Featuring Dr. Chen Yu, Founder and Managing Partner, TCG X
Published September 30, 2022 | 3 min read
Key Points
- The biotech market is changing and the interplay of investors, private and public markets will be important going forward.
- IPOs need a strong follow-on market to really spur growth, but there’s a good chance of a slow and steady cadence.
- A certain amount of investor caution is something the market needs in order to mature.
- Limited partner investors are still behind the funds and sticking through the cycle, so capital will be ready to deploy when the market turns.
The dynamic in the biotech market has been highly volatile in the last few years, from the high peaks immediately after the COVID vaccine, to the lowest downturns of the last 20 years 2022. This uncertainty makes calling the exact timing of the market’s turn something of a fool’s errand, according to Dr. Chen Yu, Founder and Managing Partner of TCG X, but to get any idea, you need to consider whether the market has fundamentally changed.
“If you were to go back before the boom period of 2013, we used to say that preclinical companies had a negative pre-money value, you have to actually pay me to invest in these companies. But of course, over the last seven or eight years, it was the reverse. Almost a third, if not more, of the companies that were able to go public were actually preclinical. And so I think one of the big questions that we're trying to figure out is, is the world going to go back to that pre-boom-time era, where preclinical companies become very challenging to finance?” he asked.
The market has already changed quite a lot. Where once you had early-stage and formation-focused VCs, then late-stage venture investors and then public investors, that middle segment all but disappeared during the boom time, and private markets are still adapting to that. Now, private companies are staying private and being forced to finance privately in the downturn, so will public investors still stick around?
“I try to focus on how we create a resilient portfolio that can last,” says Yu. “And I think companies have to do the same.
“Those companies that don’t have the luxury of really strong inside investors, but continue to spend as if it was 2021, will put themselves in a tough situation. But those that cut spending and think about how to find nondiluted capital, that could be very valuable in the next two to three quarters.”
Dr Chen Yu, Founder and Managing Partner, TCG X
IPOs: slow and steady?
According to Yu, for the IPO market to be robust, first the follow-on market needs to be robust.
“Follow-ons need to perform and investors in those structured deals need to profit, that’s the first thing that has to happen. And whether M&A trade continues to be robust, as it has been in the last couple of weeks, is the second thing. [Those things] can flip the switch toward green and attract and reattract generalists back into our space, which is what you need to have robust IPOs,” he says.
“But I think it’s very possible that we will see a slow but steady cadence of IPOs, particularly in companies where a couple of factors are satisfied.
“Number one, you've got a very strong insider syndicate, where those friendly investors can just muscle at an IPO and commit big time to that book. The second piece is that their clinical stage is a bit more mature, where there's an upcoming catalyst that is high contrast, and I think people can legitimately say, “Look, that's an interesting data card I want to bet on.”
And I think you have a comp set that's trading attractively where there's that arbitrage trade between what your value will be at the IPO relative to your comps. I think if you satisfied those three things, you could see a slow and steady cadence of companies going public.”
Why anxiety might be a good thing
Investor concerns aren’t usually welcomed by the markets, but in this case, they could be just what the market needs, according to Noël Brown, Head of US Biotechnology Investment Banking at RBC Capital Markets.
“I think there is a healthy level of cynicism with respect to valuation and with respect to what works in the market now.
“I expect what helps us recover is people managing their day-to-day with a little more of this healthy anxiety, which tamps down the likelihood of irrational exuberance.”
Noël Brown, Head of US Biotechnology Investment Banking, RBC Capital Markets”
There are also the different lenses that investors are applying to the market. For a closed-end fund like TCG X, their patient, committed capital over a long duration means they’re betting on long-term value creation catalysts, not immediate trading returns. But companies with a mark-to-market compensation are focused on year end performance and have to consider redemption pressure. So, they must be cognizant of near term volatility. If they support an IPO and it drops 30%, that has a huge impact.
“If you care a lot about your returns up through December, because that's how you're gonna get paid this year, companies that have a catalyst that is going to happen two years from now are almost fundamentally unattractive to you. Because even if you believe those data readouts will be positive, you just can't hold them,” says Yu.
What’s behind the market cycle?
“I'm seeing CEOs take one of two paths. There are some that are saying; ‘You know, what, I'm gonna rip the band-aid off, I'm gonna raise a bunch of new capital, because I think this downturn could be three or four years long, I want to make sure I finance my company to get through my critical milestones.’ And I think there's another class of CEOs who are saying, effectively; ‘Let me make an XBI bet, it's going to be back in a year.’ So if I've got strong inside investors who've got money, let's just do a flat round and kick the can down the road.”
“In the end, the winner on these bets will be related to the duration of this downturn. If it's short, that kick-the-can strategy is going to work just fine and will be the winning strategy. And if they're wrong, it's going to be a world of pain.”
Dr Chen Yu, Founder and Managing Partner, TCG X
“I think it just goes to show you that the folks who have strong insider syndicates and/or mountains of capital, they have resilience, they get to choose. Those companies that haven't pursued a strategy of resilience are going to have to let the market dictate to them what's going to happen,” he adds.
But there’s also something on the positive side of the ledger that gives both Yu and Brown renewed optimism, and that’s the continued interest from limited partners (LPs). LPs are demonstrating that they’re willing to stick through the cycle and that means that general partner (GP) firms like TCG X will have the bullets to fire when the market does turn around.
“I think that makes an argument that if and when it does turn around, the turnaround will be robust. And I think it's hard to argue that this is not going to be one of the best deployment periods, probably in history, when we go forward now, five to 10 years from now. As long as you can tolerate the volatility, in the longer view, people who deploy in the next year are going to do very, very well,” says Yu.
Featured Guest:
Dr. Chen Yu
Founder and Managing Partner, TCG X
