Is biotech an investment opportunity not to miss or a bubble set to burst?
The pharmaceuticals industry clocked up a staggering $234bn in announced acquisitions in 2014, and it looks like 2015 is going to be another record-breaker. By March 2015 alone, pharma deals accounted for 10.5 per cent of all mergers and acquisitions worldwide, up from its more usual three to
four per cent, according to data from Thomson Reuters.
Some of the stand-out deals include Abbvie"s buyout of Pharmacyclics for $21bn, Teva"s acquisition of Auspex for $3.2bn, and the high-profile hostile bid of $35bn for Perrigo by Mylan, which, at the time of writing, remains in the balance.
The trend in takeovers of young biotech companies with promising new medicines looks set to continue as the giant pharmaceutical firms look for ways to boost growth. Rather than solely invest in research and development themselves, they buy innovative biotech companies with the intention of bolstering their pipeline of new drugs. (Biotechs tend to develop new drugs, while the giant pharma companies commercialise products.)
And last year"s record number of biotech IPOs means acquirers have had a large pool of candidates to choose from. The high level of acquisitions has driven individual stock valuations up and biotech funds have naturally benefited from what has been an extremely buoyant sector.
As Mark Piper, Investment Director at Canaccord Genuity Wealth Management in Guernsey, points out: “Biotech has been the best performing sector in the US for the past five years. With the NASDAQ Biotech Index up 250 per cent since the start of 2012, the cumulative market capitalisation of five of the largest biotech firms is now over $500bn, up from $128bn in 2011 and $82bn in 2001.”
Andy Merricks, Head of Investments at Skerritt Consultants, believes biotech has undoubtedly been the place to make money in recent years. “In the 70s the place to be was gold, in the 80s it was Japan, in the 90s it was technology, in the noughties it was emerging markets, and in this decade it"s been biotech.”
The question is how much further can biotech go? It"s been an extremely active sector offering good growth potential for investors, but has it accelerated too quickly - does a bubble exist or is one forming?
The fact is that the biotech market has already seen a significant correction. Biotech stocks have sold off sharply since the peaks of July 2015. Towards the end of September, the NASDAQ Biotech Index fell more than 16 per cent, underperforming global equity markets by seven per cent. This is in stark contrast to the preceding six-year period, in which the biotech industry substantially outperformed the broader S&P 500.
Consequently, investors are correctly questioning whether we are witnessing the burst of a biotech bubble, similar to dotcom, or whether this is simply an opportunity to purchase discounted tickets to board the bio-bandwagon.
Still in good health
Alan Le Maistre, Investment Manager at Ashburton Investments, believes that despite the correction, the biotech sector remains in decent shape. “The current biotech crash was, until recently, predominantly driven by market rather than biotech-centric factors. Yes, disappointing earnings results from the likes of Biogen were a catalyst but, by and large, there was no clear deterioration in sector-wide fundamentals or sentiment during the period.”
He concedes that fears of a biotech bubble have resurfaced this autumn. He points to media coverage of a drug called Daraprim, purchased by a small US biotech company called Turing, which bought the drug and immediately increased the price from $13.50 to $750. Hillary Clinton tweeted "Price gouging like this in the speciality drug market is outrageous" and vowed to tackle the issue.
Le Maistre insists US pricing power is key to the success of the pharmaceutical and biotech industries. Strong opposition from a potential US presidential candidate campaigning to limit prescription drugs prices is a clear negative for the industry and was taken as such by the market. Pharmaceutical and biotech stocks sold off heavily.
At times like these, he says, it"s often best to step back from the noise. “Perhaps markets are getting carried away with themselves. First, Clinton hasn"t yet secured the Democratic candidacy, let alone the presidency. Second, many of Clinton"s key proposals aren"t new and have failed to gain momentum in the past, the Republicans control both the House and Senate and elements like a proposal to reduce the biologic period of exclusivity from 12 to seven years will be near-impossible to change legislatively.”
The heightened sensitivity of biotech stocks to negative news flow is undeniable. It"s probably a reflection of the high ownership of biotech stocks, the high expectations for future earnings growth and the large profits biotech investors are sitting on following years of outperformance. Le Maistre explains: “Each of these factors makes the sector susceptible to a pullback on little news. In itself that feels like a bubble, but fundamentals and valuation leave me feeling a little less concerned.”
Rise in demand
Piper agrees that the fundamentals for biotech remain good. He says that while the investment case for the healthcare sector initially was based on exceptionally cheap valuations, the rise in demand for healthcare goods and services globally
has a longer-term attraction.
The ageing population in the West, Japan and China coincided with a rapid expansion of healthcare provision in Asia and emerging markets, as wealth creation brought healthcare services into the reach of vast numbers of people that were historically unable to access them.
“We had a catalyst for change, as the huge increase in demand provided healthcare companies with pricing power - a very attractive attribute in an otherwise deflationary world,” Piper explains.
So if you are going to invest in the biotech sector, what are the risks and is now a good time?
In terms of timing, Le Maistre believes the "easy money" in the biotech rally has probably been made. “Whilst not outright expensive, the sector no longer offers the value for growth it once did. This late in the cycle, differentiating between the winners and losers is becoming more and more difficult, and investors will need to be more selective. However, at the sector level, until we start to see a deterioration in biotech sector fundamentals, capital flows moving away from the sector or valuations becoming materially stretched, there is still money to be made in biotech.”
Piper echoes this view, suggesting biotech should continue to figure on investors" radars. “Ultimately, in a low-growth world, investors should be willing to pay a premium for structural growth stories. Biotechnology and the broader healthcare sector provide such an opportunity and while weightings to the sector have to be commensurate with the level of risk that investors are willing to take, as well as their investment time horizon, a small, dedicated allocation to the sector within any portfolio should be considered.”
As far as risk is concerned, for investors taking the plunge into biotech this late in the cycle, exposure is probably best achieved through an ETF, a specific biotech fund or an actively managed fund with a biotech component, advises Le Maistre.
“The sector is highly heterogeneous. Outside a handful of large-cap diversified companies, most companies are involved in just one or two products in perhaps a single therapeutic category or a disease that is poorly known or understood. Therefore stock-specific risk is high.”
Piper agrees that a pooled investment is a safer investment option and namechecks the Polar Capital Healthcare Opportunities fund and Worldwide Healthcare Trust for broad exposure to the major global themes and opportunities in healthcare. For those wanting the added risk but potentially higher reward of a pure biotech fund, he cites the Polar Capital Biotechnology fund.
It seems that while our experts think there is still mileage in biotech, it's not without risk and care should be taken.
Three biotech stocks to watch
Trevena
Across two mid-stage studies, Trevena"s experimental medicine for acute pain, TRV130, has easily outperformed the most commonly prescribed drug, morphine, in the post-surgical setting. Potentially we could be looking at a drug that is set to capture a significant chunk of the $11bn acute pain market.
Spark Therapeutics
Spark Therapeutics is using neutralised vaccines to deliver missing genes to patient cells in order to significantly improve disease symptoms. Initially, the company is focused on phase 3 trials for the treatment of sight loss in patients. Spark Therapeutics hopes to report phase 3 data from this trial soon and, if those results are positive, the company could file for FDA approval by the end of 2015. If approval is granted, the company could be generating major sales in less than a year.
Geron
Geron is a small biotech company that has already attracted interest from Johnson & Johnson via its biotech subsidiary, Janssen. Geron is focused on developing its flagship telomerase inhibitor, Imetelstat, into a game-changing treatment for a host of blood-based disorders. Janssen decided to sign a lucrative licensing agreement with Geron following some impressive early clinical trial results for Imetelstat. Hopes are that Geron"s research will result in a blockbuster product.