By Ailsa Craig and Marek Poszepczynski, co-investment managers of the International Biotechnology Trust
With long-term drivers of demand including an ageing population and accelerating scientific innovation, the biotech industry remains on a stable and long term growth trend. However, the investment cycle in biotech stocks does not always reflect this, with new technologies and shifting sentiment often driving exaggerated highs and lows in share prices – which investors can exploit.
We have identified five stages in this investment cycle: despair, recovery, equilibrium, euphoria and correction.
The most recent loop around this cycle was exaggerated by the Covid-19 pandemic, which increased focus on the biotech industry. This led to a rise in retail trading over lockdown, but the subsequent comedown in the Spring of 2021 was equally sharp and the biotechnology sector has now lagged the market as a whole for two years.
However, there is a glimmer of hope on the horizon. At the moment, we think the market is alternating between recovery – in which the pace of mergers and acquisitions (M&A) kickstarts and valuations start to recover – and equilibrium – in which there is an influx of capital, a steady stream of M&A and an active IPO environment.
Signs of a silver lining
There are several signs experienced fund managers will be looking out for to give them confidence in a genuine recovery. During 2022, M&A in the sector picked up, with appetite driven by the combination of impending patent expiries and large cash balances at the big pharmaceutical companies. This has continued into 2023, with major deals taking place such as Amgen’s recently completed $28bn takeover of Horizon Therapeutics.
The reopening of the IPO window is another positive sign we could be moving from the recovery phase to the equilibrium phase of the investment cycle. In early May, J&J successfully spun off its consumer healthcare arm Kenvue, raising $3.8bn, the largest ever IPO in the sector and one of seventeen biotech IPOs so far in 2023.
Access to equity finance is key to establishing an equilibrium in the valuation cycle.
Restless investors rally for results
As the biotechnology sector moves out of recovery and into equilibrium, there also tends to be an uptick in shareholder activism.
We believe shareholders become more assertive during this period because they are frustrated with the lack of activity and lacklustre returns during a protracted downturn, so they start to rattle the cage in order to extract returns on their investments.
Investors may feel the market recovery is taking too long, and they need to take proactive steps to accelerate the next phase. They might also think management at individual companies are failing to live up to expectations. There has been an uptick in such shareholder activism in 2023.
In April, the hedge fund Farallon Capital sent a letter to the board of Exelixis announcing its nomination of three directors to the board. The hedge fund said the biotech firm should focus its research and development efforts, communicate a differentiated and coherent strategy and commit to ongoing distributions of excess capital to shareholders. The company was initially reluctant to support the nominations but then capitulated and all three Farallon candidates were elected at the May AGM and a share repurchase program commenced.
In June, Illumina CEO Francis deSouza resigned from the company amid pressure from activist investor Carl Icahn. The proxy battle was sparked by the market punishing the valuation of Illumina after deSouza pushed ahead with the acquisition of cancer blood test developer Grail in the face of opposition from the US FTC which continues to challenge the deal. Icahn supported the new CEO Jacob Thaysen at the September AGM. Subsequently in October 2023, the EU regulators ordered Illumina to dispose of Grail, dismissing Illumina’s claim that Grail’s lack of EU revenues put them outside the EU’s jurisdiction.
Following on from its resounding success deposing the chairman and imposing seven new directors at Amarin in March 2023, Sarissa Capital embarked on a third proxy battle at Alkermes, aiming to secure its choice of three new board directors. Sarissa accused Alkermes’ board, which already includes one previous Sarissa nominee, of overseeing “tremendous shareholder value distruction” but failed to win sufficient broader shareholder support to depose any directors in the June 23 AGM.
More recently, in November, we saw another established biotech company, Biomarin, come under attack with Elliot Management reporting a $1BN investment into the company. The company which is valued at c$16BN saw a share price rise of 12% on the news. The timing was interesting as Biomarin recently announced that its CEO Jean-Jacques Bienaime who had headed up the company for 18 years, was being replaced by former Genentech CEO Alexander Hardy.
As well as shareholders agitating for better management of biotechnology companies in order to improve share price performance, they will also start to pressure biotechnology companies to be sold. For example, in April, MKT Capital wrote to fellow shareholders of Aurinia Pharmaceuticals asserting the company was worth over 190% more than the prevailing share price, urging them to join MKT in withdrawing support for the current board and pushing for the company to be put up for sale. Two directors, including the Chairman, tendered their resignations after failing to gain majority support in the May 2023 AGM. In July 2023, Aurinia’s Board announced that they would initiate a review of strategic alternatives including a potential value-maximising sale and in September, MKT’s candidate Robert Foster was elected to the Board.
There remains strong evidence to indicate the biotechnology market is on the cusp of moving from recovery to equilibrium, and we are cautiously optimistic about its trajectory.
