Data Signals Some Green Shoots for Biotech in 2023

Following epic capital inflows and stock market outperformance for the biotech sector in 2020, the XBI index subsequently had its steepest and longest decline from early 2021 through 2022. The XBI underperformed the S&P 500 in each of the past two years; something that has not happened since the inception of the index more than 15 years ago.

Much has been written about the reasons for the rise:

• An innovation renaissance that attracted unprecedented capital investments in the sector. In fact, in two years, 2020 and 2021, the total money raised in IPOs totaled about 35% of all the money raised in IPOs over the past 15 years.
• An unprecedented number of the companies who went public were preclinical- or early Phase I-focused.
• All eyes were on the potential of vaccines and therapeutics against COVID-19 to reopen the shuttered economy.

• With the economy in freefall, biotech was one of the very few places for investors to generate alpha.

Then the drivers of the long hard fall emerged:

• With the introduction of vaccines, investors anticipated a V-shaped recovery in the economy and fled expensive growth stocks for cheap value stocks pinned to the inevitable economic boom.
• Biotech stocks went into rapid decline, the IPO market shut down, and follow-on offerings were few and far between and were restricted to companies generating strong clinical data.
• Many of the newly public companies found themselves with limited cash runways, limited options to access new capital, and (as a result) many were trading at below cash and with less than 12 months of runway.
• There have been restructurings to create more runway and live to fight another day. Mergers and outright shutdowns are the result of the limited access to cash.
• The economic recovery brought inflation, as the Fed raised interest rates over the past nine months aggressively. In fact, the rate hikes have been the most pronounced over the shortest period of time in a generation.
• As the longest dated asset class, with biotech stocks trading on long-term expectations for future cash flows, they trade inversely to rates. As such, much of the decline in biotech can be tied to unbridled euphoria in 2020, which my colleague, Arda Ural, PhD, industry markets leader, EY Americas, refers to as the “sugar high” to a nasty and lengthy hangover.
• Macro factors such as inflation and interest rates have dominated biotech sector performance over the past year.
• While cash-strapped biotechs suffered, their cash-rich large cap pharma peers giddily outperformed the S&P indexes, with strong cash balances, rising expectations for sales and earnings, and reasonable valuations.

Green shoots are providing reason for optimism in 2023 but not for all. Fresh inflation data suggests that inflation may be easing, which may mean the Fed takes its foot off the pedal on rate hikes. Expectations for a more dovish Fed are increasing. This, combined with the potential for a recession and rate cuts later this year, could reverse last year’s trends. Investors may rotate out of value and the economically sensitive sectors right back into growth stocks like biotech.

Large pharma is flush with cash. According to EY’s most recent annual Firepower report, they have, collectively, more than $1.4 trillion to fund M&A and strategic partnerships and collaborations. M&A has always been a core pillar of the leading companies’ growth strategies, and the emerging biotech innovators are their targets.

The growth gap is widening to impact the industry’s leading commercial companies, as they collectively face product exclusivity losses totaling $225 billion in revenues beginning in 2025. Expect a strong year of M&A and dealmaking in 2023.

The IPO market appears to be opening up with several biotechs on the road. If these deals are well received and successfully completed, this could set a much-needed improved tone for the IPO market in 2023.

The XBI hit a high of $99 this year, up over 60% from the lows in May 2022. It has backed off since and is below the high of 174.79 on Feb. 9, 2021. That said, we will continue to see companies fail in bankruptcy. Some are barely hanging on by their fingernails.

Barbara Ryan is the founder of Barbara Ryan Advisors and a member of Pharm Exec’s Editorial Advisory Board.