The Optimism Behind the Biopharma Market - Transcript

Joe Coletti  00:05

Welcome to Pathfinders and biopharma brought to you by RBC Capital Markets. I'm Joe Coletti, your host, and our guest today is Dr. Chen Yu, founder and managing partner at TCG Crossover, or TCGX as it's also known. I'm also joined by my colleague Noel Brown, the Head of US Biotechnology, investment banking here at RBC Capital Markets. Thanks for joining us. Thank you. Thanks, Joe. Chen, we did want to give you a chance to sort of introduce yourself even more to some of our listeners. And if you could share a little bit about your own background. You're a founder of TCG, and maybe you could tell us a little bit more about TCG, particularly, you know, your philosophy and your sort of investment focus.

Chen Yu  00:44

Sure. So I'm a physician by training. I started my investment firm biotech in the early 2000s, when I joined as an associate for BMO capital, which is another life sized investment firm. I was there for 16 years, basically left in August 2020 as the managing partner, and really started TCG X, a summary as part of an ongoing conversation I had with the Column Group, which is a very well known early stage company formation focused VC. And so I think the idea of offering effectively complement to what they already did so well in early stage, by essentially having what we call mixed mandate funding, where we could invest both in private late stage rounds and classic blue book crossover rounds. So our mandate is 50/50, across two markets, and we're really committed to both sides of the market, I think that's quite unusual. Most funds you see are typically dominated either as public funds or as private funds. And for many reasons that we can talk about later, we really believe this mix many funds offered us the flexibility to really adjust and accommodate different market cycles. So that's really the gist of what we're doing two subjects is why excited, I think, the summary that the market cycle is kind of proven out the value of having some flexibility.

Joe Coletti  02:00

And that's great. I mean, let's dive right into the market off of that, because obviously, you're going to have a very unique and informed perspective that our listeners want to hear about, can you take a step back and share your thoughts and your perspective on sort of the state of the market and where things may be headed?

Chen Yu  02:17

Well, I think it's been pretty amazing to see how dynamic has been when we started the fund, which was in q1 of 2021, we were effectively at the peak of biotech for the last 20 years. And I think at the end of q2, we were effectively at the bottom of the biotech market of last 20 years. And so I think it's obviously very, very challenging to figure out how to call up markets like when I think we've basically that's fundamentally a probably a fool's errand. So I think maybe inside think of is, here's the things that we're thinking about or looking at. So I think the first is, how has the market changed, fundamentally? Meaning if you were to go back before the boom period of 2013, we used to say that pre medical companies had a negative pre money value, you have to actually pay each investment. But of course, in the last seven or eight years, it was a reverse that right, almost a third more companies that were able to build public ration, right, you can generate a lot of value on there. 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 pre global companies become very challenging to finance? Or has something fundamentally changed, that we're never going to go back to that era? I think the second thing that we're looking out is how will the private markets change? As you know, the old market used to be in venture side, a split between early stage and information focused VCs, then you had late stage venture investors, and then you had public investors. And during the boom period, that middle segment of late stage venture investors basically disappeared, because they either had to become public information investors or public investors. And so how will the private markets adapt to a market where that group of financiers don't really exist? And then finally, how will public investors react to private exposure? Right, we're just at the beginning splash, middle of a downturn. And so as many of these private companies now are being forced to finance as private companies, well, those public investors who came into the product market want to stick around. So those are the three things that we are looking forward in terms of how we're thinking about the next year or so in the market.

Joe Coletti  04:16

Let me ask you a question about maybe IPO market specifically, as we sort of continue this, as you said, it's calling the markets a fool's errand, which think is a great way to put it. But when you kind of look at the IPO market, what signals that you're watching for what else are you paying attention to that might indicate to you at some point that something's changing, or that it's opening up more than it may pick up? Are there things that from your standpoint that you're going to keep your eye on particularly over the next six plus months?

Chen Yu  04:44

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 out. If you don't commit big time to that book, I have a second piece is that their clinical stage 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 house I want to bet on. And I think you have a concept that's in the public markets, that's trading attractive, what you want to call it that arbitrage trade between what your value will be at the IPO, was trading at two times that value, I think you'd be satisfied those three things, I can see a slow and steady cadence of companies going public. And I can tell you that, you know, as an investor, right now, we're on the side of a couple companies, we're really tempted to test the market, it's very scary to try to be the first company out there. But the flip side of it is if you're too late, because there's such a long queue of private companies seeking to go public, there's a real risk that if you don't come out quickly, you're just going to end up stuck behind literally over 100 companies that are trying to get public. And UBS may not be able to have that real estate window. So I think my current bias is actually that as long as the market stays in its current status, which is volatile, but the summary a bit more stable than it was just really forward to, I suspect a couple of moments, will test the waters.

Joe Coletti  06:10

Thank you Chen. Noel, what do you seen from the banking side?

Noel Brown  06:13

It's interesting time, I agree with everything Chen is saying. And I actually think that this sort of anxiety in the market may be a healthy thing. I started thinking about an analog, like a person who's walking a high wire, and knows the pain of falling off and they've been hurt, right? So long as that person isn't left, rigid with fear, that person walking across that Highline next time around is going to operate with hopefully, their antennae sort of attuned to the dangers of pitfalls. And that might be wishful thinking, because we say that every time there is a downturn. Well, hopefully, we learned our lessons from these past events like we should have known when the IPO market had gotten so hot that things are going to end badly. I don't know necessary, but all that I think there is sort of a healthy level of cynicism with respect to valuation with respect to what works in the market. And following those three rules that Chen laid out makes total sense. But I expect what helps us recover is people managing their day to day with a little more of this healthy anxiety. This could go horribly wrong if this market does not execute well. And so I think it tamps down the likelihood of, to coined the term, irrational exuberance right, to sort of steal a term, I think there's lower likelihood of things raging out of control. And then us ending up in a bad spot again, people are sort of walking tentatively.

Chen Yu  07:32

Yeah, I would agree that I think that you have now existing investors who are reasonable on valuation, right. No one's looking to overprice the deal and find themselves person under water a day after the IPO. I think the second thing and this was made to me, I need one more layer, which is I think different types of investors are looking at this question a little differently. So for example, for us, we're a called a closed end fund, meaning we have patient committed capital over a long duration of time. We don't have redemptions, right. So that's something we have to care about. And so for us, truth be told, for the vast majority, the public actually doesn't care how it trades, because I'm usually betting on a full value creation house that's oftentimes installed a year or two after the IPO itself. But other investors that are, let's say, public structure, meaning they have market to market compensation, and they have to think about redemption pressure, I think it's a little bit different for them, because for them, it's like, okay, if I support my IPO and drops 30%, you're just killed, because I can't recover from that hole by December of this year. And so for those investors, I think going public is a pretty scary proposition. So I think this will speak to in the longer run, I think, as private companies think about their quote, unquote, crossover rounds, the next time around, has no point. If you're smarter about it. Now you think, Well, gosh, I really loved having those public guys around back then. But now in a tough market is not so obvious. It's helpful read, because their incentives are now not necessarily aligned to the long term vibration path that I want to be as a company. So as I said, this was kind of how it would be branching to see how public market investors who were in the private side kind of react because I think how they react the next year, we'll have a long term impact and how companies perceive them when the cycle turns around.

Joe Coletti  09:19

So I'm hearing for you is for you, in particular, short term volatility. It's not as much of a concern from your standpoint, but it may be for others, especially between now and the end of the year or beyond.

Chen Yu  09:30

That's correct. I mean, we actually see a couple of structural issues that kind of impact how assets are basically priced as an example, if you care a lot about your returns through December, that's how you're going to get paid this year. Companies that have we call them long dated catalysts. catalysts that are in half and two years from now, are actually most fundamentally unattractive to them, because even if people believe those houses will be positive. They just can't hold them are over right. They have just carry market exposure risk, right? So in contrast for us, I basically don't care about any of those things. I just care for the long term powers as positive. And so those tend to be in our view, most mispriced in the market and are actually the most attractive for us because they offer the best reward for the lowest risk. So that's how I think how structure may alter how folks months between how much they want right now versus managing risk in the next couple of months.

Joe Coletti  10:26

Thank you, Chen. Those are some really key things that you pointed out there. And well, how does this affect the financing side?

Noel Brown  10:32

And it really affects the financing market as well, that whole line of thinking of whether or not to I have milestones or critical catalysts that are going to occur within a current bonus cycle, for example, right? I mean, it becomes very difficult sometimes to finance even on the back of a catalyst, we do see some slowing down of deal activity, as we get later in the year, partly because investor attention really starts to wane.

Chen Yu  10:59

Yeah, it's going to be very interesting to see how deal pace changes for us, we have been to some degree waiting for recalling a capitulation in the sense that, on the private side, you have many companies that financed during this boom era that were expected to be public. And so they've been waiting to say, look, let's see if the public markets come back. And obviously, they haven't yet come back to where there's a real IPO alternative. And so they're not going to be forced to finance privately. And so we've kind of been waiting for that moment. I expect that to happen in q4 Slash q1 of next year, I think that will be an interesting bellwether to see how those deals reprice, if at all, and I think that's going to be a really interesting opportunity for folks who are going to be active in the private side. Likewise, something on the public side, we're seeing a lot of structure transactions were very faded in terms of the deal terms that you get, because we know roughly a third of the small mid cap biotech sector is going to have to raise money in the next 18 months. So these are the reasons why at least for us, we suspect that this market where doesn't really read, it's probably in the state of play for the next year or two. And until this kind of financing, Bogey, if you want to call it that gets satisfied, it's hard for us to see a really, really robust enough return to call the 2020, 2021 era, hence the best for me was the 90s was really, essentially that thesis.

Noel Brown  12:25

It's interesting, on your point about capitulation, I would have expected to have happened sooner, and it just seems to be taking longer to occur than we all sort of expected publicly traded companies have felt the pain much more immediately, right, their share prices have adjusted dramatically from last fall to where they are today.

Chen Yu  12:43

Yeah, I think it's interesting, I'm seeing CEOs take one or two paths, there are some that are saying, You know what I'm going to rip the band aid off, I'm going to raise a bunch of new capital, because I think the down turn could be three or four years long, I want to make sure I plan as a company to get through my critical milestones. I think there's another class of CEOs who are saying, effectively, let me make an XPI 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 battles will be related to the duration of this downturn, if it's short, that kick the can style is going to actually work just fine. And that will be the winning strategy. And if they're wrong, it's going to be a world of pain. So I don't know what the answer is. I mean, it just goes to show you that the folks who have strong insider syndicates and or have capital elicited by use the term resilience, they get to choose those companies that have pursued a strategy for resilience are going to have to let the market dictate to them what's going to happen, think about how many deals we saw the private market in the last three years, where it was a Series A, into a crossover round. And now you look at that and you kind of want to shoot yourself in the head because then you suddenly realize this is a series A, series A venture deals could be five years to that IPO. And suddenly you're sitting there as a public lender, and you're thinking, Okay, on my left hand, I could do a pipe in a company that's trading 60% off its recent highs, with a catalyst that's going to happen in six months, or I could invest more money into this series B, that's probably going to be four years to an IPO. But I don't have a DC yet. That's going to be a really tough fiduciary duty question. If I'm sitting in that IC, right. And that's why this question of well, public investors who are now in all these early stage privates, what will they do? Because I think the near term financial decision is very honest, they should not be participating in those private rounds. But the long term reputational damage is kind of forever, right? You know, once you start watching, it's there's no way someone's going to let you in again, and some of those funds welch, it affects not just those funds, but it affects the broad class, I would say public investors for private right because Okay, sure you didn't welch me this time, but half of your compatriots did. And so, generally speaking, do I kind of lump you into that class? That's why I'm fascinated to see how long this was. I think I remember you had some great data to demonstrate that this current downturn has already longer than a downturn in the last 20 years.

Noel Brown  15:17

Yeah, those will be some heavy dark days, thing goes on much longer. I mean, sometimes I spend too much time looking at statistics. And we just haven't seen a double bottom test after we've began to experience a return from a correction. But there was a lot of stats I was citing while we were in the last downturn, right. So it was just, again, so many unprecedented things. However, this correction was the first time that the nadir, assuming we've seen it was actually slightly lower than the last nadir. Before this downturn, every nadir was at a point considerably higher than the prior one. So even though the market was going up and coming down, every point it came down to was a positive slope from the prior nadir. Right. And I sort of took some comfort in that like, it's up and down, but it didn't and de the line of best fit even through the bottoms is a positive slope. This one, it cut a little bit lower single digit percentage, I do feel like I kind of go out on a limb and say, I feel we've turned the corner, it feels like things have turned up this past summer was really encouraging. We tested bottoms earlier in the summer, and then by July started to see stocks react in a way that that they had tended to react. And let's just hope that this continues because it just apart from how stocks react and apart from how valuations are impacted. It can also be demoralizing for the people working in certain of these companies. Right?

Chen Yu  16:43

I think that's a really important point that and why the downturn has ripple effects that impacts people's willingness to take risks, like the leaves their company job at Big Pharma and jumped into a biotech. So there are many scares where if this lasts for four or five years, you can meaningfully impaired the innovative capacity of the sector. Look, I think on the positive side of the ledger here, the one thing that people don't fully think about is that there are GPs made investments like me, but there are LPs behind us to fund us to do the work that we do. And what I think is most interesting is that I have yet to see LPs really run away. And if you think about the level, the downturn of the western half, we actually still haven't seen as a wide broad skill reductions in plateau catchments. Despite that many of them are down, you know, 50% plus. And so I think what that tells me at least is that if the LPs are willing to stay through the cycle, that means the GPs have the bullets to face the fire when this market does turn around. And I think makes an argument that if and when it does turn around the term will be robust. And I think if you zoom out that lens, why don't know if this is the quarter that says you go deploy, or when it was last quarter. But if you take the next two years, I think it's hard to argue this not to be one of the best deployment periods, probably in history when you go forward now five to 10 years.

Joe Coletti  18:20

Hope you're enjoying our conversation with Dr. Chen Yu and that you'll stick around for the second half. But first, just a reminder that you're listening to Pathfinders and biopharma presented by RBC Capital Markets. I'm your host, Joe Coletti. Our goal on the podcast is really to bring you trusted market insights from industry experts in the fast changing world of biopharma people who know how to turn change into a competitive advantage. To find other episodes, you can go to, I hope you'll share this podcast with friends, colleagues, and anyone you know, could you some perspective on the changing investment landscape in this industry. Now, let's continue the conversation.

Noel Brown  19:08

I have a very non scientific perspective on this? I believe that the way in which the broader world is viewing biotech is different than it was pre pandemic. Think a lot of people who kind of weren't the day to day participants in this space, like the dedicated folks looked at this space as sort of like, quasi lottery tickets. Who knows there's tons of these companies. If I sprinkled some money around on this roulette table, the numbers will turn up, and I'll do well. But if I can't really spread around, maybe I shouldn't touch it, because I'm just kind of picking again, individual numbers on the Roulette Wheel, not even picking colors. When we really deployed capital and we being the government and companies and investors really put money to use behind trying to find a solution. When you think about the scramble to come up with a vaccine. I think the whole world witnessed Wow, we put together a lot of capital with this innovation, you will get product and you'll get it in a timeframe, so much shorter than we historically even thought was possible. I mean, if you ask me how long a vaccine would take to produce from scratch, right from finding the immediate appearance of said bug to vaccine, there's no way people would have thought inside of nine months. But I think that really showed people how you can accelerate development and obviously the FDA to be more flexible on emergency use authorizations, and things like that. But that aside, the speed with which the progress was made was just unprecedented. And so it's less of a gamble now. It's like, Okay, we just have to have the money there. Like if we put the money to the right technologies, and back the right people, the right management, we should see some results. So it's less of a gamble now and more of just like every other industry, you're kind of tactically picking the ones that you think are going to be winners.

Chen Yu  20:51

I would actually agree. I think if you think about tech, every LP even if you're jealous, the question Does Google Apple, right? It's a part of your lives. And before Moderna, and those vaccines, that wasn't the case, but if you asked an average house, they couldn't answer. But now Moderna's, like literally like Kleenex. Right? Everyone knows that company. So I think that's a big part of it. I think the second piece is, if you were to go back pre 2008, the top decile healthcare venture funds were returning. And it was a tough place to be. And through the boom period, I think LPS realize that biotech can actually be profitable, in many cases, even more profitable than our tech competitors. And so when you look at the market, right now, you're an LP, you're looking ahead, and you're saying, Okay, let's say there's a recession, consumer discretion, internet is at risk. But by just post long, right, that's a defensive sector. So in many ways, we are the most relatively attractive sector, I think, in a tough economy. So I think those are two things that kind of lift Biotech right now. But you know, there's a lag, right? For example, if biotech folks can't deliver in the next three or four years, I can guarantee you LPs in their lifecycle will go right back to saying, Well, maybe they will lie somewhere else. So I do think it's incumbent upon GPs, like ourselves that deliver. And I think if that's the case, we'll get

Joe Coletti  22:11

We're getting towards the end. The couple more questions I want to ask first, maybe over to you, Chen, we've obviously talked about a lot of different things. But for those listening, what's the most important thing you want some of the listeners to take away from the conversation, whether you're, particularly I think, biotech companies that are there listening to the podcast.

Chen Yu  22:31

I think it's Yeah, to to beat the dead horse. But for me, it remains this concept of resilience, that don't try to spend your time trying to predict what the market will be up or down tomorrow. But try to set yourself up that you don't care. I mean, the way we set up TCGX was effectively by that concept, which is an unknown from hot market or cold market. But I know that, whichever one it is, I can move into the private side or the public side, and find the fact of the best overall opportunity to sector. And so I think the same rule should apply to companies who should be adding to their resilience strategy, to make sure that just in case, this lasts for four years, they can make it.

Joe Coletti  23:08

And we always end with two questions that we ask all of our guests, the first one very biotech focused, are there any innovations or advances in the space that have you kind of most excited for the future?

Chen Yu  23:19

That's the great thing about biotech right now is there's almost too many things to talk about there. Right? I mean, I think about the scientific advances that we're making in this era, versus when I was first starting in 2000. And it is literally like night and day. And that's good to know for like, if I link a little zoom out, right, you have to be pretty bullish around robotics heading.

Joe Coletti  23:40

Great. Now, on a personal note, we want to know what you're reading, and our listeners want to know what you're reading.

Chen Yu  23:45

Well, this is probably a COVID phenomenon. But I am reading a book called What should I do with my life by Po Bronson, who wrote a really interesting book where he chronicles this kind of existential career question, realized I should going to call that among a bunch of different folks who've made some decisions that turn out to be great, and some that are not the total disasters. And I think it's a really interesting book for folks to think about as they emerge out of this period where you, you have more flexibility about what to do with yourself. And I think it's a both inspirational but also posture tale that I think is actually for me, at least, I found quite useful.

Joe Coletti  24:23

Chen and a well. Thanks for joining us today.

Noel Brown  24:25

Joe. Thanks for having us,

Chen Yu  24:26

Joe. Thanks for having me.


Joe Coletti  24:32

You've been listening to Pathfinders and biopharma brought to you by RBC Capital Markets. I hope you got as much out of that conversation with Chen Yu and Noel as I did. What's really exciting about the conversation we had with Chen today was getting his unique perspective on a range of things impacting markets today. We learned a little bit more and in fact a lot more about TCGs philosophy, their investment focus and how they approach the market but also getting his broader perspective on the market. We talked a lot about some of the differences between private and public investors and some of the other considerations that particularly companies need to be aware of and thinking about as they figure out how to raise capital in this market and beyond. And we also talked about, you know, deal structures, different deal trends that we're seeing out there, particularly in this environment. Now that might change and evolve over time. And finally, Chen's point about resilience really stuck with us, both resilience for companies and investors, to continue to be prepared for volatile markets and boom markets. That's it for today. I'm your host, Joe Coletti. Thanks so much for listening.