Will Calendar Change Bring an End to Run of Volatility in Biotech?

The XBI, as of late last month, was trading about 15% off of its lows back in October and continues to be volatile. The biotech index continues to trade in an inverse correlation with rates, with the pendulum swinging between whether investors latch on to the peak Fed narrative or shift back to the higher-for-longer one—each based upon economic data. The bull/bear debate on the economy remains in play, with the bulls betting on a soft landing, while the bears point to corporate commentary and earnings, which are suggestive of a recession.

From peak to trough, the XBI has traded down 55% from its $141 peak in October 2020, and, according to Brian Gleason, managing director at Raymond James, investor sentiment, not surprisingly, is also at a low.

“The narrative remains painfully consistent, which is simply that the headwinds created from high interest rates continue to overshadow positive fundamental drivers like M&A, commercial success, and clinical/regulatory wins,” writes Gleason in an investors note. “Biotech trading dynamics will likely continue to pivot off two key variables, which are (1) conviction that the Fed will not hike again and (2) timing for Fed cuts. Current market expectations are for the Fed to hold rates at the current level and begin to ease by mid-2024.

The variables Gleason cites continue to fluctuate, he adds, thus keeping the cycle of volatility ongoing in the sector.

“Based on our conversations with multiple parts of the biotech ecosystem and our investor survey work, we put mid-2024 as consensus for timing of a sustained biotech recovery,” he writes. “The timing is obviously tied closely to Fed cut predictions.”

The biotech financing market continues to be challenging with over 200 trading below enterprise value (EV), and depressed valuations are driving painful dilution for the companies that actually can finance.

It is interesting, however, because the market remains highly bifurcated—companies with good data are able to finance, and often the aftermarket performance is quite positive, as the deals are viewed as a clearing-event lifting the financing overhang. As of press time, there had only been 11 biotech IPOs this year, in contrast to more than 100 each in 2020 and 2021. Sadly, however, too many companies went public in 2020 and 2021 that were at a far-too-early stage in their development (i.e., preclinical, Phase I trials) to be public companies; they were not sufficiently funded to proof-of-concept data. This is where the real pain is—with stocks down 70% to 90+%. In fact, Gleason pointed to the extreme bifurcation in the sector by noting that 50 biotech stocks are up 50% or more in 2023 year to date, which he adds is actually the mean for that statistic over the past six years. It certainly doesn’t feel like it.

As a result, we have seen record numbers of restructurings, reverse mergers, and pipeline prioritizations, which were necessary and successful in extending cash runways. According to Gleason, 217 biotech companies have announced at least one restructuring, which is about half of the universe of biotech organizations.

Despite the underperformance of biotech, fundamentals for the sector as a whole remain quite positive.

The innovation renaissance is alive and well, with record numbers of FDA new drug approvals in each of the past several years. M&A continues to be another bright spot. Beginning in 2025, large pharma will be losing exclusivity for products currently representing over $350 billion in revenue, leaving a huge growth gap that needs to be filled through M&As, licensing, and partnering. Dealmaking has always been a key pillar of the industry’s growth strategies.

More good news: according to EY’s Annual Fire Power Report, large pharma has a record $1.4 trillion to fund deals. There have been a total of 30 public biotech acquisitions this year, and 15 of these were above $1 billion each, which surpasses the number in any year for the past 10.

As we wind down 2023, the hope will be for rate relief in the year ahead—and substantially improved biotech performance.