'The music stopped': Biotech rout leaves drug startups grounded as demand slumps for IPOs
Early in 2021 there were few more promising bets than investing in a new biotech company.
After all, the biopharmaceutical industry had shined in the spotlight of the COVID-19 pandemic, developing vaccines and drugs that saved hundreds of thousands of lives. Stocks of publicly traded biotechs soared to all-time highs. Startups launched initial public offerings at a record pace and immediately made money for their backers. Investors not typically involved with the sector piled in, hoping to get in on the action.
"You couldn't afford not to participate in initial public offerings," said Jerel Davis, a managing director with biotech investment firm Versant Ventures. "Every IPO was generating value."
But the momentum that once lifted biotech to its peak has since petered out. Stock prices of newly public companies tumbled in 2021, leaving many of them worth much less than when they debuted.
The downturn — driven by clinical and regulatory setbacks, macro-economic forces and increasingly negative investor outlook — accelerated into a market rout. The value of a widely followed stock index was nearly cut in half, wiping out years of gains and sending shockwaves throughout the biotech ecosystem.
Startups and their investors are now assessing the damage and adjusting to the most substantial downturn in 14 years. Biotech IPOs have slowed to a trickle, raising questions of whether the pipeline of new companies will narrow substantially.
Already, venture investors and startup executives are preparing plans to save cash while keeping companies private for longer, according to more than half a dozen who spoke with BioPharma Dive. Some fear a broader shakeout.
"To me, it feels not unlike 2008, when both companies and investors got winnowed down," said Michael Gilman, CEO of the private biotech Arrakis Therapeutics and an industry veteran who previously formed and sold two other startups. "The strong and/or adaptable will survive."
Biotech stocks have nosedived since February 2021
The biotech boom that has birthed hundreds of new drug startups began in earnest early last decade, right after the 2008 financial crisis that had forced many venture capital firms to either close or dial back their investment in the life sciences.
Advances in scientific research and the emergence of cutting-edge drugmaking technologies made the industry, always a risky bet, more attractive to a broader group of investors. That interest in turn empowered young biotech companies to tap public market funding via IPOs, an important source of new capital and investment returns for venture backers.
As more biotechs went public and performed well, early-stage life sciences investors raised new funds to start more companies. Their path to an IPO shortened and, along the way, the market for biotech stocks soared in value. At the start of 2013, when the pace of new stock offerings quickened, shares in the XBI biotech stock index were worth $30. Eight years later, they reached $174.
Still, some industry experts felt uneasy as valuations swelled. "There is certainly a part of this that you can look at and say, "Wow, do we have a little bit of a frenzy here?'" said Todd Berry, life sciences leader at consulting firm BDO, in an interview at the beginning of 2021.
In 2020 and again the following year, biotech IPOs broke and re-broke records, as more startups went public and raised more cash than ever before. Over that period, 149 biotechs raised at least $50 million in IPOs, compared with 83 the two years before, according to data compiled by BioPharma Dive. Combined, those 149 biotechs pulled in almost $30 billion in funding, triple the total in 2019 and 2018.
"Up until recently, the reflex for management teams, and perhaps the other existing investors was 'let's do this financing and then we'll go public in six months,'" said Otello Stampacchia, founder of the investment firm Omega Funds.
The proliferation of early biotechs going public at higher valuations created a "disconnect" between their market capitalizations and their actual worth, said Todd Foley, a managing director at MPM Capital. Companies with "cool technologies and ideas" that were far away from clinical testing were getting billion-dollar-plus valuations, much more than those of companies with marketed products, he said.
"It was a self-fulfilling prophecy," Foley said. "Prices were going up. People were making money on IPOs, so people were buying more of them."
Then, he added, "the music stopped."
Over the second half of 2021, the pace and performance of biotech IPOs plummeted.
Almost 50 biotechs had priced at least a $50 million stock offering by the end of June. That number slipped to 18 in the third quarter and 10 in the fourth quarter. At 2021's midpoint, more than half of the companies that had gone public in 2021 were trading below their offering price. By December, about 80% were, and more have joined them early in 2022 — a sharp break from recent history.
In notes to clients, Jefferies analyst Michael Yee described investors as "fatigued" by the high values of companies "trying to outdo each other to get the highest valuation." Public investors who bought into IPOs were holding stocks at prices that companies hadn't earned. Many hadn't even yet begun human testing of their drugs, making high valuations less sustainable as the market weakened.
After boom in IPOs, fewer biotechs are going public
For example, Sana Biotechnology and Lyell Immunopharma, both cell therapy developers, raised more than $1 billion combined in 2021 in two of the sector's largest biotech IPOs. Both were at least 12 months away from clinical testing when they did. And both, without any notable news, have lost more than two-thirds of their value since going public.
They have plenty of company. Some five dozen biotechs are worth near or less than their cash balance, according to a recent analysis by Jefferies. And many so-called crossover investors — firms that invest in both private and public companies and helped fuel the IPO boom — have pulled back, said Mitchell Bloom, chair of the law firm Goodwin's life sciences practice.
"Now people are talking about it, and that feeds into it," said Bloom, who represents a number of private and public biotechs. "The perception is, it's bleak."
Across the board, it's time to retrench a little bit and reflect.
The market retreat has left emerging biotechs with tough decisions to make. Many of them recently raised Series A or B funding rounds and are seeking to join the public markets at higher values.
More than 75 biotech companies are now looking to go public, said Jordan Saxe, the head of healthcare listings at Nasdaq. "The inventory is there. We haven't seen a slowdown," Saxe said. "The question is demand, and how do investors react?"
Another question is whether companies in those positions should try to force their way out, or wait.
Versant's Davis said that IPO-ready biotechs are going to have to adjust their expectations. There's now more scrutiny of the financings that preceded their stock offerings, he said, and those biotechs aren't going to get the big step-up in value they might have been anticipating.
"We need ... great teams to develop great products for patients, not to just push out companies," said Stampacchia of Omega Funds. "Across the board, it's time to retrench a little bit and reflect."
In all likelihood, that means the average size and total number of IPOs will decline in 2022, industry experts say. Just four biotechs went public by early February 2022, compared to 11 by the same time in 2021.
"I don't think this is going to be a nuclear winter," said Foley of MPM. Rather, he's predicting a more selective investment mindset and fewer high-priced, preclinical stock offerings.
Most biotechs that went public in 2021 trade below their IPO price
Startup biotechs and their venture capital investors don't all have to rush into a bear market. Unlike in previous downturns, VC firms are loaded with cash. Many early-stage life sciences investors, like Arch Venture Partners, Versant, Flagship Pioneering and Third Rock Ventures, closed large new funds in the past few years, giving them ample ammunition to either support existing companies or start new ones.
"This is a time when true life science investors, who have been around a long time, lean in," said Chris Garabedian, the former Sarepta Therapeutics CEO and now a biotech company creator and investor with Xontogeny.
Two weeks ago, for instance, Third Rock launched Septerna Therapeutics with a $100 million round and a group of crossover investors in place. That strategy means "we don't even need to pay attention to the market at this point in time," said Septerna CEO and Third Rock venture partner Jeffrey Finer. "For now, it's not affecting our plans at all."
Then there's Arrakis, which would have fit the profile of a biotech well received by Wall Street during the sector's recent peak — a preclinical company with a new way to drug RNA molecules, multiple partnerships and a syndicate of well-known investors. According to CEO Gilman, Arrakis wasn't considering an IPO in 2021 and is currently more focused on building relationships with public investors that will stick around.
Arrakis can afford to wait, with $200 million in the bank even before it signed a lucrative deal with Amgen in January, Gilman said. "When the market cycles back to companies like ours — which it will eventually do — we'll be ready."
Others, though, are adjusting financing plans to reflect the new environment. Gene editing biotech Metagenomi raised less money than it could have in a recent $175 million Series B round, said chief investment officer Simon Harnest.
"It was a very careful discussion," according to Harnest, "to allow room in this next round for new investors." Company executives also didn't want to push Metagenomi's valuation too high before it hit inflection points, like applications to start human trials, he said.
Each company's plans appear tied to which crossover investors they've aligned with, and how those crossovers are redrawing plans for 2022.
Atlas Venture partner Bruce Booth noted how his firm closed "multiple crossover-type rounds" in January. "I'm not yet seeing the private markets tighten up significantly, though that could happen," he said.
While one biotech MPM's Foley spoke with recently had no problems raising cash, another company's round fell apart at the last minute because a lead investor dropped out, he said. "Now they're in scramble mode."
Venture investors interviewed by BioPharma Dive say they aren't yet making wholesale changes. Garabedian, for example, has preferred smaller, targeted investments in prospective drugs since starting the biotech accelerator Xontogeny in 2017. The idea was to have a model that would work even in lean times, so he views the current environment as a "healthy pullback."
There are "great opportunities to invest in companies that can deliver real value," Garabedian said, but "it may be tougher for those who rode the wave and don't have the substance behind them."
"It's certainly a tough public market environment right now, the toughest in years," Booth said. But firms that create companies "take a very long-term view," he added, and that "doesn't fundamentally change" in a downturn.
Venture investors do, though, see a shift in how long companies may stay private and how they're funded.
According to Davis, of Versant, "the idea of rushing to the public markets" behind fast financing rounds has already changed. Stampacchia's reaction, now, to any companies predicting a fast-tracked IPO would be "to laugh them out of the room."
"The whole field is going to have to be a little bit more cautious going forward," said Finer, of Third Rock.
That means the look of a biotech that can go public and hold its value may be different. "I think you're going to see a lot of companies coming out with milestones that are 12 to 18 months out," regardless of what stage of development they're at, Saxe, of Nasdaq, said. "Investors want to see an opportunity for an inflection point."
They also want to see differentiated science, not just "tweaks" to things like gene and cell therapy, Davis said.
One option venture investors may pursue is to put big money into fewer companies, as seen with the $3 billion Series A round given to anti-aging startup Altos Labs in January. That strategy makes big returns harder to come by. But it also shields companies from the whims of the market and gives them freedom to experiment.
Moderna stayed private for years, raising billions of dollars in partnerships and financings. That secrecy enabled Moderna to tinker with its strategy in private, pivot to vaccine development before going public and then seize the moment during the pandemic.
Moderna is an exception, however. At least so far, others in its mold, like Sana and Lyell, "have not fared as well," Garabedian said.
This is a time when true life science investors, who have been around a long time, lean in.
Emerging biotechs may also be more willing to partner with large pharmaceutical companies earlier. Such partnerships often involve mortgaging away part of their future. But they can be an important source of validation and cash for young biotechs, giving them resources and time.
"We've seen a lot of appetite from pharma for collaborations," said Stampacchia, adding that they may be even more crucial now that public equity dollars aren't a given. He, like many Wall Street analysts, expects a surge in dealmaking, particularly for privately held biotechs or smaller publicly traded ones.
Most of all, though, companies that had intended to go public "are going to have to figure out how to be patient," Davis said. That could mean conserving cash by slowing hiring or dialing back expansion plans, according to Booth. Or it could mean starting fewer R&D projects, something Arrakis CEO Gilman worries "might limit our creativity as an industry."
"There's a view that companies with a lot of money can get a little sloppy with it, but we are in the science business and sometimes you just have to try stuff," Gilman said.
Beyond cutting costs, biotechs have other options. They could add to an existing financing round by giving up more equity. They could merge with special purpose acquisition vehicles, or SPACs, an IPO alternative that, despite a recent cooling, has been more popular than in the past. They may rely more heavily on existing shareholders to buy their IPOs. Some may even be forced to take "down rounds," several VCs said, a term for selling shares at lower prices than in previous fundings.
When the markets tighten, "money is time," Foley said. "You want to buy more time before raising your next round."
Jacob Bell and Ned Pagliarulo contributed reporting.
Article top image credit: Spencer Platt via Getty Images