Semper Maior: Reflecting on a quiet 1H24

Our usual top-down biotech sector metrics showed that 1H24 was… pretty boring (though for us bottom-up folks, individual companies offer plenty of excitement). After the last few years, boring ain’t bad. 

With expectations of Fed easing interest rates due to waning inflation, the excitement level for the second half of the year has already picked up, but that’s not reflected in the metrics here.

Our approach

As you may know from our past Semper Maior reports, we track the performance of the Universe of US-listed public development-stage (cash burning) biotech companies with valuations $10B (there are currently nearly 600 of those). 

Our approach differs from how most others do it because we tag companies as being either Core to specialists (if one or more peer specialists we track own a stock) or Peripheral (if no specialists we track own the stock) according to 13F data. This is relevant if one wishes to understand how the sector ​“feels” to specialist investors, which is relevant if management teams wish to understand investor mood and behavior. This analysis is also relevant to the Limited Partners (i.e., the real investors in biotech) who wish to understand what’s happening to the portion of the biotech public markets that matters to biotech specialist fund managers.

We also run our analyses using both an equal weighting and a market-cap weighting; the equal weighting causes small caps (let’s say companies $1B in market cap) to have a big impact on our perception of sector performance, which is reasonable if you think about what the mood would be like in a room full of CEOs (most run small caps). If small caps are up and larger caps are flat, then the mood in the room would be overall positive and the equal weighted performance would reflect that by showing positive performance for the sector. But consider that specialists managing any appreciable amount of capital are likely weighted towards larger caps. In that case, they might feel that sector performance is tepid, which is what market-cap weighted performance would reflect.

In a nutshell, the biotech sector has been gradually recovering from the last downturn. Core companies outperformed Peripheral, as we’ve come to expect since that’s the case every time we run this analysis. Core was up only slightly (+1.8%) and that little bit of positive performance was due to acquisitions, with the rest of Core essentially flat. M&A has been more modest than last year but is more robust than in most years in the last decade. And as in the past, nearly all M&A was in the Core set. The rate of companies going public via IPOs or other means has been as low as in 2022 and 2023, so the crossover conveyor belt has not picked up speed. All these dynamics have resulted in the continued distillation of the public biotech Universe, which shrank slightly in 1H24 from 599 to 593 companies. As of MY24, Core biotech consists of 339 companies. The conditions for continued recovery remain very favorable, in our view (and July has already gone well for valuations).

A quick word on combating the existential risk to innovation

Before I drill into the usual sector data, I wanted to step back and mention that all continued progress in our sector depends on America not deciding to price control novel medicines. Whether Democrats or Republicans win the White House and Congress, each side has ideas for addressing America’s outrage over affordability by using various kinds of price controls on prescription drugs. Democrats use Medicare Negotiation. Republicans favor International Reference Pricing (and Trump’s VP pick JD Vance has indicated that he liked Medicare Negotiation, too, though it’s unclear if he means the 13-year reasonable kind or as early as possible, which would be toxic to innovation). 

As I wrote previously in Eroding Tolerance and as we’ve discussed in other pieces, our industry needs to mount a campaign that channels public outrage over drug affordability where it belongs: with out-of-pocket costs. Because ​“drug pricing” for patients is about out-of-pocket costs determined by their insurer, not the prices drug companies charge (as Mark Cuban has shown, even a $15 generic can become unaffordable once a PBM has done its worst). 

The key instruments we envision for channeling public outrage into constructive insurance reforms are videos that simply ask ​“what’s the point of a copayment for a drug no one would take if they didn’t have to?” We created our first one, focused on asthma inhalers. 

Please check out and amplify these posts on Twitter, LinkedIn, Instagram, and Tiktok. Like them and Share them. Help us #fixinsurance. These posts are designed to punch through the noise and raise this issue with influencers known to care about asthma. So all of us amplifying these posts will help achieve that. 

That’s all I ask you to do. If you would be willing to go further, please forward these posts to others at your company or to your family and friends, and urge them to amplify them as well. Thousands of amplifications of this single post can push it into national discourse. That’s how we can together turn our own small contributions into a movement.

Once Congress caps what insurance plans can change out-of-pocket for covered medicines, patients’ pharmacy counter frustration and rage will no longer be misdirected at innovators. It won’t be the whole solution or the end of debates over price controls, but it will go a long way towards making drug price controls less of a vote-getting issue than they are today.

Digging Into the Details

Table 1 shows a lot of the data that we use to create the charts here.

Table 1: The Big Table

Table 1 is your one-stop shopping for data cuts of the development-stage, US-listed, $10B small-mid cap biotech universe. A few highlights are that the Universe has slightly shrunk but the number of Core companies has slightly increased, both in number and in market cap, which shows that biotech is continuing to distill down to Core (companies specialists hold). While many companies (roughly half) are down to 2 YoC, they only make up about 14 – 15% of the Universe/​Core set by market cap (that’s what all the tiny numbers in parentheses are… the market cap weightings). That shows why we shouldn’t overreact to the number of companies of one type or another but rather look at the substance of the sector, which is largely weighted to larger, well-capitalized companies that investors value. The number of companies trading below cash held steady at 140 (67 in Core) but these make up only 3.3% of the Universe by market cap (only 4.6% in case of Core). Healthcare/​biotech XBI and IBB have negligible exposure to companies trading below cash (NegEV). Looking at weightings of NegEV companies and those with 2 YoC is helpful to appreciate that the sector is far more weighted to better-funded companies pursuing programs that investors value (i.e., have a positive enterprise value, PosEV). Source: Factset; Bloomberg; RA Capital.

In 1H24, the main sector indices IBB (+1.1%) and XBI (+4.0%) were up modestly. Core companies outperformed Peripheral ones, as usual, but much of the action was in small caps and the reality is that the companies that make up the bulk of the development-stage public biotech sector were essentially flat.

Figure 1: 2024 Public Development-Stage Biotech Performance

Figure 1 shows the 2024 performance of the $10B public development-stage biotech drug-focused Universe, showing that Core significantly outperformed the Peripheral subset of companies. We present two ways of weighting the companies and also performance of two biotech/​healthcare ETFs, XBI and IBB. Core and Peripheral classifications are based on 1Q24 13F filings. Performance is reported through MY24. Source: Factset; Bloomberg; RA Capital.

The equal weighted basket in Figure 1 shows that Core was up +7.5% while Peripheral was down ‑15.9%, which resulted in the Universe declining ‑3%. But when you look at the Market-Cap Weighted performance, which is relevant because it’s closer to the reality of how specialists’ portfolios look, the Universe was up only +0.7%, Core was up +1.8%, and Peripheral was down ‑7.8%.

So a room full of Core CEOs would have a positive vibe while investors would likely feel less excited about their portfolios.

Figure 2 shows there were fewer acquisitions compared to last year, but that we’re on track to match or exceed the levels of M&A we have seen over most years in the last decade.

Figure 2: M&A Dollars Flowing Into the Biotech Universe

Figure 2 tracks the cumulative M&A transaction value as well as the cumulative premium paid in each year, as well as the total number of transactions, just within the public Universe (US-listed, development-stage, $10B in market cap). For 2024, we show the mid-year totals as well as an annualized total based on mid-year data. The red solid line reflects the actual number of deals through 2023 and the dashed line shows the transaction volume annualized. What we see is that 2024 M&A metrics so far are nowhere as awesome as for 2023 (which in retrospect looks like a year where pharma made up for depressed M&A levels in 2021 and 2022) but are still tracking to 2024 being the 4^th best year of the last 11 years. Source: Factset; RA Capital.

In typical fashion, 98% of acquisition dollars went to Core companies, and these acquisitions are responsible for a decent amount of the +1.8% performance of Core on a market-cap basis. If you remove the companies that were acquired, Core was up only +1% on a market-cap basis. If we remove acquisitions from the major indices, IBB would be up 1% instead of +1.1% and XBI would be unchanged at 4.0%. We’re not even going to bother with figures for these yawn-inducing data.

Figure 3 shows little change in the ratio of strategics’ cash flow relative to the valuations of Core development-stage biotech. As before, major Strategics have significant cash flow with which to acquire what they want from the development-stage Universe.

Figure 3: Years of Free Cash Flow to Acquire Smid Cap Biotechs @ 100% Premium

Figure 3 shows Years of Strategics’ Free Cash Flows needed to acquire the whole Biotech Universe or the Core subset for a 100% premium. We’re not doing this to suggest that strategics would or should acquire all biotech companies for a 100% premium; that would be silly… it should be a 200% premium. Okay, no… we’re just doing this to show how small the target pool is relative to the cash flows that acquirers generate. We’re not even counting all the cash that strategics already have on their balance sheets. Because this was created as part of a different historical analysis that predated the Semper Maior series, it is based on data that exclude companies $50M in market cap (and it’s a ton of work to redo going back to 2016), but this impact of this is so tiny that it doesn’t change the results anyways. Source: Factset; RA Capital.

What Figure 3 tells us is that over the next few years the Core companies that haven’t yet been bought will either a) become uncharacteristically cheap (as a group) relative to Strategics’ buying power, b) get bought (which drives Core returns), c) appreciate in value (which drives Core returns), or d) be augmented with many more private companies going public (likely driving returns for those holding private shares). We anticipate a mix of b, c, and d will play out over the coming couple of years.

Figure 3 actually underestimates how cheap biotech will get in the next few years relative to Strategics’ buying power since we don’t project all the failures that will cause this ratio to shrink. It’s a more involved analysis which we did in our last Semper Maior piece and we’ll do it again in our next one.

Figure 4 shows that there’s been relatively little turnover in the total number of companies in the Universe. The biggest changes were that nine companies were acquired (eight of them in Core) and 18 went public. The count dropped by less than 1% from 599 to 593 (only six fewer companies, of which two – congrats to Insmed and Sarepta – graduated from the $10B market cap range, which is a good thing). Core picked up 10 companies and Peripheral lost five. We’ll detail the breakdowns for each group in the next Semper Maior report in January 2025.

Figure 4: The Development-Stage Biotech Universe

Figure 4 shows that the number of Core companies shrank from YE23 (which is based on 3Q23 13Fs) to MY24 (which is based on 1Q24 13Fs) as companies lost and gained specialist shareholders, some were delisted, others acquired, and some graduated out of and into the $10B valuation limit, though more left than entered the set. Yet the Core set’s valuation increased slightly, showing that biotech is distilling down to fewer yet more valuable companies, as we wrote in our January 2024 Semper Maior analysis. This will likely be a continuing trend until the crossover conveyor accelerates. Source: Factset; Bloomberg; RA Capital.

Figure 5 shows that we are not yet increasing the rate of companies going public compared to 2022 and 2023. The crossover conveyor belt is churning somewhat slowly. The window has always been open and remains open for select companies, but its narrow aperture is likely driving more interest in partnerships and M&A as IPO alternatives.

It is worth noting that, at $367B in combined market cap, those 593 companies currently in the Universe are slightly more valuable than the $351B combined market cap of the 599 companies at the start of the year. Biotech continues to distill to a more valuable essence, which is why we think the crossover conveyor will pick up speed eventually.

Figure 5: How Private Companies Went Public

As you see in Figure 5, only 13 private R&D‑stage biotech companies went public in the first half of 2024, on pace for roughly the same as in 2022 and 2023, though we expect this pace to accelerate in 2H24 and that we’ll end 2024 above the 2022 rate even if below 2021. Source: Factset; RA Capital.

As I mentioned earlier, improved macro conditions have already lifted the biotech sector in July. We see continued M&A boosting Core biotech returns and the prospects of the industry’s strategic buyers, who are obliged to run just as fast as they can to stay in the same place on the patent treadmill (now backstopped by the IRA’s price controls) and to run faster still if they are to get ahead. Quite a few companies are eager to IPO, some of which I think will be greeted warmly by the public markets (I can at least speak for our team). And underlying all of that will be the continued pace of scientific progress, which has been astounding these last few years. Ultimately, it’s that scientific progress that I think makes biotech nearly irrepressible. 

So while this 1H24 update doesn’t look all that dynamic, I think that the year-end Semper Maior issue will more clearly reflect that Core biotech is experiencing a strong fundamental recovery.