Biotech IPOs: Outliers, Value Creation, And The Dispersion Of Returns

Posted September 27th, 2016 in Capital markets, Exits IPOs M&As | 1 Comment

Although many wrote off the biotech IPO markets as moribund earlier in 2016, the sector has been quietly issuing a steady stream of new offerings. Despite the volatility related to drug pricing, and disastrous first six-weeks of the year, we’ve recently witnessed the 24th biopharma IPO of 2016. For context, in the past two decades, other than the recent window, we’ve only seen more than two dozen VC-backed IPOs in three vintage years. In light of these metrics, and despite the negative sentiment and malaise about biotech IPOs, it’s actually been a historically very strong year in terms of new offerings.

Further, to add to the growing positive sentiment, the recent biopharma IPOs have been strong: dermatology-focused Novan (NASDAQ:NOVN) and Alzheimer’s antibody play AC Immune (NASDAQ:ACIU) priced in the range and both jumped up, closing their first day of trading up 95% and 50%, respectively. Whether these prices will hold is anyone’s guess, but positive initial trading tends to have a reinforcing effect on investor sentiment – especially when the NASDAQ Biotech Index has had such poor performance year-to-date.

As we head into the final quarter of year, it’s worth revisiting the performance of the largest and most prolific window in biotech history – the 2013-2016 cycle.  As most readers can guess, there’s some good and some bad in the analysis.

Let’s start with post-IPO stock performance by annual class, as per the chart below.

chart1_ipo-post-mkt-performance

Four observations of these data. First, the median underperforms, like most asset classes. The bottom half have largely destroyed value in each of the 2013, 2014, and 2015 IPO classes. Many of these represent stories where their lead drug failed (in case you didn’t know that pharma R&D is hard).  Second, the top quartile performers of 2013 and 2014 have done well, but most of the 2015 Class is off the mark. This is largely due to the downdraft in the NASDAQ Biotech Index in the second half of 2015; many of the offerings priced when the markets were solid only to see fund flows pour out of the sector and drive prices down after July.  Third, the 2016 Class is off to a solid start despite the volatility in the markets – an average return of 16% so far.  Some of the bigger outliers include pulmonary disease company Reata (NASDAQ:RETA, up 136%), gene therapy player AveXis (NASDAQ:AVXS, up 113%), and cystic fibrosis play Proteostasis (NASDAQ:PTI, up 90%).

And fourth, to understand how the macro biotech trends shaped the after-market performance of these IPOs, we compared it to the Index as if it were bought on the same day as the IPOs of that year – and then looked at the average performance. As is clear in the chart, top quartile IPOs performed in line with the Index, with significant skew above that for the top performers.

As with prior cycles, a rather large proportion of these IPOs are currently underwater.  Of the 159 IPOs that are still trading from the 2013-2016 window (excluding post-IPO M&A), less than half are above their IPO prices (43%).  But one of out of six offerings are up over 100%.

chart-2-distribution-of-returns

With 57% of the offerings below their IPO price, have these IPOs as a cohort destroyed value since their offerings?  Not at all.  The chart below says it all – laying out the puts and takes on value.

chart-3-value-creation

At the time of their offerings, these 159 stocks had a market capitalization of $61B.  The winners – the 43% that have traded up – have added $32B in market value since their IPOs.  The not-so-fortunate loss-makers – the 57% that have traded down – have destroyed $13B.  This includes some of the big blowups, like Tetralogics, Globeimmune, and ProNai and a number of others, that are off more than 90% since their offerings. To get a full picture of the value creation, we have to add back to the market value the acquisitions of recently IPO’d companies (e.g., Receptos for $7.2B, Auspex for $3.2B, and ZS Pharma for $2.7B). This contributes an additional $16B to total.

Summed up, the IPO window of 2013-2016 has created or added some $95B in market value since their initial offerings.  That’s like creating one Bristol Myers Squibb in less than a 4-year period.

The outliers are a big part of this contribution: the winners often win big.  It should not be news to anyone that it’s the top quartile and top decile returners that drive most of the gains.  The top 16% of companies with >100% stock upticks since their offerings (~25 companies) delivered nearly 80% of the positive change in aggregate market value.

These data highlight the importance of picking winners.

As a closing perspective to put biotech in context, it’s worth reflecting on the concept of dispersion. Stock analysts often refer to the “dispersion” of returns in a sector: the degree of variance in returns within that sector over time. In general, there’s a widely-held belief that the higher the dispersion in a sector, the more likely stock-picking drives value (versus simply picking a good sector).  BMO Capital Markets team covered this topic in their February/March 2016 issues of “What We’re Thinking About This Month”, and highlighted a relevant piece on this concept of dispersion.  A quick and dirty measure of dispersion is the average standard deviation in 12-month returns of the stocks in sector.

The chart below captures data at a sector level on the left (source here) for 2014, which includes all stocks in a sector with market capitalizations bigger than $200M. These sector dispersion rankings largely hold for the ten-year period of 2005-2014 as well, with Pharma and Biotech topping those charts there as well.

chart-4-dispersion

To draw a comparison with broader sector data, the dispersion of returns of recent VC-backed IPO cohorts in their first year post-trading is on the right.  As one would expect, these less seasoned stocks have greater variance – more dispersion of returns – than the broader pool of companies in the sector data on the left: biopharma IPOs have a chart-topping 91% dispersion in their first year of trading.  This dispersion of returns is bigger than any other VC-backed IPO sector.  And even after “seasoning” the dispersion in biopharma is sector-leading.

All this reinforces the message that picking the winners is a big part of investing in the world of biopharma. Importantly, in the long run of the capital markets, winners are typically those who’s drugs make it through the gauntlet of R&D and deliver value for patients.

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Saluting Biotech M&A: Onward And Upward

Posted September 23rd, 2016 in Exits IPOs M&As, VC-backed Biotech Returns | 1 Comment

As larger Pharma externally-enables more of its pipelines, the cadence of biotech M&A appears to be accelerating, especially for early stage deals. Another week, another biotech acquisition in the news: Allergan has acquired two private and two public R&D-stage companies in just two weeks, involving Tobira, Vitae, Akama, and Retrosense. Exciting data from PARP inhibitors and immuno-oncology programs have catalyzed hopes of a further wave of acquisitions.

Demand from larger companies for innovation is a (the) major source of gravity in VC-backed biotech. More than half the venture-related exits in the past few years, even during the bull market for IPOs, were from M&A. At our firm, Atlas Venture, nearly two-thirds of our exits in recent years were M&A.

It’s also critical component for recycling capital to new and emerging stories. The $14B acquisition of Medivation by Pfizer alone will likely channel as much capital back into earlier stage biotech (in search of the next Medivation) as all of the IPO funding flows into the sector since the fall of 2013.

But not all acquisitions are like Medivation, or like the monster StemCentryx-AbbVie deal on the private side. As an investor in the space, having a good grasp of the “market” and context for M&A is important, both to be able to benchmark but also to see the macro trends around the scarcity of innovation and where negotiating leverage can help drive up returns.

To that end, I thought it useful to revisit the distribution range of valuations from M&A and how they changed over the last decade.  Working with the platform at Pitchbook, who is now the NVCA’s preferred data partner (and a great help on analytics), we explored M&A values of VC-backed biotechs over time, focusing only on upfront payments.

Over the past decade, there were 325 M&A events in their dataset. As shown below, the entire distribution of upfront values has shifted upwards considerably over time.  Median values have nearly doubled ($63M to $115M) for all M&A.  Medians matter in portfolios of investments, and ensuring adequate returns even at median outcomes can strategically aid fund-level returns. At the high of the range, valuations have also soared: top quartile upfronts have moved up by 50%, from $215M to $310M, and top decile numbers have rocketed to north of $650M upfront.

vc-backed-ma-biopharma-value-ranges_sept2016

Of course, this distribution is skewed lower by the large number of immaterial exits, either quick sales or salvage deals around intellectual property in failed companies. To look more at the typical range for “winners”, examining only the 192 exits above $50M shifts those distribution ranges up considerably, as you would expect: medians move to top $225M, top quartile above $515M, and top decile above $920M – all significantly higher than the range of outcomes a decade ago.

Deal valuations have moved up such that today’s top quartile looks remarkably like yesterday’s top decile – which bodes well for driving up venture portfolio returns considerably in the sector.

Further, these Pitchbook data just represent the VC-backed private company biotech exits. The reality is a large number of R&D-stage companies went public in recent years – and lots of M&A is happening there too.  Take one of the Allergan deals mentioned above: Vitae Pharmaceuticals, one of our portfolio companies, went public in 2014 and was acquired for nearly $640M.

To look at the combined public and private dataset of M&A, BMO Capital Markets kindly shared their extensive M&A dataset. They classified the lead program at the time of the exit, which enables a look at changes in M&A valuations over time by R&D stage. These data include both upfront payments and the contingent success milestones.

bmo-ma-chart_numbers-values

Two observations of these data: first, the number of early stage M&A deals has gone up considerably, while late stage Phase 3 deals have been flat (probably reflecting lack of inventory more than lack of interest).  This reflects the accelerated cadence of early M&A, which we’ve benefited from recently with preclinical M&A deals at Padlock and CoStim, to name a few.  Second, the average valuations of these deals, across all stages, have escalated significantly – especially in the recent few years. Preclinical and Phase 1 deals now average nearly $450M in upfront and milestone payments.

This upward trend is obviously a good thing for returns to investors and teams alike.  Sometimes bittersweet, as these companies and their prized programs lose their identity inside of large Pharma, which Sam Truex highlighted in an earlier blog post.

Looking forward, the structural forces behind this rise in valuations for M&A deals remain strong and likely persistent: large companies need to externally-source a significant proportion of their pipelines (especially in light of the future pricing environment, as described here), and there’s a scarcity of startups and innovative assets in the market (which takes years to change, if it can be). Biotech M&A comes down to simple macroeconomics: supply and demand.

Before signing off, biotech venture doesn’t just exist in the life science world. We compete for LP capital, and are compared with other sectors in venture. To shed some light on the M&A trends in biotech relative to the largest tech venture sector, software, the team at Pitchbook helped look at distribution ranges of M&A in both – this time focusing on medians and top quartile values to simplify the chart.

ma-of-bioharma-software-sept-2016

A couple points worth noting in these data.

First, median and top quartile valuations in VC-backed biopharma have greatly exceeded those in software. Although not shown, even if you exclude all the small micro-acquisitions (like aqua-hires) and focus on “winning” exits greater than $50M, while a top quartile software M&A deal in 2013-2016 is a respectable $280M, that’s only about half of where biopharma deals have gone: over $515M at the top quartile.

Second, valuations are great, but returns are what really matters. There, too, the Pitchbook data shows the strong performance of biopharma: a decade ago, both software and biopharma’s median multiple of invested capital in M&A deals hovered around 2.8-3x; since 2013, both sectors have seen nice upticks in multiples – but biopharma’s median multiple has grown more, reaching above 7x, about 40% higher than median returns in software.

The recent venture dynamics in these two sectors are strikingly different with regards to the supply of new startups and the demand for them (M&A, IPO), as discussed previously; these differences are likely to continue to shape the performance of venture investing in these sectors.

For those biopharma folks about to rock (with M&A), we salute you.

 

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