Solebury Trout
Preamble [SYSTEM]: Biotech sector thoughts - Flat-footed into 2019...
Solebury Trout

Some management teams have been asking Brennan Doyle in our Boston office what has transpired in the wild biotech markets over the last 3-4 months. He wanted to share some of his thoughts. 

Investors were caught flat-footed heading into 2019 after the 4Q18 sell off from:

  • fears about U.S. economic slowdown
  • rising interest rates
  • trade war with China
  • signs of economic weakness out of Europe + China
  • crude oil slump à oil prices are often used as proxy for WW economic growth
  • Tech rout on concerns of increased regulation, economic slowdown, and tech overweight on indices snowballing negatively

So as you would expect, Healthcare & Generalists setup defensive positions going into 2019:

  • But investors got bullish in early 2019 after the capitulation trade in Dec’18 (in hindsight):
    • Federal Reserve about-face/wait-and-see approach to interest rates in January
    • China trying to jumpstart slowing/stalling economy
    • stocks were relatively cheap again
    • China trade war rhetoric thawing
    • fundamentals looks pretty good for 2019
    • fears of US economy beginning to sputter hadn’t materialized
    • ECB stimulus in March to support weak Eurozone economy
  • Catchup trade commenced à market rallied in early 2019

In HC, it was even more dramatic thanks to M+A in January before, during, and after JPM conference:

  • LLY for LOXO – closed process, but folks speculate several other buyers involved
  • BMY for CELG 
  • Roche for Spark
  • Lots of folks were walking around thinking M+A activity heating up, generalists chasing

So HC investors had to adjust and do it quickly à and you’ve seen the result:

    • XBI up 25%
    • BUT that move has all been in a narrow band of companies: smid cap biotech
  • HFs: Short covering to protect 1Q19 from ruining their year
  • LOs: set up defensively now scrambling to meet their bench marks
    • So catch up trade by LOs to get more smid cap bio exposure 

Currently, HC investors scratching their head thinking: what do I do right now?

  • Smid caps too expensive to buy presently: too far too fast
  • Large caps are falling apart in terms of fundamentals and tough to put a real position on
  • HC Earnings 1Q19 à but 1Q is always the worst Q for #s because of the Obamacare “donut hole”

Folks starting to think if M+A doesn’t continue as the biotech group fades

Plus, recently a reputable analyst put out well circulated note saying there is no leadership in large cap biotech, which is key for a sustained rally:

  • BIIB – Alzheimer’s failure
  • GILD – NASH failure
  • All expected the big catalysts for large cap biotechs that could drive sector are now gone

On top of that, you have Trump still chirping about drug pricing and doing this IPI Drug Pricing demo by HHS

  • Trying to make drug pricing more in line with European counterpart countries
    • Which quite frankly is DOA, but it’s a sentiment overhang/headline risk

And finally, Obamacare under theoretical threat of being repealed after the recent Texas ruling

    • Nobody really believes this, but again negative sentiment and headline risk for generalists that extend and supersize rallies and keep IPO windows open

After all that background/context…the good news: biotech IPO financing window still open and follow-on deals are still getting priced!

While there is still demand in the public markets for biotech deals, folks on the buyside are beginning to wonder if/leaning towards the public investors are “getting full” from all the financing over last couple of years? And as always, though, this is just something nobody really knows…never a dull moment!