Biotech in­vestors and CEOs see two paths to growth, but are they equal­ly vi­able?

The dy­nam­ic in the biotech mar­ket has been high­ly volatile in the last few years, from the high peaks im­me­di­ate­ly af­ter the COVID vac­cine in 2021, to the low­est down­turns of the last 20 years in 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 Crossover (TCG X). He speaks with RBC’s Noël Brown, Head of US Biotech­nol­o­gy In­vest­ment Bank­ing, about the mar­ket’s road ahead and two pos­si­ble paths for growth.

IPOs: slow and steady?

Look­ing at the mar­ket to­day, one of the biggest ques­tions is whether the re­ver­sal in biotech’s for­tunes will take the mar­ket back to be­fore the eco­nom­ic boom when ear­ly-stage com­pa­nies were dif­fi­cult to fund.

“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 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, was ac­tu­al­ly pre­clin­i­cal. So is the world go­ing to go back to that pre-boom-time era?” Yu asks.

For the IPO mar­ket to be ro­bust, 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 house 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.”

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 RBC’s Noël Brown, Head of US Biotech­nol­o­gy In­vest­ment Bank­ing.

“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. I think there’s a low­er like­li­hood of things rag­ing out of con­trol, and then us end­ing up in a bad spot again,” he says.

There are al­so dif­fer­ent lens­es that dif­fer­ent in­vestors are ap­ply­ing to the mar­ket, says Yu. 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 re­turns on an IPO. But com­pa­nies with mark-to-mar­ket com­pen­sa­tion are un­der re­demp­tion pres­sure, if they sup­port an IPO and it drops 30%, that has a huge im­pact.

How does the mar­ket cy­cle af­fect scale-up strat­e­gy for biotech com­pa­nies?

There’s a sense of wait­ing for pri­vate firms to ca­pit­u­late to the new re­al­i­ty of fi­nanc­ing and come back to the mar­kets, some­thing that’s hold­ing the mar­ket down and is like­ly to con­tin­ue to re­strict deals for the next 18 months, says Yu.

“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. You know, if it’s short, that kick-the-can strat­e­gy is go­ing to ac­tu­al­ly 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 of TCG Crossover

“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 gas in the tank when the mar­ket does turn around.

“I think that makes an ar­gu­ment that if and when the mar­ket 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.

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Noël Brown

Head of US Biotechnology Investment Banking, RBC Capital Markets