The ebb, flow and necessity of the biotech IPO
EY Global Biotechnology Leader
At the recently concluded 35th J.P. Morgan Healthcare Conference in San Francisco, New Year’s prognostications abounded, including about the fate of the biotechnology IPO market. (See here for one of the best.)
The IPO market is a critical indicator for the biotech industry. Because of the risk, duration and cost of drug R&D, innovation stage biotech companies cannot access enough private capital to bring an idea from molecule to market. Therefore, a robust capital market that syndicates risk across many investors is essential to foster tomorrow’s future innovations. In this context I was struck by the January 6 article, “America’s Roster of Public Companies Is Shrinking Before Our Eyes” in The Wall Street Journal. The article does an excellent job explaining the “de-equitizing” of the US economy, with implications for company growth, shareholders and income/wealth inequality.
Some of the statistics in the article are stunning — especially for a society that promotes and celebrates disruptive innovation (mostly) and the entrepreneurial dream:
- The total number of public companies in the United States has decreased 37%, or by more than 3,000 companies, since peaking in 1997 (a surprising year to me for a peak since it was the beginning of the dot-com market bubble).
- The number of public companies as of June 2016 approximates the total in 1982, even though the US economy doubled over that time frame.
- As a result, the market cap of the average public company is three times higher than in 1997 on an inflation-adjusted basis.
The article describes many trends influencing companies’ decisions to stay private, including the short-term outlook of investors, competitive disadvantages (from required public disclosures) and increased regulatory requirements and risks. In addition, there is the disappearance of small regional investment banks, which played a critical role in technology and life sciences deals in the 1980s and 1990s. When I worked on my first biotech IPOs in the early 1990s, there were several small banks that were willing to shepherd early-stage biotechs to market in transactions that commonly raised less than US$20 million. Today, a Series A venture round of that amount strikes us as modest, and the fees and subsequent trading income that would come from such an IPO would be insufficient to interest most investment bankers.
While the technology companies quoted in the article may have options to access sufficient private capital, this is not the case for biotech. Thus, public market access and capital is critical to the entire biotech funding ecosystem. For this reason, I thought it would be interesting to look at the trends noted in the article from a wholly biotech point of view.
According to data included in EY’s annual biotechnology report, Beyond borders, even though the number of public companies has decreased markedly across the economy since 1997, public biotech companies in the US have actually increased from 317 in 1997 to 458 at the end of 2016 — despite significant M&A activity over that period. This illustrates both how vital IPOs are for biotech and the expansion of promising drug development technologies and strategies over the decade since the human genome was first sequenced. This technology that has been supported by increasing levels of venture capital and a pharma industry more focused on external innovation than ever before.
However, in keeping with the broader market, the average market cap of a public biotech has also increased significantly, from less than US$300 million in 1997 to more than US$1.5 billion in 2016. Of course, the industry has matured since 1997 and commercial leaders such as Gilead Sciences, Amgen, Celgene, Biogen and Regeneron had a significant impact on the 2016 figures. If one excludes the top 10 companies by market cap at the end of 2016, the average is US$458 million. Thus, the market cap for development-stage biotechs has increased, on average, less than it has for all public companies. This is likely in part because the higher risk profiles of these companies tempers investor enthusiasm, even in an environment of limited investment choices. Biotech IPO “windows” open wide when generalist investors get excited about the sector and, for a time at least, become more accepting of the underlying risks.
The Wall Street Journal article notes that the 10-year rolling average number of IPOs in the US is less than 200. As indicated in the chart below, there have been 235 biotech IPOs over the last 10 years in the US, meaning that biotech has comprised, approximately 10% of all IPOs over this period.
It’s unclear whether the broader “de-equitizing” trend will reverse itself or what might cause such a reversal. The trend is certainly not the result of a lack of willing capital. It is clear, however, that the IPO will continue to be a key event in the development of most every biotech, enabling access to the wider pool of investors to sustain development over many years.
That said, the trend toward fewer (better capitalized) biotech start-ups may well mean that the aggregate number of public biotechs will climb only mildly. IPO preparedness is part of the standard playbook for every biotech management team, and the ability to seize market opportunities as they occur is a critical success factor.
As for 2017, I have no cause to disagree with other commentators — the IPO window is neither closed nor wide open. Barring some significant change in sentiment for drug stocks (say from a change in government pricing policies), I expect biotech to maintain its overall share of the US IPO total.