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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