Typically, venture-backed biotech companies go public well before they’re generating revenue. For these companies, an initial public offering (IPO) is less of an exit and more of a financing event, aimed at raising capital for costly research and development (R&D) as well as clinical trials. While biopharma companies enjoyed a decade-long IPO window that peaked during the coronavirus pandemic, the window slammed shut in 2021. This pullback is significant, as over the past 10 years, IPOs have been viewed as a bellwether for the biotech industry — fueling the clinical development plans of young biopharma companies and generating returns for the venture investors who back them.
With IPO momentum effectively coming to a halt, the stock prices of biopharma companies tumbled in conjunction with the decrease in the number of public offerings. To provide some context, the value of the S&P Biotechnology Select Industry Index, a widely followed stock benchmark that the SPDR S&P Biotech ETF (XBI) replicates, is currently down nearly 60% from its peak in February of last year, wiping out years of gains. As this week’s chart illustrates, median biotech company enterprise value fell steeply in 2021 and has done so again in 2022.
According to Jefferies, 128 companies are now trading at a market capitalization smaller than the cash they have on hand, a “historical” number owing to macroeconomic environments, as well as negative clinical events and FDA developments. Startups and their investors are now assessing the damage and adjusting to the most substantial downturn in 14 years.
Far from being an ideal situation for most parties involved, the valuation reset could play a role in spurring merger and acquisition (M&A) activity in young biopharma companies at a time when large pharmaceutical companies hold record levels of cash. According to SVB Leerink, 18 large-cap U.S. and European biopharma companies will have more than $500 billion of cash on-hand by the end of 2022. Considering their ability to use leverage, the theoretical firepower of these companies is more than $1.7 trillion.
As a point of reference, more than 100 biotechs priced an IPO in 2021, raising nearly $15 billion in funds. Along with the potential to use this cash to make acquisitions, it could also be used to pay down debt, pay dividends to shareholders and/or buy back shares. While having cash on hand does not guarantee M&A, it does point to an uptick in M&A activity when combined with lower biotech valuations, a decreasing level of capital deployed for R&D and large pharma’s desire to maintain a strong drug pipeline.
While the IPO window closing for biotech companies will slow the pace of realizations for venture capital investors, many signs point to a potential increase in M&A activity, as large pharmaceutical companies must continue to own leading drug portfolios regardless of market direction. An active M&A market is not likely to replace IPO activity in number of transactions or total value, but should serve to allow company and drug development to continue at a healthy rate, while offering exit opportunities for early investors.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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