Joe:
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 sharing a conversation with you taken from our private health care company conference, featuring commentary from John Hoffman and Jason Levitz, co-heads of RBCs healthcare equity capital markets group.
They'll share their insights on a variety of topics, such as market divergence, biotech innovation, regulatory tailwinds, valuation challenges, ESG, digital transformation, and we'll talk about how each are reshaping transactions across the industry. They also reveal their outlook for 2024 and explore the evolving role of private equity investors, the importance of optionality and creativity and potential deals in the pipeline across different sub sectors in the year ahead. Let's dive right into their conversation.
John Hoffman:
Good afternoon, everybody. This is John Hoffman speaking co head of RBC is healthcare equity capital markets with my partner Jason Levitz the other co head of healthcare ECM here at RBC. And what we thought we would do this afternoon is spend a bit of time just having a candid discussion between Jason and myself. Talking about key themes and trends that were speaking to investors about key topics that are on top of mind for companies and a bit of an outlook for 2024 and what we can expect for the months to come from a capital markets perspective. If 2023 could be summed up with a simple phrase or characterization, it's clearly been a tale of two studies. I think historically, when I've heard that moniker used to describe a certain market environment, oftentimes it pertains to the front half of the year behaving different than the back half of the year or vice versa here this year, it was actually into a calendar year or lots of different trends going on. And the dichotomy between those two trends in a few stark ways or for one for a couple of statistics. You had the S&P that was up 21% but the S&P healthcare index down to 2% on the year. You had equity volumes that were up 55% year on year but IPO issuance volumes that still said 70 or 80%, below the pre COVID trends that we saw in that market. And while there was a little bit of a resurgence, IPO activity from some higher profile issuers, the aftermarket outcomes for those companies have been somewhat measured or even anemic only posting a 3.9% offer to current so while there was lots to unpack, in those statistics and how the markets behave, it's certainly been a very eventful year and it's felt like there's a lot more to do and I think hopefully that's a harbinger for things to come. I guess Jason, I'll post the first question to you. When we reflect on statistics like the ones that I just read off what's most surprising to you, or what do you think some of the key takeaways are?
Jason Levitz:
Yeah, thanks. I'm actually fairly shocked that we haven't seen a broader rebound in the IPO market. I think a lot of John's high level commentary until two cities analogy is quite interesting. I think another point you can add, is looking at the S&P on a weighted basis, relative to the unweighted index, which if you look at the performance gap is about 13%. Or you look at the Russell 2000 index, very good proxy for smaller cap performance, which has also been anemic. I think that index is up six or so percent. So that performance gap between whether it's the Magnificent Seven or just large caps and small caps, which is where obviously, we spend a lot of our time there's been a striking dichotomy and I think that continues to kind of nag at investors that are looking to move out the risk curve and focus on the IPO market. I'm quite surprised that we haven't seen the market snap back in in in earnest more quickly. We're kind of nine quarters in now. It's really more of an IPO activity. but you're looking this year and kind of roughly 30 IPOs. Last year, similar quantum. The interest rate environment and you know, with the Fed having tightened through nearly the last couple of years at a very aggressive clip, certainly in the context of recent history, you would say that, okay, well, that's just given, you know, competing assets, whether it's risk free rate or looking at credit investments are others that are now generating a more attractive return relative to how you think about the IPO market and potential returns there. But if you roll back even further and look back to say the mid 90s or early 90s, I should say when, when the rate environment was similar, or even more punitive than it is today, you still saw substantially greater IPO activity than you're seeing now. But I do think that a pivot by the Fed will be an important catalyst and when that comes and if that's mid year next year, I think that bodes well for back after ’24. But we are where we are.
John Hoffman:
Yeah, it does very much feel like there's a little bit of a groundswell of tailwinds that will make for a much more constructive new issue environment and receptivity for new issues. I think one of the underappreciated dynamics that's occurred this year has been the return of the active manager and their ability to outperform in a volatile market environment something like approximately 60% of active managers have outperformed and they think anecdotally we hear every day everyone, fund managers that have really been over levered to some of the outsize either takeouts or clinical catalysts that have had very substantial return profiles in the public markets, which is clearly one of those dynamics that is a necessary ingredient so laying the groundwork for that more robust receptivity in 2024.
I think one of the other questions that we're often asked by investors, that's a little bit of a leading indicator of just how active do we all think the market will be next year on the on the capital market side and where do we expect issuance to come from within the different healthcare sub verticals? My view is, at least for the first part of next year, I think we'll see what amounts to a bit of more of the same. So likely to see biotech companies who have a fairly predictable playbook around what ultimately works in the public markets as those companies grow into their clinical catalyst calendar and have kind of step function like changes in their potential valuation paradigms versus other sub sectors where it may take a little bit more time for certain companies. To grow into some of the historical valuations that were achieved in the private markets prior to 2023. So I do think that we'll still see the biotech calendar continuing to dominate but beyond that, there's a number of other subplots that I think make for a really interesting backdrop for some of the non biotech related healthcare sub verticals, one for instances, the deconsolidation of certain businesses, I think we're seeing that take place in a total space right now where you've got a bit of a forcing function with the Illumina Grail, dynamic playing out in the public markets, having a public market company like Grail earthed into the public markets with a unique valuation framework. In a very important space. I think those anecdotal transactions or potential outcomes like that could really lay the groundwork for more substantial activity and some other sub verticals that have really not seen the same level of activity as we've seen in biotech, which has been phenomenally persistent throughout the course of the market cycle that we've seen. Jason, I don't know if you have any other perspectives on where we may see other areas of issuance, but at least from my perspective, we should start to see some diversity creep into the calendar throughout the course of 24.
Jason Levitz:
Yeah, no, I totally agree. But I think the other vector obviously, is what are the large investors in these private companies across the healthcare spectrum, doing with our portfolio companies. And, and one of the things we talk a lot about just is pressure on venture capitalists, growth equity investors and traditional private equity to generate returns and return capital to LPs. And, you know, that's certainly an issue. I'd say that that spans the market more broadly than healthcare and I think depending on the investor subcategory, obviously has a big impact on IPO activity and expectations within healthcare. I think private equity investors are looking for ways especially for companies and older ventures funds where they may not have more capital to put to work and there are options like continuation funds, but short of that, I think there will be some pressure in ‘24 and we already know that there's a building pipeline of some potential companies in that category. And I think when you get to growth equity and venture capital, I think certainly those investors I think, will feel similar pressure and there will be inertia you know, once the market opens in some of those other categories, and I think we should talk more general and get later on in the presentation because we will spend a lot of time on biotech, obviously, just given the velocity of activity and a number of private companies in that space in particular, but I would say more generally, the mathematically I really hope and expect to see more activity from some of the other sub verticals for some of the reasons John mentioned. And also, again, on the investor side, I think that there'll be more interest in if not pressure to take some of those companies public, you know, that could create other monetization events also, which we can talk about, but I think certainly IPOs are one path that investors will be particularly focused on for companies in some of those other some verticals.
John Hoffman:
Yeah, I mean, the nice thing about healthcare is that there's distinct investor groups to pursue for each of the different sub verticals. It's not an either or dynamic where you need biotech activity to recede to make room for other separate articles. I'd actually argue the contrary, when you look at some of the statistics for the biotech secondary team, as of late, that is company issuing follow on offerings, the performance has been almost IPO like on a weighted basis. We pulled the statistics on how follow ons have performed this year and I think on an average offer to current basis transactions are up circa 15%, which is which is just an excellent return profile, particularly given the fact that those companies that have ADD access in the sizeable way to the follow on market, tend to be those that have been outperforming year to date and have further expanded their outperformance through the sizable financings that they've been able to achieve. I'd always argue that the capital markets tend to have a dynamic where success begets success and with the good receptivity we've seen towards some of these secondary transaction within the biotech tape would expect that to continue in spades in the first half of next year. By my count, something like 38% of all primary issuance this year came from the biotech sector, which is again just kind of a staggering statistic when you think about the diversity of different areas that investors could direct their capital towards. The other interesting dynamic around the secondary side of things with biotech follow lenses, the absolute pricing that they've been able to achieve, notwithstanding the volatility that we live through has been by historical metrics, very robust. On average transactions are pricing down at around 5% where if you were to compare that to historical outcomes, they've typically tracked towards a high single digit type framework. So better, more better aftermarket performance, tighter pricing, an already robust backdrop that suggests that there's a real depth in the market to absorb the amount of supply that we've seen on the biotech secondary side. Again, I think that all points towards a robust calendar into the first half of next year that hopefully again lays the groundwork for more capital markets, transactions across different sub verticals, but then also across different products to come when we hit next year.
Jason Levitz:
Yeah, I'd say one, you know, one interesting point. And, you know, reflect on you know, other points in time because certainly over the last 10 years, there have been periods where the biotech IPO market in particular has been closed, and there have been windows of opportunity. And I think historically we like to say that follow on market and performance is probably the best leading indicator for return to IPO activity, right just because some slightly lower risk asset class quote, unquote, when you see good performance there, investors get more comfortable out on the risk curve. I think the reason at least in part of it hasn't been as because notwithstanding John's point about activity levels and performance, you might say, Okay, well that precursors there, why haven't we seen more IPOs? I think, in part, and we hear this anecdotally from investors visa vie, the private mark, but I think it also certainly holds with respect to potential IPO opportunities is that there are now so many public biotech companies that have market caps frankly at or even below where a traditional IPO would come. And because there are so many of these companies, and they're trading in many cases at cash or below, I think investors have seen the follow on asset class so to speak as, as somewhat of a replacement for potential IPO activity because the return opportunities I would argue were as good or frankly even better in some of these cases, I certainly think we're getting to closer to the end of that cycle. Not to say there aren't interesting, small cap public opportunities, but I don't think we're at a point anymore, where we're really going to cannibalize the IPO calendar into ‘24.
John Hoffman:
I think as a number of the processes that we've run, you kind of had to think through how do you convince an investor in what was a bit of a liquidity constrained environment to sell one to buy one or allocate new capital to a new opportunity, whether it be a publicly listed follow on for a company that was trading at a dislocated value or for the handful of IPOs that came in an IPO setting. I think the other important ingredient that will precede a ramp up and IPO activity is a high conviction belief or a consensus view that the biotech sector has reached a durable bottom.
We've done a lot of different fundamental analysis on this. And it's one of the favorite analyses that we've had the team put together is just trying to take a top down macro view on the XBI as a whole to justify where we were trading at different time points. When you take that macro math, and you juxtapose it with some of the other analytics that we do, where you kind of look at what some investors are doing with respect to the take private transactions of the cash, shells, etc. I think those are all experts that signs that hopefully we have reached that bottom here and we can start to get people to focus on new opportunities in a pronounced way.
Jason Levitz:
Yeah, one other point I reflect on, you know, visa vie the XBI which there are always some challenges there and really assessing how good a proxy it is. But certainly it is an important one, but I certainly remember back in other periods of dislocation for small cap biotech, we used to look at the XBI versus let's say the IBD or the NYSC biotech index, it's pretty interesting to see that there hasn't been much separation between those two indices, meaning that you know, unfortunately, the large caps haven't performed as well either, but I do think when you see that kind of uniformity across the sector, hopefully, it could be another potential leading indicator for [inaudible] and a move higher for kind of epic in companies across the biotech space.
John Hoffman:
Why don't we spend a minute talking about some of the other sub verticals and what the outlook may look like for those that I mentioned before there's that high profile Grail transaction that's taking shape, and clearly will not I'll have a read through for companies that broadly operate in the med tech tools and react space. What do you think about that sub vertical in particular, what does it take to get that market moving in a more active way?
Jason Levitz:
Yeah, I think there's there certainly is, I think we'll both agree, you need to see kind of a broader rebound in biotech and small cap growth IPOs I would look in part also to the tech sector. Some of the challenges that those some vertical space are one that there's probably less discrete capital attached to those investment opportunities. So it's a little trickier to navigate in private and public market context to get to those investors to get the right deals done. I think those companies because they also tend to be and I think we'll have to be in this next cycle, certainly commercial stage largely, and also in a position where they've got a meaningful revenue run rate. And the other piece of the puzzle just around these sectors is there’s a bit more focused on how much capital you're raising, where it's going the nature of the balance sheet. You know, whereas in in biotech, I think you have more latitude just around your sizes, the time of IPO, there's a little more focus on what to call traditional ECM metrics, which are deal size and percentage of market cap, etc.
John Hoffman:
I’m shifting gears momentarily, to services broadly. defined, where do you think activity comes from in that area?
Jason Levitz:
I think it's interesting because there are unlike I would say, you know, other sub verticals that there's a little bit of a, you know, called visible shadow back. If that's a term I can use in the sense that they're kind of, you know, a couple of deals out there that that I think people are somewhat aware of in various spots within kind of healthcare services broadly, and they tend to be in niches where I think there's been good performance so you know, could be skilled nursing, could be behavioral, could be value-based care, some are privately owned by entrepreneurs, most are private equity held that I think at some point in ‘24, could come to market due to some of the dynamics we talked about earlier, just around private equity, portfolios, vintages. So there certainly are, I think, examples where private equity firms are putting more money to work, certainly even in the public market. But with that said, I think they've got one eye on potential monetization events and the other on thinking about, well, what's in my portfolio, that I can either take public or think about some kind of dual track. But I do think there are, you know, various levers that that these owners can push and pull around monetization that that they're thinking about. And, you know, I think that means that while we'll see a pickup in IPO activity in services, I think you'll see other forms of monetization events as well.
John Hoffman:
And then maybe just round out on the last final sub vertical, broadly defined again on the digital health or HCIT side of things. My belief and I think this is shared by you and by investors as well as there's no more disruption is, is necessary then in healthcare from a technology perspective to really just modernize technology infrastructure across the broad landscape as a whole. I do think that the HCIT universe does represent a very viable and potentially high source of supply for IPO products. That said it does feel like many of those will come towards the back half of the year, or maybe even into early 2025. I think a number of those businesses are thinking about ensuring that they can forecast the business appropriately, having just lived through the economic cycle that we're all going through whether we were in a recession or close to a recession, just having certainty on what the forecast stability of a business is clearly an important ingredient. When you think about accessing the public markets and needing to stick to that regular cadence of, of about performing on your quarterly call. So again, another vibrant area of conversations. There are a handful of businesses that I think could come early are just given how scale they are and the fact that they fit very nicely into some of the key parameters that investors generally think we characterize those companies as top quality and towards the upper echelon of financial profiles that are publicly available to invest in correctly. So hopefully, some of those get pulled forward and executed against at reasonable valuations. And again, that will lay the groundwork for more companies to come public thereafter.
We can't go with a weekly meeting without joking about the GLC-1 phenomena and what that ultimately means it's clearly something that's taken over conversations across a range of sectors. I'll put it to you Jason. We stand with that GLC-1 right now?
Jason Levitz:
Yeah, look, I think and I would point anybody on the call to a research piece that our our team published, not just around biotech, but but certainly in a second third derivative opportunities I'm sure people are, are certainly aware of those I think the you know, is no without mentioning at the Roche acquisition of Karma, also the registration statement and the price paid there, which is so high $2 billion $3 billion dollar and reflecting on an IPO that again without perfect detail would probably have come at a significantly lower valuation; so highlights the strategic interests directly and GLC-1s but certainly other just the metabolic obesity space obviously in our certainly our biotech coverage colleagues can expand upon that perspective. So I think there are going to be a lot of ways to win and a lot of opportunity to invest and I think there are absolutely going to be tailwinds and potentially some headwinds for other sectors, whether it be med tech value based care or what have you. But I do think navigating the environment will be a marathon, not a sprint, because I think this is going to play I think we all believe it's going to play out over a long period of time. So I think you have to look through some of the near term volatility and try to think strategically which I think our research team has done a nice job of just around how to play this over the long term.
John Hoffman:
Fair points. I think one of the other one of the other questions that we're getting with increased cadence is what about the election cycle, which feels like people are finally waking up to the fact that it's kind of just around the corner and what does that ultimately mean for the capital markets calendar? We've sliced and diced the data historically a number of different ways. And I think you can come to different conclusions based on the data that you look at, as to whether or not the calendar stays open or closed through the actual election cycle itself. I think there's evidence in certain markets that has stayed open. There's evidence in certain election cycles that it's that it's been a bit more because what is clearly evident, though, in almost all instances, is that capital markets activity tends to get accelerated to the first half. So whether or not it persists through the election cycle itself, is a bit of an unknown but the fact the fact of the matter is, you can just look back to 2020. And look with the notion of the uncertainty around the election caused in the capital markets, which was a clear acceleration of activity by a number of companies that sprinted towards the public markets; that was enabled in that in that window by the SPAC mania that took place. But that was that was the off ramp that many companies chose at that time point to accelerate their issuance activity, but I think it is a good reminder of what is likely to happen of if there is a window to execute. I think many companies will choose to do that to avoid the uncertainty that was likely to come in the back half of the year, as we do approach the election dynamics which will be volatile, I think, to say the least if there is a consensus view and that's probably what it is. So with that, maybe we'll just close with a couple of bold predictions for 2024 Jason, I'll let you give yours first and then I'll wrap mine.
Jason Leviz:
I'm gonna say there will be 40 plus healthcare IPOs and 24 across I think ‘23 was in the low teens. I'm hopeful given you know, everything that John and I talked about here that it may be heavily second half 24 weighted, but I think we have a good shot to
John Hoffman:
I think we're going to see the return of the opportunistic biotech financing in particular, in a very pronounced and robust way. Just given all the dynamics we talked about with respect to how the fields have performed this unit or uncertainty that's likely to come in the back half.
Joe:
Thanks for joining us today on another episode of Pathfinders. This episode was recorded on December 13 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 you're interested in more information, please contact your RBC representative directly or visit our website at rbccm.com/biopharma. See you all next time