This Biotech Bear Market Too Shall Pass

THE COWEN INSIGHT

We analyzed biotech bear markets back to ’98 and compared the fundamentals of the industry today to those that were in place when the more recent ones ended.

Biotechnology Market Conditions

Biotech investors are depressed, unengaged and feel doing fundamental work is futile. We are often asked the timing of when the sector could return to favor, and what could spark a recovery. As Niels Bohr said, “prediction is very difficult, especially if it’s about the future,” and we think this is particularly the case when assessing sentiment swings toward biotechnology. Nonetheless, we believe that an analysis of prior biotech bear markets and of the industry’s fundamentals can provide insights into the prospects for performance.

Analysis of Previous Biotechnology Bear Markets

We have analyzed the duration and depth of prior biotech bear markets dating to 1998, the ability of the balance sheets of the 194 biotechs under coverage to fund operations, the prices of a representative basket of biotech products over the past ~20 years, the prospects for meaningful drug pricing legislation, the FDA environment since 1993, the correlation of biotech stock performance with aggregate industry revenue since 2000, and the industry’s prospects for growth through 2026.

Key Takeaways from Our Analysis

We conclude that:

1. this biotech bear market will end just as all prior did
2. 95% of covered companies have at least one year of cash to support operations so can weather a downturn
3. SMIDcap valuations have retrenched, though admittedly do not appear overly cheap compared to historical levels, nonetheless
4. as biopharmaceutical prices have increased over the past decade, end markets and hence pipelines should be worth more now than in the past
5. innovation is alive and well in the industry with products being launched at a steady pace, thus
6. the biotech business model remains poised to deliver meaningful revenue growth over the long term

While these analyses do not guarantee that there is no further downside or that this biotech bear is about to end, they do suggest that it is a matter of “when” and not “if” growth investors will return to the sector.

Key Catalysts

We suspect clarity on the potential for drug pricing reform, through either the passage of the current proposal or the abandonment of the legislation, will lift an overhang on the sector. The number of NMEs approved and the number of FDA review cycles necessary over the coming quarters will inform about both the productivity of biotech pipelines and the accommodativeness of the regulatory environment. Our analysis makes it clear that the value of biotechnology companies is highly correlated with revenue, and that strong product revenue growth is a key driver of the outperformance of the biotech industry. Therefore, perhaps most important to watch will be revisions to long-term forecasts for product sales.