There are early signs that private money in biotech is being accumulated but sitting on the sidelines waiting to be deployed. Q1 2023 was the 4th strongest quarter for new capital raised by venture funds in 6 years. There is growing interest from investors in jumping back into biopharma deals, at least in the private markets. However, there haven’t been enough enticing deals for money to be put to work, as investors are shying away from early-stage bets (preclinical/Phase I).
Annualized, the Q1 2023 amounts raised are on track to be the third highest in history for new capital raised into healthcare venture capital funds. This is a promising, albeit early trend that indicates there is growing capital demand to invest in healthcare.
Bull markets generally have an equilibrium; rising demand is met with sufficient supply of quality companies looking to raise. That is currently missing. As a result, transaction activity has fallen from peak levels in 2020/2021. Deal volume of 2023 YTD is roughly similar to what it was before the Pandemic in 2018 and 2019 (~$80B annualized).
The “go-public” craze of 2020 & 2021 saw record number of biopharma companies being taken public, creating a gut of supply, much of it early-stage companies that have underperformed their later-stage counterparts and dragged down the XBI. This hangover was felt in 2022 and continuing into 2023.
When will market rebound?
If viewed as a cycle, a market reset needs to flush out existing supply and replenish new demand. From the supply side, this could mean transaction activity is likely to remain subdued for the remainder of 2023, down to pre-pandemic levels or lower. With low transaction volume, valuations are likely to continue moving along sluggishly. The XBI has stayed in the $70-$80 range for the better part of the last 12 months. During this time, the number of companies trading at or below cash has remained steady.
The growth in venture capital funds raised during Q1 2023 is an early sign of replenishing demand. This trend will need to continue in the coming quarters to validate that demand is actually picking up and heading closer to a market reset & eventual rebound. This could be at least a few quarters out, an estimate based on the comparison to the Genomics bubble that peaked in March 2000.
It took 28 months for the Genomics bubble to bottom (July 2002), after it was down over 70% from peak. During the next 8 months from bottom, it was up 50% and it took 18 months to be up 100%. The “Pandemic bubble” peaked January 2021. We are now 26 months out and down 50% from the 2021 peak.
Timing the bottom is impossible. Trends to watch over the next few quarters that could indicate changing sentiment are:
- Growth in VC funds that are a measure of rising demand
- Growing M&A volume as another measure of rising demand
- Growing transaction activity (IPOs, follow-on offerings, private deals) that measures rising demand/supply
Bottom Line: A growth in venture capital funds for Q1 is an early sign that private money in biotech is being accumulated. The money needs to be matched with a stream of quality companies raising funds to be deployed. This is currently missing and could take the rest of 2023 to correct. Keep an eye on trends that measure changing sentiment. In the meantime, selective stock picking is likely to be the ideal path forward until the current market resets. Names that have resonated with investors have been quality assets in later stage development stages.
