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Biotech Stocks: Perspective in a Bull Market

July 17, 2014
Investors are increasingly interested in biotechnology based on scientific breakthroughs, an improved regulatory environment, strong earnings growth from large companies, and a more mature industry.

Recent advancements in biotechnology are revolutionizing treatments and cures for many illnesses, creating new value for the healthcare system. In 2013, our understanding of how therapeutics can be used to harness the immune system to destroy cancer cells exploded with many companies reporting solid data in human testing. In 2014, we have seen combination trials of these “immune therapies” expand the advancement in this field across multiple cancers. Advancements in blocking the ability of viruses to replicate has unleashed a new era of anti-virals for Hepatitis C. Many patients are now seeing complete removal of the virus after just weeks of new therapies. Gene therapy, once considered decades off, is now proving itself in the clinic. In fact, recent clinical studies in 2014 using gene therapy have led to reversal of genetic diseases with lasting changes in patients’ lives.

Many small businesses are working to bring breakthrough medicines to market, a long and arduous process that often takes more than a decade and costs over $1.2 billion (Tufts Center for the Study of Drug Development). The entire timeline is undertaken without the benefit of product revenue, so all research funding comes from external investors. Today’s investors understand that small biotechnology companies are research-intensive businesses that operate for years without corporate earnings and thus are valued using different metrics for success than quarterly EPS reports. Investor value is driven by a drug’s probability of clinical success, FDA approval, and market potential.

This means that investor interest in biotech is pegged primarily to scientific progress and other related factors that affect drug development.  For example, the regulatory environment is a critical factor that affects investors’ willingness to invest in this sector. Over the last several years, there have been positive changes at the regulatory level.  A large study of institutional investors found that approximately 70 percent of investors believe there has been material change in the way that the FDA weighs the risk/benefit analysis when deciding whether to approve a new drug.

Investors also recognize that today’s industry leadership is much more experienced now than a decade ago. Back in 2000, during the tech/genomics bubble, the industry was still in its infancy and the number of clinical programs that management had taken from bench to clinic was small in comparison to today.

Since the passage of the JOBS Act in 2012, more than 90 emerging biotech companies have gone through with an IPO to access public capital.  Interest in small public biotech companies has returned after a multi-year drought that prevented many private biotechs from having this financing option. These start-up companies, although small, are critical for the life science ecosystem. It takes time for their full potential to be realized. Indeed, the vast majority of these newly public companies remain at “small cap” valuations trading at levels below $1 billion in market capitalization. In fact, 82 percent of public biotech companies have sub $1 billion market cap valuations – a percentage that has remained fairly constant since 2007.


Biotech Companies

For their large-cap brethren that have earnings and can be valued based on future expected earnings, valuations appear to be below historic levels. When taking the high growth expectations into account, it appears investors are paying for the solid growth resulting from strong product launches of these large biotechs.

Biotechnology holds great promise for addressing our most devastating and prevalent diseases. Based on this important public health mission, the industry maintains relatively strong market performance, and we remain optimistic that the long-term prospect of the industry will prevail within the public markets.