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Our first Biotalk podcast is focused on Locust Walk’s 2022 year-in-review market conditions, which was released the first day of JPMorgan and rapidly accumulated over 500 downloads. Each quarter, Locust Walk’s deal team compiles key statistics and trends showcasing what is happening in the global private and public capital markets and strategic partnering and M&A.

We wanted to share some insights into the report and discuss key trends, opportunities and predictions for the industry in 2023.  To download this report, please go to locustwalk.com and go to our “Insights” page.  As always Locust Walk is happy to speak with you further if you have any questions about our views or if we can be helpful to guide your organization through the current market environment.

Timestamps:

Recap of How We Got Here: 1:03

Key Trends for Biotech Management Teams to Monitor: 4:36

Locust Walk Expectations for 2023 Biotech Market: 6:01

Signals of Market Recovery to Watch For: 9:45

How to be Successful in This Market: 11:19

Transcription:

Welcome to Biotalk. My name is Geoff Meyerson, CEO and Co-founder of Locust Walk, and you are listening to Biotalk, our new podcast for biotech deal makers.

Our first Biotalk podcast is focused on Locust Walk’s 2022 year-in-review market conditions, which was released the first day of JPMorgan and rapidly accumulated over 500 downloads. Each quarter, Locust Walk’s deal team compiles key statistics and trends showcasing what is happening in the global private and public capital markets and strategic partnering and M&A activity.

We wanted to share some insights into the report and discuss key trends, opportunities and predictions for the industry in 2023.  To download this report, please go to locustwalk.com and go to our “Insights” page.  As always Locust Walk is happy to speak with you further if you have any questions about our views or if we can be helpful to guide your organization through the current market environment.

It’s important to review recent history to provide context for the path ahead.  The industry became victim of its own success

• Easy monetary policy with 0% and even negative interest rates in the US and major economies coupled with the success of COVID vaccine development and the intense focus on the biopharma industry to save the world led to a massive wave of biopharma fundraising and industry expansion
• Starting February 2021, a mere 2 months after the first COVID vaccine approval, the balloon started to deflate with the gradual decline in the XBI and gradual reduction in financings although still occurring at a frenetic pace. In retrospect it is fascinating that the public market was declining yet the volume remaining amazingly high for crossovers, IPOs, and follow-ons.  During the 2020 and 2021 boom and from before COVID, way too many companies were created, too much private capital was invested and way too many companies went public leading to an explosion in number of publicly traded biotechs
• 2022 was a perfect storm of events occurring all at once leading to the first time in memory where macro political and macroeconomics took over control of the industry direction. Over these 12 months the continued aftershocks from COVID and the industry resetting because of too much company supply and too little capital availability created an accelerating negativity to the environment.  The Fed hiked rates 4.25% through the course of 2022 in response to the fastest inflation in 40 years, which led to a risk off environment from investors
• 2022 the XBI fell 25% on the year and 48% since its February 19, 2021 high. IPO issuances stood at only 9 companies compared to 92 in 2021
• Companies both public and private have been forced to prioritize their portfolios, focusing on their most advanced viable assets and unfortunately downsize their teams. A consequence of this contraction in pipelines and employment is greater capital efficiency and return on investment on a go forward basis.
• While we have seen some large M&A and high value strategic partnerships this year, on an aggregate level, by deal value, M&A has been below historical levels and nowhere near the flood of activity that was anticipated in January 2022. Interestingly, we are seeing an emerging strategic valley of death.  Page 18 from the Locust Walk repor  t shows that we had 76% of license deals for discovery/preclinical compared to 49% in 2021 for the same stage.  Page 22 from the Locust Walk report shows that 65% of M&A deals were commercial stage up from 50% in 2021.  By comparison, 30% of M&A deals in 2021 were Phase 2 and earlier and only 24% of 2022 M&A deals of similar stage.  Thus, the ability to secure a license or M&A deal between late pre-clinical and phase 2 PoC is increasingly more challenging.  Couple this with a tighter financing market moving later stage will lead to a shift in 2023, which we’ll discuss.

Key Trends for Biotech Management Teams to Monitor

Macroeconomic Headwinds: Inflationary pressures led to rapid and sustained interest rate hikes in ’22 which disproportionately affected growth sectors like biotech as the cost of capital increased. The expectation of the Fed to continue rate hikes, though at less aggressive increases, and maintain elevated rates through ’23 and potentially into ’24 will likely prevent significant generalist capital from entering the early stage biotech space. If anything, generalists might consider dipping their toes back into the biotech waters but at later stages of development.  This likely will skew private and public financings later stage in 2023.

Political Legislation: A divided congress is unlikely to result in additional legislative disruption to biotech over the next two years. However, the impact of the IRA will start being felt in how companies make decisions despite the actual price negotiations still being 3 years away. FTC headwinds against pharma mergers may continue to impact M&A deal volume in ’23 that was widely anticipated in ’22.  Additionally, CIFIUS pressures have the potential to impact cross border deals between the US and China as we are hearing increasing noise on this front.

Locust Walk Expectations for 2023 Biotech Market

Stance on Market Conditions: The markets have likely priced in the initial shock of 2022’s macroeconomic deterioration and expectations moving forward are already more modest. We do not expect the XBI to get materially worse than it is starting the year, but we also do not expect it to drastically improve. We believe a dramatic recovery would require additional generalist capital, which we’ve previously discussed.  We hope to see signals of recovery in 1H ’23 with a few IPOs of the strongest companies but advise our clients to prepare for a modest recovery this year at best.  An improvement in the XBI also does not necessarily translate into better finance ability of private or early-stage biotech companies.  More advanced companies will likely have increasingly better access to capital as the year progresses and larger investors search for growth.  In short, the financing market has some ways to go to fully heal and for the IPO and Follow-On windows to really reopen beyond the strongest companies with the best syndicates with material insider participation. The financing crisis is, however, creating opportunities for buyers to pursue strategic partnerships and M&A on great terms.

Access to Capital Remains Limited: Completing public or private financings will be feasible but challenging and will take longer to close. Public investors will be open to the companies that have either extraordinary ground-breaking science or clinically de-risked assets with a clear path to approval. That market will likely continue to thaw as ‘23 progresses.  The bar for private investors to deploy dry powder to new investments will remain high as they both focus on shoring up their existing PortCos finances and seek to extend the life of their current funds as fundraising for their own funds faces limited partner challenges. Insider support for both public and private financings will be critical from well-known life science investors.  Companies without such investors will likely struggle to raise capital and should consider additional strategic options.

Clinical Data Rules All: Meaningful clinical data, or at minimum line of sight to a near-term readout, will be rewarded by investors and strategics alike. Those with it will have easier access to private and public capital. Those without it should prioritize decisions that extend runway allowing development programs to achieve clinical PoC and seek strategic alternatives to access additional dilutive or non-dilutive capital.  VCs are likely to shift even further away from towards companies in the clinic where they can potentially achieve a strategic exit without relying on an IPO something not frequently discussed.

Strategic Deal Interest Shifts: Deal-making trends that began in ’22 continue in ’23 with early-stage licensing for discovery through early pre-clinical continues to move towards phase 3 or approved products. The new ‘valley of death’ of late pre-clinical through phase 2 programs will carry too much risk to attract serious strategic interest from the biggest companies. Signals of efficacy in Ph. 1B studies will no longer serve as ‘clinical PoC’ and many strategics will seek clinically meaningful data from larger Ph. 2 or Ph. 3 trials.

Signals of Market Recovery to Watch For

Three Barometers of Success: We still believe the three signals to show we are close to the ‘other side of the market malaise’ are 1) a reduction to <50, or double the pre-pandemic average, of companies trading below cash, 2) a contraction in the number of small- or mid-cap biotechs via selling, merging, or going out of business (i.e., re-allocation and consolidation of capital in our industry), and 3) the Fed stopping interest rate hikes or injecting more liquidity.

Return of High-profile M&A: An increase and more consistent stream of $1B+ acquisitions with healthy premiums can restore investor confidence that biotech exits with attractive returns on investment are feasible and re-invigorate investor interest. This would be even more meaningful if the deals start to materialize at phase 2 or earlier rather than the drumbeat of commercial stage acquisitions.

How to be Successful in This Market

Proactivity Required: Management teams that successfully navigate this market will be proactive in finding creative financing and strategic deals with non-dilutive capital to keep priority development timelines on track. This is a historically challenging market and you cannot expect to operate on the same timelines and strategies with the same resources that worked in 2015-2020 and win.

Optionality is Critical: Looking beyond typical deal processes and parallel tracking strategic options, financing options and if a small public or private company, strategic mergers, can create competitive tension leading to better deal values.  This provides optionality to management teams to select the best path forward. Dual or triple track processes are recommended as they can catalyze transactions that previously would not have been pur sued, but that we expect to become more commonplace in this market (e.g., financing process leading to an investor-driven and value-creating merger with another portfolio company).

I want to thank everyone for listening to our first episode of Biotalk.  Please let us know what you thought and feel free to suggest potential topics for future episodes.  We look forward to a productive dialog and hope you tune in to our next podcast.  Please share with all of your friends and colleagues so we can grow the audience.  This is Geoff Meyerson for Biotalk signing off.