Noel Brown: Hello and welcome to Pathfinders, a new podcast series from RBC Capital Markets, where we'll be exploring the fast-moving world of biotechnology and what the road ahead looks like for companies and investors in this sector.
I'm Noel Brown, Managing Director, Biotechnology Investment Banking here at RBC with a special two part episode on a very timely topic.
It's no secret this has been a big year for biotech IPOs. Overall, 2020 is on track to post the sector’s highest IPO numbers in five years.
But even in a boom, undertaking an IPO involves risks that many biotech executives may be unprepared for.
In part one of this episode, we'll be looking at the best practices to follow on the road to going public. In part two, we’ll be showing you the steps to take to avoid some of the new pitfalls in today’s landscape.
With all of that in mind, let's bring in two of my colleagues here at RBC – Tim Papp, Managing Director, Healthcare Investment Banking, and Jason Levitz, Head of Healthcare Equity Capital Markets.
Tim, Jason, thank you for joining us.
Tim Papp: Good to be with you.
Noel Brown: So Tim, maybe we'll start with you. I'd like you to offer some perspective on what's driving the IPO boom in biopharma.
Tim Papp: Yeah. I think the question maybe is is the boom because of COVID, or in spite of COVID? And I think the answer really is a little bit of both. I think certainly COVID has driven an upsurge in interest in biotech and as a result, we've seen a lot of capital flowing into the sector on the buy side. Fund flows have been really positive over the six, eight months since COVID began.
Tim Papp: We've seen a lot of interest not only on the IPO side, but on the crossover side. And the depth of the market is as probably as good as it's been for the long-onlys and specialists, with a little bit of participation from the growth sector as well. When you look at what's driving the IPO side, it's largely driven on the demand side. There's a lot of appetite for IPO paper.
Noel Brown: Jason, any thoughts on how IPOs have changed, virtual road shows, what impact that's had on just the process generally?
Jason Levitz: Two high-level points I think around the process that have evolved over the past several years. The first is what Tim alluded to in his comments about the growth of the crossover market. And by that, I mean investors looking at pre-IPO investment opportunities to then follow through and participate in IPOs. That dynamic which was once unique to biotech has actually spread more broadly into the growth IPO market. And it's because of those investors driving interest at the outset that we've been able to deliver these really positive outcomes around these biotech IPOs over the last number of years.
Jason Levitz: The other key point relates to the more recent COVID period, and our ability to get deals done in the virtual environment. And whereas traditionally, the biotech IPO was called an eight or nine-day physical roadshow, the current paradigm and format has been compressed into a much more efficient four-day virtual process, done exclusively through phone calls and Zoom meetings. And because of the first factor I mentioned, meaning the deals are largely subscribed at launch from existing investors and crossover investors, we're able to compress timelines and get deals done in a really efficient way, leveraging that existing investor participation, to get deals done that are ultimately multiple times over-subscribed and trade well in the aftermarket.
Tim Papp: And I think we've seen that demand result in some real pricing tension. Roughly 60% of IPO's have priced in the range and the remaining 40% have priced above the range. We haven't seen an IPO priced below the range this year, so, the appetite on the investor side is really driving some pricing intention in the favor of issuers.
Jason Levitz: Just to circle back on a point you mentioned earlier, what's driving demand in the market? Well, a lot of it has to do with post-deal performance and our investors making money. There have been 59, five nine, biotech IPOs year-to-date. And if you bought all of them, you'd be up 42% on the year. And so, the fact that these deals have performed as well as they have, and as Tim mentioned, are largely pricing within or even above initial expectations, has created a much more transparent environment both for issuers and investors, and that transparency has facilitated the boom and I think is one of the primary reasons why we think it'll continue.
Noel Brown: I'd be interested to hear both of your thoughts on will this boom ultimately slow down? Maybe we can start with you, Jason, and then go to Tim.
Jason Levitz: Yeah, look, I think it's a great question. And for those of us that have been around the sector for 20 plus years, we've seen the ebbs and flows.
Jason Levitz: And while there are certainly risks that post-deal performance will deteriorate,I think given the dynamics I mentioned earlier around the fact that deals are well-subscribed and well-positioned to succeed at launch, number one. And number two, there's still a tremendous amount of capital looking for a home in both the private and public market in the sector, suggests that this boom should have more legs.
Jason Levitz: And then look, there's a chance that we see just a raft of clinical failures and disappointments in the sector. I think that's always a possibility, but our view is while that risk is there, it's mitigated by the breadth and depth and quality of companies out there.
Tim Papp: Yeah. I think that's a good point, Jason. And I think we will be remiss if we didn't talk about the quality of the company, the quality of the science that comprises the 2020 IPO class. Companies have gotten better at identifying opportunities and bringing high-quality programs, platforms, technologies to market and together with a collaborative FDA, a collaborative funding environment, we're seeing better companies with more interesting science and new modalities that really are underlying the interest.
Noel Brown: I agree with you. I think there's been a really exciting maturation of the industry.I think about, say, how things were back in the early 2000s and biotech was really the space of very niche specialists that had very small funds. We had sort of an intellectual advantage that these scientists had over the rest of the market because their knowledge was so far beyond what we could appreciate that we were dazzled by it.
Noel Brown: And we were dazzled by things that frankly perhaps had less rigor around it. Not that anybody had any ill intention, we just didn't have the intellectual filters in place to assess what was great technology, what was going to ultimately become a drug, what was a well-run trial, what was a well-designed trial. So, there's been tremendous amount of progress around the market generally, the investors as market participants. When we go to roadshow meetings now, it seems like almost everybody's an MD PhD, whereas back in the day, that combination was pretty rare.
Noel Brown: So again, there's been incredible advancement on the side of the investors. There's been incredible growth in capital because back in the day, a big fund in biotech was a couple hundred million dollars, we're now facing multi-billion dollar funds. I mean, again, going way back, deals really had a dependence on the generous community in order to get done decently.
Noel Brown: Whereas now, you can get a quality deal done just among "healthcare specialists" or biotech specialists. So the pool of capital specifically dedicated to biotech has grown tremendously And I think that weaves into why we won't see some of the crashes we've seen historically in this sector.
Jason Levitz: Yeah, Noel, maybe one other point is the availability of capital and the quality of company has really led to a scenario where the majority of companies are coming public with extremely strong balance sheets. On average, pro forma the IPO, the average 2020 biotech IPO has roughly 28 months worth of cash.
Jason Levitz: So, when you reflect on that quantum of funding, it's clearly taking the public investor through several potential value inflection points. So when you think about one of the challenges that companies in earlier cycles we have faced, obviously these companies are capital users and require additional funding in the public capital markets. But because these companies are such high quality, one, as Tim mentioned and two, Noel, as you mentioned, the availability of capital is such that with the crossover financing and the IPOs which are skewing larger in size... we're seeing companies that are really well-funded and really well-positioned to manage through multiple value inflection points, which is great for the public investor, because it gives the company a lot of time to build on their success, prosecute their pipeline, do it in a way without substantial financing overhang. And it gives the investor time to wait for the company to succeed.
Noel Brown: It's interesting. We've gotten to this point where we have investors offering up to companies more capital sometimes than they're even looking for, I mean, companies are going out saying, "Well, I can kind of get by $50 million bucks," and then having the investors turn around and say, "Okay, but what can you do with 100?" To your point, the market kind of wants to see these companies succeed, They're buying into the longer-term vision in a way that I think frankly sometimes throws off some of these management teams,
Tim Papp: Yeah, I think investors are looking to fund not just more clinical activity, but certainly accelerating some of the CMC work and making sure manufacturing is ready to go forward, especially with some of the advanced modalities, with the idea that you're going to need that in order to attract either one, big pharma interest in a potential takeout, or if you're going to launch it yourselves, you're going to have to make that investment. And we don't want to be in a position where we're delaying activities on the commercialization front down the road because we didn't make that investment upfront.
Noel Brown: So, following up on that discussion about how strong the IPO market has been, perhaps Jason, you could talk a little bit about what are the predictive key success factors for an IPO today?
Jason Levitz: I'll hone in on one specific topic, which we've talked about quite a bit, but I think is probably the most important predictive factor in today's market, which is the company's ability to attract long-term focused high-quality investors with deep pockets. And I would say, when you look at the successes in the biotech IPO market over the last number of years, there's certainly a number of investors that pop up. Both the healthcare specialists that Noel referred to earlier, but also a select group of the large long-only mutual funds that have been active in the private market as well. And what I think that highlights is the critical importance of investor- outreach very early in a company's life cycle. So once the series A or the seed funding is done and the company starts to take shape, and the science is prosecuted, it's really almost never too early to get out and start to meet investors in the ecosystem that will ultimately drive later financing rounds and serve as a prelude to the IPO. Because, again, as far as predictive factors go, having those reference investors involved is critically important.
Jason Levitz: And in addition to capital, I think the other value add that those investors provide is having sort of a third-party endorsement, because the general investor community understands that this group of investors will do a tremendous amount of due diligence, KOL checks, market analysis. And so that validation becomes critically important. In years past, often we would say companies would need some form of a partnership with a large pharma or large biotech company in order to provide that validation. I think investors today to some degree can provide part of that. Obviously, and Tim, I'd be interested in your thoughts, maybe to transition on the importance of corporate partnerships and business development around predictive factors for success.
Tim: Yeah, I think partnerships can still play a valuable role, even in today's environment where the capital is flowing relatively freely. I think the importance is, as you're saying, it's more on the validation side of the equation rather than the ability to attract non-dilutive capital. I think a lot of investors would rather see unencumbered programs, unencumbered assets that don't have partnerships attached to them. But maybe if it's a platform company, having some earlier stage programs that you're working on with a partner can diversify the risk a little bit by having more programs in play. But I think any partnership really needs to fit in with an overall strategy that you're articulating at the time of the IPO. And it has to really fit with the vision for what this company wants to achieve. Simply having a partnership for the sake of having a partnership is less valuable today.
Jason Levitz: Noel, one other topic I think we should address, because it's clearly an important predictive factor of success, is just company focus, whether it be modality, therapeutic area. I think there's a clear bias toward areas like oncology, gene therapy, rare disease. So interested in both your thoughts around focus areas that investors seem to be spending the most time.
Noel Brown: Yeah. that's a great point. We've all seen these ebbs and flows of investor interest in either therapeutic areas or in modalities. Right? I mean, I remember back in the day, most people were saying, "Well, rare disease. That's not a very big market. I'm not all that interested." Whereas, ultimately, that's now become the source of tremendous focus, pricing has been in favor of rare diseases
Noel Brown: We've gone through these waves of, "Well, small molecules are great because they're simple to manufacture, " to, the more complex end of the spectrum with gene therapies. And that's now kind of become the great focus of the market. I think the success of a gene therapy now having reached the market, and treating patients, has really opened up the opportunity for that whole field. But that's really around modality. And I sort of see these as two currents, right? There's the therapeutic areas, and then there's the modalities. The modalities come and change and evolve depending on the success of technologies
Noel Brown: The therapeutic area, it's really a function of societal squeaky wheels, I mean, where is there most need? Oncology just is so prevalent, regrettably, so it will always be one of the spotlight areas in the broader landscape of healthcare. But we also start to see things become more of a focus as therapies become available. There are certain diseases that many of us never even knew existed until there was a drug available to treat it.
Tim: I just think the risk reward balance is shifting more towards investors being willing to accept a higher level of risk for that greater reward. That's, I think, what's driving some of the interest on the earlier stage preclinical phase one success IPOs, is the ability to get a meaningful answer from initial phase one data ... First in man is essentially first in patients. You don't have the steps of going through the healthy volunteers for any of the gene therapies really, and on the oncology side as well.
Tim: So I think the ability to get answers quickly, and see a return relatively early post IPO is important. If you look at some of the later stage IPOs that get done, you're waiting 12, 18, even longer, months for a meaningful data event. And I think investor appetite is for shorter duration before they see that opportunity to realize a return. They want to be confident that this company is on the road to success. And I think also the earlier stage companies tend to have multiple assets, multiple shots on goal much more readily than the later stage company. So you're investing less money, less time to get to meaningful data events.
Noel Brown: Agreed, agreed. And I think sort of circling back to your original question, Jason,I think for Tim and I, we have to be mindful of what ultimately is going to be an investor hook. And clearly right now it's gene therapy, I mean, gene therapy has really come into its own. In therapeutic areas it's now really become quite broad because I think there's been a broader acceptance of the fact that with the right therapy a lot can be done, so long as there's an environment to properly price and launch a drug.
Noel Brown: But what the market is interested in changes so quickly, Because if you think three years ago, everything had to be immuno-oncology. It was IO, IO, IO. It burned really brightly, and then kind of faded. IO is still important, but now it feels like everybody's trying to somehow weave in a gene therapy angle because that's become super hot.
Noel Brown: What I find fascinating though is when companies start to feel that the market wants you to be a certain thing and they try to recast it in order to end up in that category of companies that investors want to go to.
Tim: Yeah, I tend to think companies that really try and fit themselves into a category where they don't belong, I think ultimately that can be a losing battle just because I think investors see through that. They're able to identify what a company really is at its heart. And you may be able to fool people in a short period of time, but over the longer term it's not going to serve you well to try and meet what the flavor of the month is.
Jason Levitz: One other predictive factor is ultimate M&A appeal and opportunity with either large pharma or larger biotech. Obviously, the M&A calendar has picked up a little bit. We've seen some large transactions announced recently. And clearly that's part of the investment thesis for prospective IPO investors, is thinking about the ultimate opportunity as a potential sale candidate to drive return. So how much do you think that factors into predictive factors around IPOs?
Noel Brown: It's a great question, because I think that also ebbs and flows. I think back to the 2005 to 2008-ish era, where companies, be it either private or small cap publics, were getting bought left and right by pharma. There was this constant messaging of, "We've got these patent cliffs coming up and we need to restock the pipeline." And there was just aggressive buying. And then the market kind of cooled off. And I think there's still this need, there's still these pipeline gaps, but there's an increased prudence by the acquirers. And maybe there's been a lot of internal development that's gotten them comfortable with the fact that they can develop drugs on their own.
Noel Brown: So all that said, when I look at companies that are about to go public, I think how dependent is this company on being acquired to see commercial success of this drug, assuming they can get through everything from a clinical and regulatory perspective? So in other words, is this company focus an indication that they can self launch and commercialize and be successful? Or are they one that no small company could ever launch? If you're doing rheumatoid arthritis, you just can't do that on your own. So if it's one of those large indications, then I think, "Well, how attractive is this company to an ultimate acquirer, be it sort of a mid cap or a large cap pharma?"
Noel Brown: And so then it brings in a whole host of other questions about whether or not this'll be an ultimate success, because you have to start thinking, if it's a gene therapy company, for example, are there some manufacturing advantages that the company has that would be a solution for a potential acquiring pharma? Or is the technology somehow complementary or lock and key fit with what multiple acquirers do not yet have in their suite of technologies? It really comes into play quite often, frankly, in the IPO process, and I think more often than we realize, because many times companies are on a dual path where they're both in M&A dialogue while they are preparing for an IPO.
Noel Brown: I think not having a reliance on either path strengthens your bargaining power in each of those processes, You're likely to be more successful in M&A, or at least come to it with a stronger commitment to a successful deal, if you know your default is, "I'm just going to go do a great IPO." You're also less likely to take a poor valuation, in an IPO if you know that the alternative path is a successful takeout on the M&A side with another company.
Noel Brown: All right. Tim and Jason, thank you both for your insights on all of those predictive factors for success in today’s IPO markets. In part two of this special edition of Pathfinders, we’ll be looking at some of the new pitfalls and potholes that have emerged on the road to IPO.
Until then, thank you all for joining us. If there's any area that we discussed today that you'd like more information on, please don't hesitate to contact us directly for a more in-depth discussion, or visit our website for further insights.