Joe Coletti: Hello and welcome to Pathfinders, a podcast series from RBC Capital Markets where we uncover the key trends and catalysts shaping the fast-moving world of biotech and pharma. I'm your host, Joe Coletti.
In today's episode, we're joined our co-heads of Healthcare Equity Capital Markets, Jason Levitz and John Hoffman.
This week we’ll taking a look at the key themes and transactional trends within ECM, including how the market environment for both private and public companies evolved over the last year, what the acceleration of strategic interest in biotech may signal moving forward and what it takes for private and small mid cap biotech companies to succeed in today's capital markets environment. Now let's dive into the conversation.
Let's kick off quickly by first diving into the macro picture. John, maybe we start with you. How are macro factors affecting the biotech equity market right now?
John Hoffman: It's been a pretty volatile year across the equity landscape as a whole, and certainly within biotech, which has run true for a couple of years now. Lots of different cross currents in the sector. A couple of words come to mind. It's volatile, it's constrained. Generally a sector that feels like it's underappreciated against a backdrop where on one hand, there's these persistent major tailwinds that continue to catalyze the space from a fundamental perspective in a very positive way. You have scientific innovation that continues to make new leaps and bounds across a whole host of therapeutic areas and modalities. M&A activity that's gotten decidedly more competitive, which is something that hasn't really transpired for a couple of years now. You're starting to see multiple bidders in these M&A processes, which is a great leading indicator around what large cap biotech and pharma is thinking about all the novel developments within the smid cap space. You have companies that are operating with newfound capital discipline, which I think is a silver lining and maybe a byproduct of a market that's become more challenged. FTC concerns are abating a bit around smid cap M&A, which is great. And FDA approval rates tracking towards historical norms, which again is another reacceleration of a very positive trend.
On the other hand, there's these macro factors at play that have really constrained the sector and weighed on investor psychology within the space, predominantly related to interest rates and what that means for long duration assets, which biotech naturally is. Clearly, it's an industry that's predicated on future cash flows and future progress. So anytime you have these spike in interest rates, you tend to see these sectors trade with a bit more volatility. And that's been something that's clearly been playing in the sector for a bit of time. And also I think there's been some regulatory actions that outside of the control of any one company within the particular space that also has weight on investor psychology, notably the IRA, which hopefully is something we can get into a bit more detail on. But on balance, the sector has done a really good job controlling the controllable and it's just dealing with these macro factors that has really kept people a bit on their back foot throughout the course of this year.
Joe Coletti: John, how difficult is it to still raise funds and deploy capital in this environment? What are you seeing out in the market right now?
John Hoffman: Right now we're in a very constrained environment where the specialist investor is really the predominant source of capital and source of incremental buyer for all the publicly listed equities and the private companies as well. But I'd argue that tracking just the broad XBI is not necessarily telling the whole story. There's lots of different subplots and I think things that are happening beneath the surface that gives me some comfort that where we're heading to right now is a period of time where I think there's a bit of an emerging rationality to the market.
Clearly, it's a tale of two cities where you're seeing the market bifurcate into the haves and the have-nots. So long as the top performing companies within the XBI can outperform the top performing companies within non-XBI or non-biotech areas of the market, I think that's a really healthy backdrop to continue to see specialists able to raise funds, deploy capital prudently and ultimately kind of underwrite the risks and opportunities that many of these companies present themselves with. There's also, I think, some real tailwinds that we're seeing in the past couple of weeks here that hopefully catalyze enthusiasm for the space into the back half of this year, into Q4 and early next year. The number of companies that have had widely tracked and anticipated clinical and regulatory milestones in the past handful of weeks that have tracked positively has clearly outstripped what we saw in the beginning part of the year. You can probably list off 10 or 12 companies that have seen 20, 30, 40% stock price reactions in reaction to some really meaningful clinical progress and regulatory progress that they've made. That's obviously why people invest in the sector, and I think it provides hopefully a tailwind at a really beneficial time as we track towards the end of the year here.
Joe Coletti: John, what are your thoughts on the return of the IPO market?
John Hoffman: It's been very muted compared to historical norms. But you've started to see a number of companies access the market. We finally had two companies access the market at the same time just a few weeks back in the Numora transaction and the RaiseBio IPO. Both really, really high quality situations. We had the fortunate benefit of being part of the Numora transaction. And when you cut through all the different ways to assess a transaction and its success, Numora did an exceptional job raising a whole lot of capital, so $250 million, bringing their balance sheet to north of $500 million, enabling them to fund three clinical phase three studies and attracting new investor interests, which is not something that's always present in these IPO markets that we have for biotech.
And so hopefully we start to see all these different positive factors come into play and set the stage for a more robust end to the year and a fruitful start to 2024.
Joe Coletti: I want to stay on the macro thread a little bit longer here before we move on. Maybe we go over to you, Jason. I mean, you could say the factors have been fairly dynamic throughout the course of at least the last 12 months. Let's talk about your conversations with companies and investors. How has it changed? How have they evolved basically over the last year?
Jason Levitz: Yeah, it's a great question. Look, the fact of the matter is we're kind of in a new normal. For those of us who've been around the sector for a long time, we were kind of spoiled from 2012 to 2021. And I think over the past couple of years, we're back in an environment, as John outlined, that's challenging for issuers and investors alike.
And not surprisingly, given the market volatility we've seen, companies have had to change their development strategy in order to operate efficiently in what's clearly a much tighter capital markets environment.
So for companies that might mean streamlining operations, deprioritizing earlier stage or non-core programs, we've had many conversations with C-suite executives about how their catalyst calendar, which is usually centered around the timing of their clinical data cadence and releases can help shape their financing strategy. Companies really need to think creatively about different forms of capital. Could be venture debt, royalty financing, strategic capital, grants, et cetera, depending on their stage of development. But it's really been an environment where you need to use all available sources of funding to advance your pipeline and get creative.
Also, I'd say investor connectivity has never been more critical. John talked a bit about the specialist investor. They continue to be the lifeblood of our sector. Most financings that we see done in the public, and frankly private markets, are driven by existing investor demand. So investors continuing to support capital they put to work earlier in company's life cycle. The most successful transactions that we see done in the public markets leverage those existing relationships but also tap new investors.
And that creates challenges for issuers. You have to be one eye on your pipeline and business development and one eye on capital formation and thinking about investor connectivity. The good news is, and John alluded to this, we continue to see capital available. And in fact there are new pockets of capital developing in our market. For one new fund launches continue perhaps at a slightly slower pace than we've seen over the past couple of years, but we continue to see PMs and analysts transition and raise new capital, which is getting deployed in the sector. And also, I think, and this is particularly interesting, a number of high-profile, largely private-focused venture capital firms, those that traditionally focused on early-stage investing and company formation, they see some of the value dislocation in the public market.
And so they've created separate sleeves of capital for public company investments. So the good news is despite the volatility we're seeing, despite the challenges that companies face around continuing to fund their business, there's capital available to put to work. The flip side is not surprisingly, investors are increasingly selective.
Your data has to be robust and meet investor expectations in order to see the stock price reaction for public companies to catalyze a capital raise. And our sense is that investors want to fund fully their highest conviction ideas rather than spread capital too broadly. So what that means is, again, you have to find the right investors. They have to have conviction. And when the time is right, you have to strike and raise the capital you need to continue to fund your business.
John Hoffman: One of the really interesting byproducts of a tough market environment that we've lived through right now is I think companies and investors alike are demonstrating a real ability to be agile. So the agility of an investor to invest privately or publicly structured or unstructured under CDA where they take information in on an asymmetric basis from a company and really take a leading voice in helping to position a clinical data set. All of those, I think, are really healthy dynamics for the sector over a longer term time horizon.
Joe Coletti: John, can we pivot a little bit and talk about kind of what you're seeing across the private company landscape in particular and how companies have been reacting there?
John Hoffman: Yeah, for sure. I mean, I think the juxtaposition of increased appetite on the strategic side, new flavors of capital from strategic being invested into companies, either on the public or the private side, juxtaposed with a capital raising environment that's gotten decidedly more challenging has really just led to a much more robust conversation around companies evaluating their different option sets. If you dial back the clock a couple of years ago and you sat in an IPO organizational meeting like we all were doing almost on a weekly basis, the entire conversation was centered around a pretty formulaic approach to how private companies were thinking about one singular option, and that was just sprinting towards the IPO market as quickly as possible with as few friction points that acted as hurdles along the way.
Joe Coletti: John, you just mentioned a lot of different things, a lot of different dynamics, you know, as the market landscape, you know, continues to evolve. What kind of advice are you giving to clients?
John Hoffman: Today, I think how we're advising our companies is to be a bit more thoughtful in the different tracks that may be pursued, whether it's a traditional dual track process of exploring strategic interest in light of a capital need and a potential IPO or even triple or quadruple tracks where you're evaluating things like an extension round, a further crossover round, thinking about coupling that strategic process with an IPO. There's just many different flavors that these processes can now take shape in order to really deliver against a complex set of objectives as corporates think about their capital needs over a much longer time horizon than what we were thinking about them as really just optimizing for speed to market and an IPO. There's also different ways in which companies can raise capital now that I think were not necessarily viewed as either available or preferred. You have things like reverse mergers, which depending on different market cycles become in favor or track to be out of favor. Right now, I think there is a real preference in waiting around. Just making sure that you understand what those different options are and whether it winds up being a reverse merger, that's the best path for a company to think about going public and taking advantage of some of the cash rich shells that exist in the public markets or marching down a path where maybe you go straight to an IPO instead of in lieu of doing something that's a two-step sequential process, which was what characterized the IPO market for many, many years.
So there's lots of different, lots of different considerations that are now in play that I don't think we’re necessarily discussed when the market was a bit more permissive.
Joe Coletti: So how should companies, others thinking about this, what advice would you give them to navigate this landscape now?
John Hoffman: Yeah, it's a great question. And I think in terms of process where maybe we were once focused on speed of execution, taking that step back and doing things like running an action-oriented testing the waters process, where maybe historically we were focused on one-sided feedback of, is an investor interested in the company? Yes or no. And really, you just kind of had a little bit of feedback from a company's level of interest. Now, I think it's incumbent on companies, and RBC, and the rest of the syndicate to ensure that as we engage with shareholders, we try to generate two-sided feedback. We understand that if an investor has interest in a particular IPO situation, how does that potential investment fit within their portfolio? How are they thinking about their return objectives? How do they think about the relative position size of that particular investment relative to the other investments that they have within the portfolio? Are there any risks or opportunities that a company should be aware of with that particular investor, such as do they have binary risk exposure or upside exposure to a particular public situation that may exist that's not related to the company?
The other area that I think we need to be very thoughtful about is in and around IPO execution strategy when it actually comes to building the book of demand. Oftentimes, there wasn't a kind of an effort put forth to build a demand curve and understand the trade-offs between if you raise an X million dollar size round, that means Y for the type of order book that you build, or if you price at a certain level, this is what it means to leave certain investors behind that won't be a part of the actual transaction. So having an understanding of the trade-offs in that demand curve build through an IPO order book process is I think another big area of focus that we have for our clients as they think about accessing the market in the next, call it a quarter to four quarters here.
And then finally, I think just being really smart around the IPO timing decision and not necessarily having an IPO process that's a little bit formulaic and predicated on how the SEC may prosecute your comments, etc. be the determining factor around what the right IPO window is for your particular company. Thinking through things like competitor news flow or thinking through things like is the market likely to be crowded or a little bit less crowded with other IPO product and how does your story fit in with the different potential IPO competing supply that may exist at that point in time. So I think there's lots of different pieces of information that can be ignored in a more permissive environment that we need to take a step back and incorporate into the logic that we have around what makes sense for a particular company as they assess the path to IPO, where there's maybe a newfound appreciation for all that information that can be gathered if you're a bit more customized and bespoke in how you think about executing your IPO.
Joe Coletti: What are the implications for investors? For example, if companies are forgoing traditional private crossovers or going straight to IPO instead, what changes?
John Hoffman: Yeah, well, it definitely requires a rewiring of the common school of thought of what was required. And I don't think that this is an alternative that's available to every company, but certainly I think there are situations where there's good industrial logic to have a discussion with investors that for a particular company, does it make more sense at a certain valuation to take that company public with anchor quality demand that represents new investor demand? And ultimately have the clinical success and regulatory success play out in the public markets versus trying to contort the capital raising process to meet historical paradigms. So first, I think the implication is a little bit of an open-minded discussion with investors around that potential reality for certain companies. I would argue that it's a pretty favorable backdrop if you're an investor, because ultimately what it probably means is companies are coming out at valuations that are not as elevated as what they once were since they were mostly defined by things like step up multiples between that crossover round to the IPO. So that's a really, I think, interesting potential path forward. And it becomes even more interesting when you compare it to public market alternatives where valuations are naturally depressed for competitive assets that investors may be thinking about investing in the public space.
For companies, I think it requires, one, a lot of board education for sure. And two, an acceptance of potentially needing to do a larger size IPO where you're collapsing two financings into a single financing. So maybe bending the norms around typical statistics that we would look at like percent of market cap offered or acceptable dilution at a certain price. So there's a little bit of, I think I would characterize it mostly as rewiring of the thought process. And again, this isn't going to be something that's available to everybody, but I think it's kind of one of the topics that is worthy of consideration.
Joe Coletti: So let's switch over to the public market backdrop. And I'm gonna go back to you here, Jason. How is what's happening in the public market different now or the same?
Jason Levitz: Yeah, certainly a lot of similarities. I think, you know, John alluded to this to some extent around private market capital formation, but we really had to throw a lot of the traditional financing norms out the window in biotech the last few years. You know, if you talk to most ECM professionals, they'll tell you we focus on percent of market cap or multiple of average daily volume in order to think about market capacity and optimizing financing outcomes.
But we've really seen that change in the last few years. It's been driven by two factors. I think one is the compression of valuation and market caps, which make it challenging to raise modest quantums of capital, and do it in a way that's not particularly dilutive. The other challenge or driver has been investors who have said very clearly, we want to fund businesses we like through a meaningful clinical catalyst and value inflection point. And in order to do that, we may need to put more capital in the business than perhaps the company wants given the amount of dilution required. But ultimately companies understand that driving the pipeline forward, ultimately irrespective of dilution is what's critical to create value for investors. And so we've seen in many cases, what we'll call true recaps of public companies where the amount of capital raised in some cases exceeds the existing market cap. And that's something that is fairly unique in biotech, but I think is purpose driven because companies need that amount of capital again to get to whatever the next milestone is. And investors aren't shy in particular if they're already existing investors around supporting those investments and ensuring companies have the requisite capital. But I think the other key point is that companies have had to be more nimble. And that means staging financings, finding different sources of capital. I'll share two examples we've been involved with over the summer. One is Caribou Biosciences, which secured mid-year, a $25 million investment from Pfizer at about a 30% premium to the then prevailing stock price, followed that up after a clinical data release with a very successful $125 million public offering. So in a two-step process over a relatively short period of time, the company raised a substantial amount of capital and fortified the balance sheet.
Second similar example was for Veristem Oncology. Veristem early in the year raised up to $60 million in a two-trunch private placement from a single high-profile specialist investor and followed that up mid-year, following some positive clinical data at ASCA with an $85 million public transaction. So these are two good examples of how companies have capitalized on significant events and sourced capital creatively in order to round out the balance sheet over an extended period of time.
I think the other interesting dynamic we're seeing in public markets is the return of more structured tailored financings in the form of either PIPES, that's private investment in public equity, or registered directs, which are effectively private placements done with a registration statement. If you look back pre-2021, we didn't see a ton of PIPE activity.
But if you look at ‘22 and ‘23, we've seen, to give you a sense of the order of magnitude, around $4 billion of capital raised in that format in ‘22, versus $15 billion roughly raised overall by public companies. And in 2023, we've seen almost 5 billion raised in that format versus roughly $14 billion in the public markets.
Joe Coletti: Jason, why do some of these things that you just mentioned make more sense for certain companies now?
Jason Levitz: I think there are a number of reasons why pipes and registered directs have made more sense. I think one is, as John outlined earlier, providing some investors with asymmetric information in order to de-risk transactions. And by that I mean, sharing clinical data with a select group of investors in order to generate demand ahead of a public announcement to ensure a successful execution, wanting to raise the quantum of capital needed for the company. So I think that ability to share clinical data early with a select group of investors has really opened up transaction opportunities to companies that might not have existed otherwise.
And look, there are issues associated with PIPES. There is a period of investor illiquidity. There are some structural permutations that you have to address in order to get these deals done in large size. But ultimately, the risk reward for investors coupled with a company's ability to... to raise perhaps more capital or in a more structured targeted way than they would otherwise has really ignited interest in this market. And I think you'll see more creativity. You'll see more staged and structured financings. And you'll see financings with multiple pools of capital, again, whether it be strategic, single investor privates followed by public transactions, as I mentioned earlier.
I think the last piece of the puzzle just around financing alternatives and public markets I want to touch on is the ATM and how that's facilitated capital access for public companies and allowed them to be nimble. These facilities are important in two ways. One, they allow smaller companies to kind of raise capital as they go. And so raising small quantums of capital over time with a relatively light touch in the public market has helped bolster balance sheets. The second benefit of the ATM is the reverse inquiry dynamic where investors, whether it be around a catalyst or just more generally, say to a client or say to an underwriter or ATM agent, we're interested in deploying capital in company X and using the ATM as the tool to invest opportunistically in larger size than they'd be able to do regular way in the secondary market. So I think the punchline around public markets is a lot of tools available for public companies. There is capital available. Investors are looking for creative ways to put capital to work, whether it be in the context of PIPES, ATM reverse inquiry, direct investments.
And it's really incumbent on us as advisors and companies to ensure that they're aware of all their options, are opportunistic and nimble and capitalize on opportunities to raise capital on what continues to be a challenging environment.
Joe Coletti: So Jason, you talked about a lot of different ways that companies can raise capital. Another thing that we're hearing a lot about, particularly with these tougher macro conditions, are new forms of capital across other sectors. One example, private credit. There's been a private credit boon, and the right word is to say it's been fascinating to watch. Right now, is there a natural corollary in biotech?
Jason Levitz: So I think it's a good question, Joe, and it dovetails with some of my comments earlier around finding new pools of capital and creative ways to fund the balance sheet. So we talked briefly earlier about the royalty finance market. Now on one hand, that's a deep pool of capital. Not only are there specialists focused on that market, but there are also hedge funds that are now looking to invest really up and down the capital structure that specialize in biotech that have pools of capital available for royalty finance. I think the challenge is many of the companies we talk to don't have an asset that is at a point where it's attractive to royalty finance providers. So for those companies that are at that stage, it's certainly become an attractive cost of capital and a differentiated pool of capital. So I expect we'll see more activity on that front.
I think the other broad point is just finding new pockets of capital and investors that are looking to deploy capital around bespoke solutions. So it could be a bridge, could be an investment in a single product rather than company… whether it's pools of capital embedded in new fund managers, sovereign wealth, specialist funds that have broadened their capabilities. There's a lot of capital to put to work and it's not just around equity. It could be venture debt, it could be royalty finance, it could be bespoke investments. And that's complemented by, as we talked about earlier, the strategic pool of capital and large pharma and biotech that are looking to make investments in both public and private companies.
John Hoffman: Yeah, Jason, I think that's a really good point. And one of the more interesting features of it is pools of capital that are not necessarily related to one another. So you've got new pools of capital that look like the old pools of capital, so specialist funds that invest in public and private equities, but then also long duration capital out of the sovereign funds, for instance. Not only does that matter from a check size perspective, but it matters from the perspective that their time horizons may be different or what they're looking for is just a little bit distinct from your traditional specialist capital that's been directed to the sector. And the same rings true for the strategic capital that we talked about where the flexibility that these organizations are showing to find a home for unique investment opportunities so that they get an early edge or an early look or something that hopefully differentiates their potential interest in a company down the road if an M&A process takes shape or a licensing process, et cetera. The fact that these are all a little bit unrelated to each other, I think is a really healthy backdrop in terms of capital formation throughout the sector.
Joe Coletti: Look, this has been a really great discussion today. We've talked about so many different things and there's honestly so many things for both companies and investors to think about. So maybe to close out, you know, what do you want them to take away from the podcast and our discussion today? What do you want them to sort of keep in mind as we go forward? Jason, maybe I'll start with you.
Jason Levitz:
Look, while we've talked a lot today about the challenges perspective issuers face, the volatile backdrop, I think it's really glass half full. If you reflect on the fact that we've raised roughly $20 billion in public markets, not to mention the quantum of private capital raised, the variety of sources available for companies to raise capital, the new pockets of capital emerging, despite all of the headwinds and the challenges we're facing, I still think it's an opportune time for new company creation, for companies to finance exciting pipelines. And we're really optimistic in our outlook for 2024.
Joe Coletti: Excellent. John, what about you? What do you want people to take away from the conversation today?
John Hoffman: Much like we've encouraged companies to be nimble, I think RBC did a great job being nimble through a tough market environment to make sure that we double down our efforts in the sector. We've got a lot of talented team members on board that I think can really help companies think through these different options that they have. And it's really this integrated approach across capital markets, industry coverage, M&A, equities, etc. that's required to navigate these choppy waters. So we would just encourage lots of different corporates to hopefully take our call and collaborate with us in a way that helps them navigate these tricky times because we think that there is really bespoke solutions that can be created to accomplish a variety of objectives.
Joe Coletti: Well, thank you, John. Thanks, Jason. Really, really great conversation today. I think it's going to be highly valuable for our listeners and we look forward to having you back on the podcast again soon.
Thanks for joining us today on another episode of Pathfinders. This episode was recorded on October 6th, 2023. If you're enjoying Pathfinders, don't miss an episode. Subscribe to us on Apple, Spotify, or wherever you get your podcasts. If you'd like to continue this conversation or are interested in more information, please contact your RBC representative directly or visit our website at rbccm.com/biopharma. See you all next time.