Is Biotech Bouncing Back?

Whisper it quietly, but is something happening in biotech? In the last few weeks, the NASDAQ Biotech Index has risen nearly 24% from a near 18-month low in late October.

Over a more extended period, the NASDAQ Biotech Index has had a torrid period of performance in absolute terms. However, compared to the broader NASDAQ technology index, the biotech sector's performance looks really ugly.

Over five years, the NASDAQ broader tech index has more than doubled whilst the biotech index has managed about 30% growth, but over three years, the index is down. This painful period has seen investor confidence in the biotech sector enter a deep freeze, witnessed by the number of quoted companies with a negative EV regularly exceeding 200. Against this backdrop, only those businesses with the later stage compounds in development in the "right" therapeutic areas and with institutional backers with deep pockets had any prospect of successfully completing a financing round. For the rest, the only option was to cut costs, shed staff, focus on priority programmes and pray for the weather to change.

Could this be what we are beginning to see happen right now, or is it another false dawn for the sector?

Our hunch is that this is real and that we are witnessing a significant shift in sentiment that could see biotech once again outperform the rest of the technology sector as it has done in the past and very significantly for five years between 2010 and 2015.

The fundamental drivers of the biotech sector and, indeed, the broader healthcare industry are all still in place. Growth in the sector in richer developed countries typically outstrips growth in the wider economy, reflecting in part their ageing societies. This, of course, puts huge pressure on payers, both public and private, and often leads to rationing even in the wealthiest economies. The solution, of course, to this economic and societal challenge is innovation. Better devices, drugs, and diagnostics help the healthcare industry raise productivity and meet the relentless growing demands on it, and it is in the biotech sector where the vast majority of the innovation in this sector comes from.

However, innovation costs money, and in the case of drug development, the costs and risks can be very significant. Over the last few years, these challenges have weighed heavily on the biotech sector, and whilst investors were doing so well elsewhere in tech, investors have had good reasons to avoid the sector. However, this extended period of underperformance has left the sector looking incredibly cheap, both absolutely and relatively, and it is this valuation anomaly that, in part, has created the opportunity for the sector to start to outperform.

But as usual, valuation alone is not the only reason the biotech sector has started to attract investor interest. It would appear that it has once again started to attract large pharmaceutical companies that have traditionally looked to the sector for therapeutic innovation rather than developing it in-house. Many of these large companies have the challenge of important patent expiries on the horizon, but many also have considerable cash resources, and some are now busy putting this to work by buying businesses in the sector. In the last few weeks, a raft of deals have been announced in neuroscience, cancer, and respiratory medicine on a scale that has prompted Bloomberg to describe the volume of deals as a buying frenzy.

We think the interest in the sector will be sustained, and corporate activity will continue. One notable feature of these recent deals is that the premiums the pharma companies are paying are very significant, reflecting first their desire to secure the deals and secondly, reflecting the very depressed valuation starting point of their targets.

The 2024 J.P. Morgan Healthcare Conference has provided further evidence supporting this optimistic outlook for the biotech sector. Key insights from the conference indicate a significant shift in the industry, driven by technological advancements and strategic innovation, which could signal a promising turnaround for biotech.

So, is this another false dawn for the sector or the start of a period of recovery and sustained growth? After an extended biotech "winter" that has affected not just companies listed in the US but biotech businesses everywhere, both public and private, we suspect that this significant shift in sentiment is both real and completely justified and likely to continue. Genuinely innovative businesses that have discovered and developed novel therapeutics to address unmet needs are the companies that will be targeted by large pharma businesses, especially in disease areas where companion diagnostics can identify the right target patient groups for those novel therapies. These are also the businesses that we suspect will start cultivating investor interest on a broader front, leading, in turn, to a much better funding environment.