To let everyone’s favorite “diminutive” Fed chair tell it, biotech valuations have been “substantially stretched” for the better part of a year. Despite that, blockbuster M&A deals and IPOs for pre-revenue newcomers have managed to sustain the insanity despite the objections of both bubble-spotting naysayers and some industry insiders like Roche Ventures’ Carole Nuechterlein who recently predicted that “the end is coming.” Earlier this week we saw the sector slide amid a broad market decline and you can count us among those who think the fact that 109 out of the 150 companies in the NBI lost money over the last year is cause for concern given the sector’s absurd outperformance. Credit Suisse has now weighed in on the subject, as a new note out today asks “Are We In A Biotech Bubble?”
Here are a few fun facts to kick things off, including the rather astonishing note that biotechs have been the best performing sector for a half decade:
(a) Since 1/1/2011 the BTK has delivered 204% performance vs. 64% for the S&P500.The BTK is up nearly 400% since the previous peak reached during the mother of all bull markets, i.e. the dotcom fuelled 1999/2000 frenzy. The cumulative market cap of the 5 large caps is $513B currently up from $128B at the beginning of 2011 (and $82B at the beginning of 2001); (b)Biotech was the top performing sector for the last 5 years - 2011-2015; (c) The number of IPO's in 2014 (82 IPOs) has eclipsed the previous peak (67 IPOs) in 2000. There have been 12 IPOs YTD; (d) Multi $B valuations for SMID caps are now the norm. There are currently 44 public biotechs with >$2B market caps (outside the 5 large caps), 1 year ago there were only 26 and in 2011 just 14.
Ok so to summarize, the space has outperformed the broad market by a count of 3.5:1 over the past four years, is up four fold over a decade that included the worst financial crisis since the Depression, is riding a 5-year reign as the top performing sector, and the number of public companies in the sector with $2B market caps has tripled in four years. That all looks a bit bubblish to us. Not so, says Credit Suisse:
...we do not think we are in a "biotech bubble" per se (ok maybe the pendulum has over-swung a little!), but rather in a new era for biotech driven by fundamental changes in large and SMID cap biotech.
So basically, “this time is different.” Here’s why according to the bank:
"Biotech 1.0" is the “Hopes And Dreams Model”– Make great drugs for unmet medical needs (using great science) and sell them thus creating a unique (different to major pharma) infrastructure (high priced drugs with relatively small sales forces). Successful implementation of Biotech 1.0 allows a company to progress (or attempt) to "Biotech 2.0"– The “Nirvana Model” – Next (2nd) gen. blockbusters deliver unprecedented growth and profitability – this is what happened to BIIB, GILD, CELG and to a lesser extent AMGN 2012 to present (Exhibit 9). Biotech 2.0 not only delivered exceptional topline growth that was further leveraged to even higher bottom line growth but a massive improvement in operating margins…
Bottom line is that companies (both early stage and now even late stage - e.g. RCPT has raised $820M from its 2013 IPO to now) do not have to license/partner products to get them through the development process given the robust financing window. What would have been the take-out for Pharmacyclics if Ibrutinib was not partnered, likewise where would Medivation be trading if Xtandi economics were 100%?
Breaking that down, CS appears to be saying that we’re not in a biotech bubble because four companies managed to make it from the aptly named “Hopes And Dreams” stage to the “Nirvana Model” and because in a world where everyone is chasing after any semblance of yield, pre-revenue companies which normally would have needed to partner with a major or go bankrupt, were able to raise money and stay alive.
It’s interesting that in the world of biotechs, reaching “nirvana” is apparently when you are able to deliver top-line and bottom-line growth. There’s a name for that magical combination in other sectors as well: it’s called the “Running A Successful Business Model” and as it turns out, really isn't all that uncommon. Also, it’s not entirely clear that a “robust financing window” is something to be especially enthusiastic about. Obviously if a company that otherwise would have went out of business is able to stay around long enough to produce a lifesaving drug by issuing shares that’s great, but as we’ve seen with US shale plays, allowing otherwise insolvent companies to lumber around zombie-like by virtue of a market eager to snap up secondaries and HY issuance isn’t everywhere and always a good thing and it certainly is not a sign that the sector isn’t frothy. In fact, one might easily argue that if people are financing huge risks at non-economic spreads, we’re probably in a bubble.
In any event, have a look at the following charts and judge for yourself:
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As a reminder, here are the facts:
- Below is a chart of the 150 companies that make up the Nasdaq Biotech Index (NBI), broken down by Net Income.
- Of the 150 companies, in the last 12 months only 41 had earnings, i.e., Net Income, amounting to just under $31 billion
- Of this $31 billion in earnings, just 5 companies - Gilead, Amgen, Shire, Biogen and Celgene - had net income over $1 billion
- Just these 5 biotechs represented 83% of all the earnings generated in the NBI
- 109 companies in the NBI lost money in the last 12 months.
- In summary: only 41 companies in the index were profitable, which means 72.5% of biotechs lost money
- 83% of Biotech earnings were generated by just 12% of the companies
Visually this is shown as follows: