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In recent IBT blog posts, we have alluded to the signs of life we’re seeing in the financing of the biotechnology sector, and how the quality of the biotech opportunity set is gradually improving. Here we take a broader look at the health of the biotech sector, and how it is influencing the outlook for investors.
There are several ways of approaching this task, ranging from the start of development with the commencement of new trials, through to the end of the process, with the regulatory approval of new therapies. Most of these currently suggest that the fundamentals of the biotechnology sector is in robust health.
New trial initiations
We often refer to the accelerating pace of innovation in the biotechnology sector, and that can be clearly seen in the number of new clinical trials being initiated. Drug development is a costly process, so the continued growth of clinical trial initiations reflected in the chart below should be seen as an indication that the sector is in relatively robust health. The number of new clinical trials registered with US government website clinicaltrials.gov has risen every year since 2011 and, if the current annual run rate is continued, 2024 will be yet another record year.
1Source: New clinical studies disclosed per year on clinicaltrials.gov as of April 2024.
Equity financing
Most biotech funding comes in the form of equity. This is particularly the case for earlier-stage biotech businesses, where the lack of cash flows while drugs are in development mean that debt isn’t a viable option. There is an irony here, because, as we have explained before, the performance of the biotech sector is actually inversely correlated to interest rates. This is not due to the sector’s reliance on debt funding or the negative influence of higher borrowing costs. Rather, it is a function of how changes to the risk-free rate i.e cost of capital have an impact in analysts’ valuation models. Meanwhile, interest rate changes can also have a bearing on how investors perceive the attractiveness of biotech versus other sectors and indeed other asset classes. But, from an operational perspective, they are largely irrelevant.
The availability of equity finance, however, is very relevant to the biotech sector, and here, the signs are encouraging. As we see from the charts below, after a relatively barren period for biotech equity finance, private fundings are tracking ahead of the level seen last year. Furthermore, follow-on financings are tracking ahead of the last three years, which provides further evidence that investors are starting to have confidence in the biotech sector again.
Source: Cantor Fitzgerald to 30 June 2024.
Past performance is not a guide to future performance and may not be repeated.
IPOs
Perhaps the most widely followed indicator of the health of the biotech sector is the level of IPO (initial public offering) activity. These high-profile events see private biotech businesses make the transition to public markets and, although the increasing availability of private equity in recent years and lower valuations in the public markets has meant that businesses across all industries are generally choosing to stay private for longer, IPOs are seen by many as a pivotal moment in the development and maturity of a young biotech business.
Here, there are tentative signs that biotech IPO activity is starting to return, albeit from a very low level as reflected in the chart below.
Source: Cantor Fitzgerald to 30 June 2024.
Past performance is not a guide to future performance and may not be repeated.
The IPO window for biotech is therefore open, but only narrowly so. We have seen 12 IPOs year-to-date, which is an increase on last year, but remains well below the peak during the last biotech boom in 2021. Perhaps the most positive aspect of this is that the lack of equity finance over the last couple of years has also contributed to biotech companies deciding to stay private for longer. In turn, this suggests that those biotechs coming to the market now will be that little bit closer to commercialisation, and therefore higher quality, than those that chose to IPO during the market peak.
Regulatory approvals
Finally, the end of a positive drug development process comes with regulatory approval and commercialisation. This too is a costly process, albeit lower-risk than drug development, and often involves further capital raising from the biotech behind the successful new therapy. It's been a slow year for regulatory approvals so far, but this was expected. Oncology and neurology have been the leading therapeutic categories for approvals, although there has also been an interesting uptick in supportive care. Importantly, there are a number of key product launches, product approvals and late stage clinical read outs in areas such as cancer, oncology and obesity. All areas the fund has exposure to in varying degrees.
Conclusion
In examining the health of the biotech sector, we find a generally positive story. Confidence in the sector appears to be returning, as reflected in higher levels of private and follow-on financing, and tentative signs that the IPO window is gradually re-opening.
It isn’t a universally positive picture, however, but rarely is that the case. Indeed, if the environment did look universally positive, it would inevitably be reflected in valuations and should be seen as a reason for caution, not optimism. Nevertheless, in the context of prevailing attractive valuations and potential long-term upside, we are encouraged by what we see.
After three years of bear market and consolidation, the entire biotech opportunity set looks in better shape. The evidence suggests that more investors are finding now an interesting time to invest in the sector. Investor attitudes towards biotech are inherently cyclical, and there may be potential for long-term returns to be favourable from this point in the cycle. We are confident that the IBT portfolio is well positioned to fully capture the opportunity that lies ahead.
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International Biotechnology Trust plc Risk Considerations
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