Election year politics a wild card as biopharma weighs financing climate

SAN FRANCISCO – The crossover party is all but over. Pure public players have moved upstream. Companies that went public as recently as 2014 are going belly-up. And a hyperbolic presidential election campaign has turned the industry's life-saving mission into a source of public controversy.

Welcome to the hangover following biopharma's two-year IPO revelry.

Fortunately, or maybe miraculously, the signals aren't all negative.

"At the early level, we haven't seen a huge change," said Dan Estes, principal at Frazier Healthcare and a panelist at Allicense 2016. The day-long conference is scheduled for Wednesday at the Moscone Center in conjunction with the BIO International Convention.

"We're still seeing great deal flow," Estes told BioWorld Today. "And we're seeing valuations that are about the same as they've been the last two years."

But the crossover market "has basically disappeared," according to Estes, forcing biopharmas and their investors to re-think exit strategies. In the past two or three years, companies seeking B and C financings were seeing "great step-ups" and "massive rounds come together," he said. "That's almost entirely dried up."

Instead, investors are laser-focused on financing risk – a situation that is propping up series A rounds to ensure that companies can attain significant, planned milestones. For crossovers to return, "we clearly need a robust IPO market," Estes maintained. "I don't think we're under any pretense that's going to happen in the next year, and it might never come back."

The superheated IPO market may have been "a blip" in the history of biotech that spawned numerous public companies that failed to live up to their hype, he suggested. For example, on the same day early last month, two members from the class of 2014 – Bind Therapeutics Inc. and Nephrogenex Inc. – filed for Chapter 11 bankruptcy. (See BioWorld Today, May 3, 2016.)

A few weeks later, privately held biomarker developer Kinemed Inc. did the same. The firm had sought to join the 2014 IPO bandwagon but withdrew its filing the same day two other biopharmas – Immune Design Corp. and Pfenex Inc. – closed their offerings and began trading. (See BioWorld Today, July 25, 2014.)

Connecting the dots, Pfenex now stands to benefit from the foibles of biosimilars developer Epirus Biopharmaceuticals Inc., which took another route to the public markets – also in 2014 – in an all-stock takeover of Zalicus Inc. in conjunction with the close of a $36 million series B. Last month, Boston-based Epirus halted development of its lead program, slashed 40 percent of its work force and shuffled its C-suite while it seeks to conserve cash, expected to run out by the end of the month. (See BioWorld Today, May 11, 2016.)

Those cases represent the tip of the iceberg. The Nasdaq Biotechnology Index is down 12.6 percent year to date and 21.7 percent over the past 12 months.

"I don't think there's a huge backlog of private companies that can make a credible case that they deserve to go public," Estes said.

That said, the number of venture-backed deals in the industry is on a similar pace to 2015, which was "pretty much a record year in terms of dollars deployed into companies," said Jonathan Norris, managing director of the health care practice at Silicon Valley Bank. Norris will present data on market changes and moderate a panel on trends in IPOs and M&As for venture-backed biopharma.

Allicense will seek to "get a read on the temperature of how folks are looking at the current market," Norris told BioWorld Today. Panelists also will forecast how changes in the deployment of capital by active investors over the next 12 months may affect the sector.

"When you look at the market, later-stage public biotech and pharma companies have almost completely outsourced their research to venture-backed companies, so they're also interested in the pace of investment and where the dollars are going to be," Norris said.

Panelists won't be shy. Despite his ominous outlook on crossovers, for instance, Estes questioned their overall value to the biopharma industry, noting that the flush of cash led to companies that were overcapitalized and valuations that didn't match fundamentals.

"There's always going to be a healthy IPO market for good biotechs that will create a smaller set of crossovers," he predicted. "I hope those folks stay around, because biotech is a viable long-term sector and there is going to be a public market."

Norris agreed, noting that IPOs are still getting out the door – seven venture-backed biopharma IPOs in the first quarter, by his count.

"That puts us on a pace for 28 IPOs during the year, which would be very close to 2013 numbers – which, in 2013, were seen as really good," he said.

Through June 3, 19 biopharmas priced U.S. and foreign IPOs, raising a collective $1.21 billion, with 14 companies left in the queue, according to BioWorld Snapshots. Many of the IPOs enjoyed backing from crossover investors who participated in private rounds, so those investors still have a toehold in the market, Norris pointed out. Support from crossovers, large venture funds and other insiders increases the prospect of success for IPOs because smaller amounts of outside capital are needed to make the deals work.

The IPO last week by Clearside Biomedical Inc. was a perfect example. The company priced low but increased the size of the offering to fetch $50.4 million. In its SEC filing, Clearside indicated that insiders committed to purchase roughly half of shares in the IPO. (See BioWorld Today, June 3, 2016.)

Chen Yu, managing partner at Vivo Capital, noted that "we're clearly in a period of transition." Some biopharmas are closing solid IPOs – he cited Intellia Therapeutics Inc., of Cambridge, Mass., which raised $108 million last month – while others, such as Viamet Pharmaceuticals Holdings LLC, are throwing in the towel. (See BioWorld Today, April 13, 2016.)

"It's a bifurcated market," Yu told BioWorld Today. "The good stories make it but a lot of borderline stories are clearly having trouble."

Among the crop of IPOs that priced since September 2015, most are trading below issue, he pointed out, which has proved a bitter pill for crossover investors.

"We're dealing with a little bit of what we call 'the denominator effect,'" Yu explained. "These players ended up having a certain allocation to private, but as public market values shrank the value of their private portfolios rose disproportionately." In the aftermath, public crossover investors are spurning term sheets and private deals, in general.

THESE FIRMS 'CAN COMMAND INCREDIBLE VALUATIONS'

But so far, the exodus of crossover funding hasn't affected the size of private financings, especially series A rounds. Allicense panelists expect the drift toward large initial financings to persist.

"At Frazier, we've always tried to get as far as possible on one round – ideally, to an M&A exit after a single round," Estes said. "It's very easy to go from an M&A-focused company to an IPO-focused company, but it's harder to transition from a large platform that's built for an IPO to a more capital-efficient, M&A-focused company."

Considering the softer IPO market, Estes expects more early stage investors to follow the same model to limit their risk, and that could be a plus for firms like Frazier that syndicate their A rounds with three to four like-minded backers willing to take equally large stakes. He cited the size of Vivo's current fund – a $750 million Goliath plying capital into health care firms in the U.S. and China.

"If you look at the number of people they have to manage their positions, it makes more sense for them to put in more money per position," Estes said. "That's even true for us, with the size of our fund."

Frazier closed its eighth health care fund, dedicated exclusively to life sciences, in October 2015 at $262 million. (See BioWorld Today, Oct. 30, 2015.)

"We're all committed to these large series A rounds to have sufficient firepower behind them that we can continue to support the company if they need additional rounds," Estes said.

The degree of difficulty in the current market is enabling experienced limited partnerships (LPs) to rise to the top, Yu added. Two years ago, "it didn't matter if you were any good or not," he said. "Everyone was making money. From a selfish perspective, a tougher market will help to differentiate good investors from those that aren't so good."

The size of private rounds will likely remain strong for another reason, according to Yu.

"All of these funds just raised money and you're going to see that capital deployed," he said, predicting that venture firms will need to "earn their keep" over the next three to four years – a period that could include another round of consolidations. "Until that time, I don't expect to see smaller A rounds and, frankly, I don't expect to see valuations change much for those rounds. We just may see fewer deals."

Changes in the market also are likely to strengthen M&A deal flow, Yu added. Historically, about 75 percent of Vivo's exits have been through M&As, but the firm saw that ratio flip during the past several years, with some 90 percent of its exits through IPOs.

An upside of the windfall of biopharma IPOs was to create "an entirely new set of potential buyers even as there was consolidation in the industry," Estes pointed out. He cited Seattle-based Juno Therapeutics Inc. and Kite Pharma Inc., of Santa Monica, Calif., as two of the industry's big horse traders.

Deals such as Astrazeneca plc's 55 percent stake in privately held Acerta Pharma LLC, which included $2.5 billion up front, and Abbvie Inc.'s buyout of Stemcentrx Inc. – potentially valued at $10 billion – "clearly highlight that development-stage companies can command incredible valuations on the M&A side," Estes added. (See BioWorld Today, Dec. 18, 2015, and April 29, 2016.)

Norris expects M&A deal flow to continue, pointing to five biopharma M&As during the first quarter that exceeded $75 million up front, following by the ginormous Stemcentrx deal in the second quarter. That transaction, and the Acerta stake, bode good tidings for venture-backed biopharma, he maintained, which has not traditionally attracted billion-dollar-plus up-fronts.

"We're seeing interesting deals being done that ascribe a huge amount of value to companies that still don't have an approved product," Norris said. "To me, that shows that acquirers believe in the venture model for companies with breakthrough technology and that those models are working, from the investment side."

'HOW YOU SHOW DIFFERENTIATION IN THE CLINIC'

Yu also named "Chinese money" as an emerging source of capital that may plug any biopharma financing gaps.

"We're seeing some of the first cross-border licensing deals between U.S. and Chinese companies, going in both directions," he said. "That's another trend that will be interesting over the next year or two."

Life science partnering deal values in China have risen steadily over the past three years, with drug development alliances accounting for the lion's share, according to panelists at last month's Chinabio Partnering Forum. Examples of top deals included Indianapolis-based Eli Lilly and Co.'s $1 billion partnership with Innovent Biologics Inc., of Shanghai, for three bispecific PD-1 antibodies, and Wilmington, Del.-based Incyte Corp.'s $795 million deal with Shanghai-based Jiangsu Hengrui Medicine Co. Ltd. for its anti-PD-1 monoclonal antibody SHR-1210. The latter represents the largest deal in China for a single asset to date. (See BioWorld Today, Sept. 3, 2015, Oct. 12, 2015, and May 19, 2016.)

Most U.S.-based LPs were relationship-based at the outset but have become "more finicky and selective," Yu maintained. In the meantime, Chinese LPs have taken up the relationship mantle and emerged as big check writers, often ponying up for $100 million plus. In a global economy, that dynamic will inevitably grow the Chinese LP base at the expense of U.S. LPs, he said.

For the time being, buyers are plentiful, although they're also pickier, sources agreed.

"They're all looking for a truly differentiated asset, not innovation for innovation's sake," Estes said, advising biopharmas to "understand how you show differentiation in the clinic and create a credible plan for achieving that plan on venture dollars."

"In my opinion, companies need breakthrough technology in a very large market or a hot therapeutic area, such as an orphan indication that has very limited therapies," Norris added. "That's the model that's been working for the venture community. We've seen a lot of success for immuno-oncology. We're seeing gene therapy companies get a lot of interest. And anti-infectives continue to be a hot area because of the emergence of hospital-based infections leading to readmissions."

If technology is an area somewhat under biopharma's control, a factor almost entirely outside its influence is the impact of the U.S. presidential election, including Tuesday's much-anticipated California primary. Norris said he worries about the "unknowns" associated with the election, including the propensity for candidates "to jump into health care issues that could reflect poorly on the biotech or pharma industries. We certainly saw that in some of the early primaries with drug pricing."

"The political season is certainly contributing to volatility in the public sector, and any volatility in the public sector is probably going to hit small biotech twice as hard," Estes agreed. Long term, however, "I don't see any structural changes to drug pricing," he observed. "Maybe there will be more scrutiny on drug price increases but that's a good trend for innovation, from a fundamentals perspective."

In fact, U.S. pharmacy benefit managers already are calling the shots on pricing and market access, "so the natural market forces are having an effect," Estes added.

Yu expects the campaigns to have little or no impact on biopharma. "Hillary Clinton is actually pretty much a status quo president," he said. "On the margins – while she's tweeted a little bit here and there in ways that are perceived as less attractive for big pharma – I don't see her doing anything dramatic."

And although Donald Trump is "unpredictable intrinsically," Yu added, "I don't think we're on his radar screen. Plus, if Trump wins, there will be a lot of other things to worry about other than drug pricing."

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