That’s the question I keep asking myself coming away from the annual JP Morgan Healthcare conference this past week. The optimism. Was. Pervasive. And I’m guilty as well. Undoubtedly drug discovery and development have become more efficient and more specialized, with targeted/personalized treatments improving success rates and outcomes for patients. Meanwhile, technologies like gene therapy and the potential for one-time cures have made biotechnology exciting to the masses. JPM passes were harder than ever to come by this year, and the organizers of the concurrent Biotech Showcase conference indicated that attendance was up over 30% from last year.
But small and mid-cap biotech valuations are lofty, and healthcare specialists are aware. I spoke with many smart investors who expounded their bullish outlook for the sector and in the same breath explained how difficult it is to put money to work at these prices. In other words, speaking out of both sides of their mouth. This is a phenomenon that deserves some exploration coming away from the optimistic delirium of JPM.
- Everyone is optimistic, but few are excited about buying at current valuations.
- There’s a general sense that we may see some near-term weakness as JPM winds down, but everyone is ready to buy the dip.
- Talk of a “biotech bubble” that pervaded the conversation in early 2014 is virtually non-existent, despite indices being up another 30%.
This makes for an odd dynamic, and one that I suspect may lead to more sideways price action and volatility for the biotech sector in 2015, not the tremendous outperformance that has characterized the last two years. I don’t think we’re in a bubble, but I’m not convinced the raging bull market continues at the same pace.
Ever since Representative Waxman ignited the Sovaldi/drug pricing discussion last year and Janet Yellen mentioned biotech valuations, which sent the sector spiraling for almost two months, there’s been an underlying sense that there may be a second shoe to drop. Now, I find that this tone of caution has largely dissipated. Many thought that AbbVie’s (ABBV) deal with Express Scripts (ESRX) in December (essentially colluding to knock Sovaldi off its pedestal) was the beginning of the end of high drug prices, and the biotech bull market with it.
This may still prove to be the case, but it certainly hasn’t marked a top for the biotech sector yet.
With the drug pricing discussion ongoing, it will take a real black swan event to put significant pressure on the sector. The Chairperson of the Federal Reserve calling biotech valuations “stretched” was a black swan event; the next chapter in the saga of drug prices (ABBV/ESRX) was not. Waxman waxing poetic about a $1000/pill drug was a black swan event; the end of the JP Morgan healthcare conference probably isn’t.
Biotech is definitely coming of age and there’s hunger for new deals, but one has to wonder if outperformance will be as easy in 2015 as it was in 2014 and 2013. With the glut of IPOs in the last two years and biotech success stories proliferating in the media, many first-time or generalist investors are going to be sucked into new, sexy stories that ultimately don’t pan out. (Some, unfortunately, are likely to be promoted in unscrupulous ways). Historical outcomes tell us that 90% of drug candidates that enter clinical testing will never make it to market. Those numbers will change with the inclusion of our current, receptive FDA (the FDA’s 41 drug approvals in 2014 is the highest in almost 20 years), but the odds are still stacked against the investor.
So, proceed with caution and don’t get caught up in the FOMO (Fear of Missing Out) – focus on quality. One takeaway from 2014: it is often the “expensive” equities that continue to get more expensive; last year, picking down-and-out equities was pretty much a losing approach until the tail end of the year. A “cheaper” version of a great technology is usually cheaper for a reason and the “relative valuation” thesis doesn’t often pan out. Additionally, a bad management team can blow up a great story rapidly. Separate the science from the investment, because I don’t know any executives who aren’t bullish.
Biotech is extremely event-driven, and investors never like a lack of newsflow. This may be especially pertinent in 2015 with the lofty valuations of some small, early-stage companies and even more companies in the IPO queue, many of which haven’t even entered the clinic or are only beginning initial human testing. Phase 1 safety data may not be enough to keep investors involved.
Again, I suspect that the JPM optimism, against the backdrop of investors’ hesitance to step into rich valuations now, will make for some interesting dynamics this year. I’m as bullish as ever on medicine, and while some valuations may be stretched in development-stage biotech, there are great companies still to be found.
That’s why we do what we do. But lets see if the optimism for the technology translates into continued buying in 2015. Our take: volatility will be the name of the game, and beating the market won’t be as easy as it was for the last two years.
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