Twenty years ago, in the midst of one of the best IPOs in its history, the biotech world was filled with a number of great companies, including Vertex and Sepracor, PDL, MedImmune, Isis, Imclone, Human Genome Sciences, Gilead, Cephalon, Amylin, and Alkermes. There were also, of course, a lot of names that were lost to the annals of bankruptcy or history.
Two notable observations stand out to me. Considering the contrasting circumstances of today, I believe it is enlightening to retrospectively examine that particular period in order to comprehend some of the factors that are causing the early stage biotech industry to undergo progressive transformation and innovation at present.
During that timeframe, public shareholders offered a remarkably affordable source of capital, emphasizing the significant increase in valuation compared to the privately invested capital, which was approximately four times higher. These biotech initial public offerings (IPOs) further solidified the legendary reputation of IPOs by generating substantial profits for their venture capital supporters.
In the past, I desired to be involved in venture capital. The brief period from initial institutional funding to initial public offering, not just the remarkable increase in valuation, but also the graph provided below indicating the implied stock price, reveals everything. Both Isis and Amylin each obtained approximately $20M in venture capital after becoming publicly traded companies only a few years later in 1991-1992, and both secured their “1st rounds” of funding in 1989. Since both companies are still present and widely discussed today, let’s examine these two examples, Isis and Amylin.
Capital markets in the present day are clearly distinct: the majority of companies now raise capital privately through funding rounds that remain relatively stable over extended periods of time. If they do decide to go public, their initial public offerings (IPOs) are carefully evaluated.
Unfortunately, many of the stories from the past decade have been characterized by high levels of capital intensity. However, the majority of the total capital invested in the past decade has only seen step-ups of 1.5x or less. These biotech companies have been great, with an average price over the past 11 years of only 1.8x and Merrimack, for example, went public in March 2012 at a price of just $7.00 (see related post). AVEO is another recent example, as it went public in February 2010 at a price of $9.00 per share, even though the average private investor had shares at an average price of $8.97 over the past 10 years.
The primary observation, to a great extent, arises from the reason behind this. It is highly probable that this will not change anytime soon. Moreover, it has been in use for a decade and everyone recognizes it as the model IPO for the biotech industry.
Vertex has experienced a significant increase of 10 times, and MedImmune also performed quite well with its acquisition worth $16 billion (although AZ is currently not pleased with it). Gilead is likely the largest winner, having increased over 100 times since its initial public offering in 1992. It is evident that there were a few notable success stories. However, only a portion of the companies that went public between 1991 and 1994 have actually gained substantial value over time, with only 2 of them being included in this category.
Let’s take a look at two examples, Amylin and Isis, which represent successful biotechs that have gone from a preclinical stage to launching products and filing with the FDA. These companies have been in existence for 20 years and have consumed billions of dollars in capital equity and treasury bills. Despite this, they have not underperformed major equity indices and have traded at $25 per share, with Amylin ending its first day of trading in 1992 at $21 per share and eventually reaching $14 per share. Amylin went public at $10 per share and currently trades at $8 per share. However, it can be argued that they haven’t created much value for their shareholders.
Today, biotech investors have genuine concerns about this behavior, but they are indeed severe criticisms, and many companies do not display it. The focus on maximizing shareholder value is too concentrated on ensuring the long-term survival of the company rather than considering management teams (such as pursuing independent growth to create the next Gilead) even when selling now and accessing the resources of a larger company would be the best outcome for current shareholders and often patients. Actions that go against the interests of shareholders (in the public market, there is always someone else willing to provide funding and expand a new option pool, so it is acceptable to dilute the holdings of existing shareholders) create an endless cycle of repetition. The problem can be divided into at least three parts: excessively high capital-intensive funding of large portfolios (funded primarily through continuous public equity flows, with little emphasis on capital efficiency), and my (as well as their) analysis of it. Public investors have started to recognize the flaw in this biotech investment strategy, although it may come as a surprise.
VCs epitomize activist owners/investors in various ways, and thus, I sympathize with a majority (not all) of these investors. It is beneficial overall for investors to act like owners and advocate for strategies that enhance value-maximization. In the biotech industry, there has been a growing trend of activist buyside shareholders actively participating. Public buysiders are well aware of these tactics and naturally aim to steer clear of any involvement with them.
Appears logical. Purchasing during the initial public offering, why bother if the majority of IPOs experience a decline in trading after their IPO? The list of IPOs from the past ten years is a reasonable response to their nervousness, but now the situation has become extreme. Presently, investors who buy IPOs are frequently accused of contributing to the IPO issue and have become cautious IPO investors due to two decades of these assessments.
In order to be captivating, it is not necessary to reach the level of 1991-1994, and there would definitely be more initial public offerings (compared to mergers and acquisitions) if the cost of public equity was lower. The act of selling a company at an early stage is a much more appealing outcome for existing shareholders due to the dilution that comes with a high cost of capital. That may indeed be accurate, but in most scenarios, investors who buy shares will still support innovative biotech companies going public: in fact, I have heard them express regret that many of the best companies are being sold too soon to pharmaceutical companies.
The current reality is shaped by a couple of lackluster decades in the biotech business, where public markets aren’t open to the performance. While they are much less tolerant of the value-destroying tactics of the past, they also set a high bar to even discourage great innovative companies from considering it as a viable option. It’s hard work to just build old company models in this new world, so today we’re back with a startup investment thesis, building around the next “Gilead” – a market that is different.
In addition to corporate venturing, academic medicine initiatives with a greater focus on translation, the development of a strong CRO network, their growing involvement in mergers and acquisitions, challenges in Pharma R&D productivity, and the changes in the public capital market, the biotech industry has had to adapt to numerous other factors.
The strategies developed in a different time period to withstand the challenges of the biotech industry may now be considered a mistake, as the landscape has undoubtedly changed over the past 20 years due to these influential forces.
In this fresh setting, remarkable narratives such as Avila, Stromedix, Amira, Enobia, and others are being constructed. Moreover, numerous of these strategies are proving successful – current trials are being advanced by various venture capitalists focusing on efficient use of funds, globally dispersed research and development, asset-focused models, stronger connections with pharmaceutical companies right from the start to access more affordable capital, and alternative methods for achieving financial solvency, such as structured transactions.
Who knows what the future will hold, as we start today in a time where we are adapting to the new world and celebrating its successes. However, we can nostalgically look back at the years 1991-1994, as if we were being transported back twenty years. It is certain that the flavor of companies and the capital markets will undergo a change, as the attractive low-cost pools of capital in the public markets certainly make a comeback.