March 24, 2022

Biotech Blues: Their Stocks Tank as Newly Public Firms Find Trouble

Reported by Larry Light

Art by Scott Bakal

The urge to do an IPO was strong, and for some, much too early.

Maybe staying private before maturing is a good idea for companies, especially biotech ones. That’s the tough lesson to be drawn from the now-stanched flood of public offerings from firms that employ biological systems to create life-science products, such as coronavirus treatments.

Biotech has long been a boom-and-bust stock sector, and lately is in bust mode. The SPDR S&P Biotech exchange-traded fund is down 18% this year, three times worse than the S&P 500’s skid. This follows another down year for the biotech ETF, which lost 20% in 2021.

But, oh, did it have a glorious spell before that, increasing 20% in 2019 (matching the index) and 48% in 2020 (some 20 percentage points better than the S&P 500.) Advances in the likes of gene therapy and the rapid-fire discovery of COVID-19 vaccines stoked the popularity of biotech stocks—until they didn’t anymore.

What happened? In short, enthusiasm for biotech, paced by the excitement over digital technology shares, went overboard. “Valuations got ahead of themselves,” said Dave Mazza, head of product at ETF sponsor Direxion, which has a biotech fund that’s down 57%.

Look at Moderna, whose shares had been going nowhere since its 2018 initial public offering. Its fortune improved mightily once the company concocted one of the leading pandemic vaccines. Then Moderna had a swift rise as the pandemic appeared, to $384 last September from $30 in March 2020. Since then, the stock has dropped by half, to $187. Not too shabby a level, but a big disappointment for investors who thought they had a perpetually winning ticket.

“Enthusiasm waned as people grew unsure how COVID would evolve,” commented Darren Chervitz, chief portfolio manager at Jacob Discovery Fund. After a pell-mell period of public inoculations, vaccine resistance grew as 2021 wore on. Then late in the year came the Omicron variant, which evaded the vaccines (Pfizer’s along with Moderna’s), although the new strain proved less deadly than its predecessors.

As a result, the biotech IPO rush has slowed. Through February, a mere seven biotech outfits went public, compared with triple that during last year’s first two months, says Nasdaq.

Basically to blame was overreaching. A huge batch of biotech companies went public, with a lot of them not ready for prime time. The number of public biotech firms tripled between 2015 and last year.

Yet over the same period, the portion that was pre-clinical—meaning they hadn’t even started Phase 1 of the Food and Drug Administration approval procedure—also ballooned. Some 28% of the biotech IPOs were pre-clinical in 2015, and that proportion shot up to 53% last year, according to Paul Yook, CIO of LifeSci Venture Partners, which sponsors biotech ETFs and provides venture funding.

In the past, Chervitz said, weaknesses in biotech firms’ offerings and business models were ironed out before they went public. “The bumps and bruises happened when they were still private,” he said. Amid a bull market, biotech firms “were pushed to go public earlier and earlier.”

Also not helping is that once-vibrant merger activity has decelerated. Getting bought by Big Pharma has long been the end game for many biotech concerns.

At the same time, payroll costs have soared in a race for talent in this burgeoning field, Yook noted. “Pay is going up faster than inflation,” he said. That’s also the case for real estate costs: that is, rental outlays for laboratories in the biotech hubs that happen to be in high-cost locales. Namely, San Francisco, San Diego and Boston. Overall, the biotech “burn rate,” the amount spent on expenses, shot up to $60 billion last year from $14 billion in 2017.

Meanwhile, a welter of other problems waylaid the sector and punished numerous biotech stocks where hopes were high for breakouts from young companies new to public ownership. Regulatory setbacks, clinical trial failures, and talk of federal drug pricing restrictions all took their toll. The FDA has turned down Ocugen’s bid for an emergency authorization of its coronavirus vaccine targeting children 2 to 18.

The partnership of Galapagos and Gilead Sciences failed to win Phase 2 approval (of three in the approval process) for a drug aimed at rheumatoid arthritis and ulcerative colitis. Democrats on Capitol Hill are hustling to pass drug-price control legislation, although the plan’s prospects in a closely divided Congress are uncertain.

Biotech “has rotated out of red-hot growth,” Direxion’s Mazza said. “But better days are ahead,” thanks to the relentless pace of innovation. Such a roller coaster ride has long been true for this space, however vexing that volatile reality is for investors.