US biotech stock prices declined toward the end of 2021, following a bull run that started in 2020. Investors who had recently rejoiced in positive clinical news from public companies now fled from risk. Small-cap exchange-traded funds (ETFs)1 struggled against ETFs skewed toward mid- to large-cap biotechs. Although the recent downturn has been less severe for businesses with commercial-stage assets, most have been negatively affected.
This cycle is a familiar one for the sector. Over the past decade, biotech stocks have soared far above the S&P 500 a number of times, only to fall back to market level (Exhibit 1). Investors have repeatedly exulted in biotech’s limitless potential, then shunned the stocks after late-stage assets imploded, and finally rushed back in when breakthrough products proved to be game changers. Even including the recent rout, the S&P biotech index has delivered ten-year returns comparable to those of the S&P 500 and higher than those of the S&P pharmaceuticals index.
If history is any guide, it is a question of when, not whether, the biotech public market will become more favorable. In the meantime, emerging companies might better withstand the public market’s headwinds by wisely managing their cash, identifying the best financing options to achieve planned milestones, systematically de-risking assets, and differentiating their portfolios, partnerships, and people.
Investors’ enthusiasm dampened as 2021 receded
To analyze the sector’s performance, we identified 393 biotech companies that have gone public since 2013. First, we categorized them by the development stage of their lead asset at the initial public offering (IPO) and today. Then we calculated the median total shareholder returns (TSR) from January 2020 through January 2022 (a period that encompasses bull and bear markets) and the TSR and price changes from October 2021 to January 2022 (a snapshot of the bear market’s steepest declines).
We found that companies in the pre-2020 cohort performed poorly during the past two years regardless of their lead asset’s stage, with negative growth rates ranging from 28 to 17 percent (Exhibit 2). When we added the 2020–21 IPO cohort to the mix and focused on the steepest declines from October 2021, companies with filed or marketed assets clearly outperformed those with preclinical and Phase I to III assets (Exhibit 3). The superior TSRs of companies with commercial-stage products are consistent with recent analyses of the current decline’s risk-off nature.
When we analyzed the stock performance of biotech IPOs that made positive clinical and regulatory announcements from 2018 to 2021, we found notable share price increases in 2020 (Exhibit 4). During the first half of that year, share price increases only trended higher for biotechs with COVID-19–related development programs—understandable during a global pandemic. During the second half of 2020, the stock price bump extended to all biotechs with positive announcements, even those with programs unrelated to the pandemic. However, in 2021 investor responses to positive news were increasingly muted, dipping below the pre-2020 baseline. These muted reactions indicate that the risk-off trend held when the clinical and regulatory information was positive. That may create value opportunities for investors.
The biotech IPO boom of 2020 and 2021 saw 158 companies enter the public markets. Sixty-six percent of them had products and platforms in preclinical, or Phase I, development (Exhibit 5). There was a marked uptick in the number of early-stage platform technology companies (as opposed to asset-focused firms). IPO values surpassed those seen in previous years (Exhibit 6). Such parallel trends are noteworthy given the higher risk associated with early-stage development.
This unprecedented wave of IPOs was fueled partly by crossover funds expanding their private investments and by the reemergence of special-purpose acquisition companies (SPACs) as vehicles for biotech financing. The 2020–21 IPO boom, driven by investors encouraged by the bull market and eager to reap the potential rewards from a broad set of new technologies, was not the root cause of the recent downturn. But the resulting glut of newly public companies will face increased competition for follow-on financing.
How biotech companies can survive and thrive in a tough market
It’s not all bad news for the biotech sector. The recent downturn was a correction to S&P 500 returns rather than a significant deviation from historical trends. The fundamentals—increasing regulatory clarity and commercial viability for innovative therapies addressing unmet needs—have not changed. Seasoned biotech venture capitalists (VCs) with long investment timelines have significant resources to finance the next wave of cutting-edge innovations, and McKinsey analysis suggests they are doing so. Many large biopharma companies boast strong balance sheets and have publicly expressed their willingness to partner with or acquire companies.
Emerging companies thus have an expanded range of partnerships and, potentially, exit routes. We see two broad sets of priorities that can help biotechs navigate the new environment:
1. Scrutinize cash management and financing options
Biotechs that have depressed valuations and face a wary public-equity market are looking hard at cash-burn models and exploring how to secure alternative financing. Some will find it harder to raise enough capital to reach the next value-inflection point and transform their progress into improved valuations. It will be necessary to understand the near- and long-term risks associated with various financing options and to choose those that can build a bridge to future equity offerings. Companies that can articulate a clear, data-driven value proposition—and how the next milestone advances it—will have a competitive advantage. Management should consider the following options:
- If there is enough cash on hand to reach planned milestones, it may be wiser to execute existing plans and validate a product or technology before attempting to raise additional public funds. Companies that successfully hit milestones will probably command higher valuations. To mitigate the risk of relying too heavily on future market conditions, biotechs in this category should consider rigorous postmilestone scenario plans and evaluate their options.
- If cash is more constrained, and near- and midterm milestones require moderate incremental investments, rigorously streamline operations and explore investment trade-offs. That approach could buy enough time to pursue a public offering later at a “good enough” valuation and on a scale that isn’t unacceptably dilutive. It avoids the downside risks of alternative financing but is still contingent on future market conditions.
- Many biotechs that don’t have enough resources to meet milestones and can’t streamline their operations or prioritize their pipelines will need to seek alternative financing and partnership models. Companies with early-stage assets have financing and partnership options different from those of companies with later-stage assets. Early-stage biotechs may choose to access new debt facilities to reach planned milestones. Since debt is not an ideal financing structure for an early-stage company, it may also consider a private placement—especially one with existing investors familiar with the technologies and committed to their long-term success. Biotechs with late-stage clinical candidates have more options, including private placements, royalty deals for existing and future revenue streams, a broad range of debt-financing options, hybrid deals, and external partnerships tailored to specific milestones, such as a launch outside the United States.
2. Rethink the path to long-term value creation
The new public-market landscape is notable for its lower valuations and increased competition among IPOs that seek financing. In the current environment, there is a flight to perceived quality and a premium on the clear differentiation of opportunities. Biotech leaders can benefit from pressure-testing their value propositions even more rigorously and identifying clear paths to attractive returns with upside potential. Three areas may warrant a close look:
- Portfolios. Early-stage biotechs, particularly developers of platform technologies, may have less time to explore, refine, and optimize their technologies in the current setting. To demonstrate proof of concept, such companies often select indications with well-validated assays and end points, as well as lower levels of biology risk. These indications have become crowded, and many are rare diseases. In some situations, the recruitment requirements for clinical trials exceed the number of patients with the condition being studied. Small and crowded proof-of-concept indications can still be valuable, given a realistic assessment of their feasibility and a quick path to end points. However, to show investors that proof-of-concept indications are gateways to greater value, there should be some focus on fast follow-on indications. Later-stage biotechs with more extensive pipelines have a broader range of financing and partnership options for prioritizing their portfolios. Now may be the right time for capital-constrained biotechs at all stages to make difficult trade-offs.
- Partnerships. Capital constraints should spur a reevaluation of partnerships across the value chain, including contract manufacturing organizations (CMOs), contract development and manufacturing organizations (CDMOs), contract research organizations (CROs), and potential commercial partners. Any partnership that expands capabilities, accelerates development timelines, or de-risks assets can create value. Early-stage biotechs with no near-term clinical catalyst may be more open to partnering with larger biopharma companies; investors can perceive deals as validation before an upcoming financing round. This openness should help biopharma companies gain access to cutting-edge technologies at reasonable value.
- People. Depressed valuations are leading to downsizing at some biotechs and may lead many biotech employees to reevaluate their situations and consider new opportunities. The pandemic has created intense flux in work models and spurred a migration of talent across society. However, lower valuations could attract new employees by offering a more significant upside potential from stock incentives. Most biotechs know that their ability to attract and retain talent is critical to success, but they must sharpen their focus even more in the current environment. Thoughtful workforce planning can address capacity gaps, achieve milestones, help realize long-term strategies, and convince investors that they are financing a team with the skills to succeed.
The recent US biotech public-market downturn is a normal part of the investor enthusiasm cycle. Biotechs that deliver products to market, demonstrate their value to payers, and consistently outperform expectations can still prosper. This point in the cycle offers opportunities for value investors seeking overlooked technologies and product candidates with high potential.
Before a potential rebound of the public market, biotechs should manage their cash more closely and consider alternative financing and partnership models. Those that ruthlessly prioritize their portfolios and differentiate themselves from peers by retaining exceptional talent will probably navigate depressed valuations and volatile labor markets more successfully.