to produce cell therapies. Most approaches have used viral vectors to genetically engineer cell therapies, but this technology can be very inefficient to manufacture at scale. Sofinnova has stakes in the company MaxCyte, which aims to efficiently deliver therapeutic genes to cells through holes punched in the cell surface in a process called electroporation.

“It’s an old-fashioned notion, but the idea of in a gold rush, you sell picks and shovels because that’s how you make the money,” said Anderson. “It’s a bit like the early computers: everybody needed a chip, and it was Intel at the time. All computer manufacturers used to have an Intel Inside logo. Now it could be MaxCyte Inside for the cell therapy players.”

In spite of the promising technology in development, the punishing market environment will decide which public biotech companies will survive in the long term. It’s a VC investor’s job to pick the strongest ones and support them.

“We’ve seen this so many times before so we’re not fazed by it,” concluded Anderson. “The one thing we do know is that the fundamentals of the industry have not changed. They’re even stronger than they’ve ever been.”

Disclosure: Carlyle is the largest shareholder in Inova, Labiotech’s parent company.

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