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https://www.stifel.com/Newsletters/...FirstHalfBiopharmaMarketReview_07.07.2023.pdf

STIFEL INVESTMENT BANKING HEALTHCARE REPORT JULY 2023

Overview
The past 18 months have been historically difficult for the life sciences industry. With the end of the Pandemic, we have seen many life science companies struggle in the capital markets while simultaneously dealing with layoffs, macroeconomic headwinds and a less than helpful political environment.
We are highly optimistic about the environment going forward. To begin, we are seeing robust recoveries this year in the follow-on equity market and the M&A market. This is great news highlighting that both strategics and major investors are committed to the market.
The underlying fundamentals of the life sciences sector could not be more positive. We have seen numerous medical breakthroughs this year, pathbreaking scientific discoveries and patients everywhere benefitting from novel modalities, medicines, diagnostics and devices.
For example, key biopharma developments this year have included:

1. impressive data for Alzheimer’s patients from two companies;
2. multiple breakthroughs in immunology – particularly in IBD;
3. the first FDA approval for a gene therapy for sickle cell anemia;
4. a gene editing approach that reduced the attack rate from hereditary angioedema by 95%;
5. very good efficacy for cancer drugs aimed at BCMA and folate receptor;
6. the ability to pharmacologically drop more weight than is possible with bariatric surgery without major side effects;
7. the ability to use cell therapy to take a Type I diabetic off of insulin and
8. the ability to use a menin inhibitor to address Type II diabetes.

Extraordinary.
Ultimately, this innovation will translate into the critical fundamental for a market recovery: a desire by large strategic players to own the innovation and associated long-term cash flows.
We, at Stifel, see the market recovery continuing, but not without fits and starts, over the rest of 2023.
We encourage you to be steadfast in understanding that this market recovery will not be deterred, as it is driven by the ultimate fundamental: the growing ability of our sector to deliver highly innovative life products to patients.

Biotech Sector Update
The XBI closed Friday at 83.2. At the start of the year, it was 83.0. Basically, the XBI has not changed despite extraordinary clinical developments.
In contrast, the S&P 500 Index rose 15.9% in the first half on the back of a strong rally in AI-driven tech stocks.
U.S. Treasury yields have crept up this year as inflation remains stubbornly high and the VIX, an indicator of expectations of market volatility over the next month, is near all-time lows.

Long-Term Data Tell a Very Positive Story
A look at the biotech market over the last thirty years shows that biotech and pharma stocks, as measured by the Nasdaq Biotech Index, are up twenty times.
Three things can be said about the biotech stock market over the last thirty years: (1) there have been three temporary runups followed by crashes (about one “bubble” a decade), (2) there are long periods of relative calm in between those runups and (3) the overall trend has been up. That is, if you ignored the bubbles, the overall trend is one of strong long-term growth.
We don’t see anything to change this growth. If anything, the innovation fundamentals would suggest that the growth could accelerate. All that is required is patience and focus.
We look at how today’s global biotech population is changing and can report that the number of billion dollar plus enterprise value (“EV” companies has been shrinking this year. This largely reflects the high level of M&A activity (6 biotechs with EV’s over $1bn have been bought so far this year out of a population of roughly 55 at the start of the year). The biggest growth area has been among biotechs with an EV between $100mm and $250mm. That group’s census is up 10% in size since May 27th.

Slow Biotech Recovery
Compared to the market recoveries seen after other deep market downturns in biotech we are well behind in seeing the market come back. At this point following the trough of the 2016 downturn, the market was up 33% (versus 25% for the current market). Following the trough 2001 downturn the market had long since been up 50% or more (around day 200).
For whatever reason, we are seeing a substantially slower reaction to the market correction following the biotech bubble of 2021. The main culprit appears to be the macro picture. The “AI sizzle” driving the tech sector has not helped matters – as many generalist investors have been rotating into tech this year.

Biotech Conditions by Country
U.S. biotech valuations have improved nicely since the year began but many have negative enterprise value and average burn is under two years. U.S. biotech today accounts for 58% of the total sector’s value (up from 52% six months ago).
In contrast, the South Korea sector and the China sector are much better capitalized relative to burn. Biotechs in these countries run with much less burn than do U.S. companies.
The Chinese sector has quite a few distressed companies today – which is indicated by fact that 26% have negative EV.
Both Israel and Switzerland have seen strong rebounds in their biotech sectors. Average remaining years of burn, however, in Switzerland is quite low – as it is in Denmark, France, Germany and Canada.

Capital Picture
The overall amount of biopharma capital raised thus far in 2023 on an annualized basis Is down 20.6% versus 2022. Venture privates' volume and follow-on equity volume this year has been down quite substantially compared to 2021 and 2022.
While some key signs of market improvement have appeared in the last month, the markets remain materially weaker in 2023 than in 2021 and 2022.
Investor’s therapeutic tastes have changed quite a lot in the last 18 months.
In sympathy with pharma valuations and M&A interest, companies focused on cardiometabolic disease and immunology have seen big jumps in value. In contrast, companies working in the fields of protein degradation, rare disease, cell therapy, gene editing, GI and RNA therapeutics have fared less well. There have also been major value declines in the field of oncology.

Data, Data, Data
Declines in value have been far greater for preclinical companies than those which are late stage. Early companies remain far below their Pandemic valuations.
Phase 2 companies, on average, are also down from their Pandemic peak. In contrast, Phase 3 companies today are trading at higher levels.
Companies with very good clinical datasets have held their value since the Pandemic period. If anything, these companies are trading at historically high levels.
In contrast, companies with “good” but not “very good” datasets are down almost 70% in value since the Pandemic peak.
Similarly, those with medium quality, poor datasets or no data are down quite substantially from market peak.
The companies recovering the most in 2023 are those with no data. We are seeing quality early-stage platform companies bounce back quite a bit (think Beam, Sana, Verve etc.).
To put a further point on this, roughly 60 percent of the public U.S. biotech population has no clinical data yet, poor or medium quality clinical data. These companies get little of the value pie (less than 25%).
In contrast, just 16% of the U.S. biotech population has a very good dataset (defined as clear clinical evidence of potential superiority over the standard of care for a disease) and enjoys 68% of the market’s total valuation.
We count seventeen U.S. listed biotechs with an enterprise value today of $2 billion or more. The total value of the group is $53 billion – less than a sixth of the value of, say, Merck. The same portfolio was worth $44 billion on Dec 31, 2022, and $27 billion on June 30, 2022. This group has fifteen drugs in development that we rate today as having “very good” efficacy (incontrovertible data showing a clinical profile better than the current standard of care).
Further, overwhelmingly the companies have peak sales estimates for the lead drug in excess of $2 billion. Overall, the bar in today’s biotech market to fetch a high valuation is incredibly high.

Life Sciences Sector Overall
The aggregate enterprise value of the publicly traded life sciences sector is up 3.2% over the last year. The market recovery has been uneven with biotech value up 29% in a year while both pharma services and healthcare IT have traded down roughly 15%. We are also seeing robust recovery in valuations in the diagnostics and device field.
Global revenue multiples for pharma services and CDMO’s continue to drop while valuations for commercial diagnostics companies are bouncing back nicely in recent months.

RA Capital View of Biopharma Sector
RA Capital has become a thoughtful voice in our sector – with a particular focus on the need to maintain a favorable regulatory and payor environment to sustain long-term innovation.
They published a report in January of this year in which they noted that relatively few biotechs with specialist investor sponsors found themselves in the “danger zone” (defined as having less than two years of cash and a burn / market cap ratio over 25%). The total market cap of these “danger zone” companies was around 6% of the total cap of specialist-sponsored biotechs (which RA calls “Core”.
Interestingly, essentially all big pharma biotech M&A takes place among these Core companies.
In their first half report out last week, they noted that the fraction of value in this companies in the Core group remains at 6%. Broadly speaking, the part of the biotech sector that is backed by specialist funds is well capitalized.
RA Capital’s point is well taken. The biotech companies with the best science and datasets have no trouble attracting specialist investors, and are getting the capital to go forward. In that sense, it can be said that our sector is functioning well.
A further point made in their report is that just 2.3 years of pharma free cash flow would be enough to acquire the entire core biotech set at a 100% premium. The point here is not subtle: biotech is a bargain.

Big Pharma Outlook
As of the end of the first half this year, the ranks of top life sciences companies are substantially reshuffled from the peak of the Pandemic.
Lilly has gone from being the eight ranked life sciences company by EV to the second ranked. Novo has gone from tenth to third. Merck has gone from sixth to fourth. And AstraZeneca has gone from from eleventh to seventh.
In just 30 months, we have shifted from a world where the potential revenues in obesity and diabetes drugs is reshaping the industry and where COVID-19 drugs are largely a memory of the past.
It turns out that this is not a new story. The pharma industry has undergone continual change and reshuffling from the beginning.
For example, the list of the top 15 big pharma from 1974 is barely recognizable today, containing only six companies that are still around.
The ranks of the top players in the industry are highly dynamic as the advent of new products and modalities and patent expirations on the old, drive dramatic change.
Also notable is the decline in the EU pharma sector – once the source of most industry sales. This is likely not a failure on the part of companies in this part of the world but rather a reflection of the declining importance of Europe as a source of sales due to pricing restrictions there.
Hint: those of us in the U.S. should pay attention to RA Capital messaging on regulatory and pricing issues if we want the U.S. to stay first.
This past industry turbulence raises the obvious question. What is going to change the pharma industry in the future?
While we claim no perfect foresight, it strikes us that there are three major forces of change at work today in the pharma sector:

1. Value-based care is impacting specialty medicines (e.g., rare disease drugs, oncology drugs) in ways that were once unimaginable;
2. The emerging “Big Drugs for Big Diseases” theme is leaving some players who have overemphasized specialty medicines behind. As noted above, this is particularly drug for obesity drugs and immunology drugs; and
3. Sector democratization as biotechs and emerging pharma master new modalities such as mRNA, protein degraders, cell therapy and gene editing faster than big pharma can keep up. Another key development has been the hypergrowth of the China market where big pharma is underweight.

#1. Value-Based Care. As pharma sales have grown, pricing pressures on big pharma have grown. The obvious squeeze has been from the largest payor, the U.S. government (e.g., most-favored nation pricing, the IRA etc.).
The growing power of managed care companies and co-owned PBM’s has further eroded the lucrative specialty drug model that has emphasized profitability from oncology drugs and niche disease drugs, especially biologics. We expect that these pressures will grow over time.
Today, pharma companies often need to agree to higher gross-to-nets and higher rebates to remain well positioned on formularies. New players like Amazon are entering pharma. Remarkably, two of the largest payors (UnitedHealth and CVS) have their own PBMs. The political environment for pharma is as bad as it’s been in decades.
In the future the IRA will increasingly limit the pharma sector’s pricing power and managed care is likely to become far more influential in determining how much margin pharma companies can make. Managed care’s increasing shift to algorithmic care through groups like Optum will reduce physician discretion to use expensive specialty drugs.
#2. The Shift to the “Big Drugs for Big Diseases”. It turns out that almost all of the value added in the big pharma sector since the start of the Pandemic has accrued to just four companies (Lilly, Novo, Merck and AbbVie). These companies have added $740 billion in value whereas the remaining big large pharmas added $110 billion in value in the same period. The key differentiator is that the first group of companies has displayed news regarding one or more drugs with $30 billion plus revenue potential aimed at multiple diseases to investors.
#3. Sector Democratization. The pharmaceutical sector has democratized since 2003. While big pharma has grown, other parts of the industry have grown faster. Key changes over the last two decades include growth of branded pharma and the growth of the Chinese pharma sector. Far from consolidating, big pharma is fighting a losing battle for industry share. This is, in part, due to the rapid rise in R&D spend in the biotech field. In the old days, Amgen and Gilead emerged from “biotech” to become “Big Pharma”. Now, there are many more biotechs that have a credible case to drive “big pharma” type revenue ($25bn+) on their own (think BioNTech, Moderna, Argenx or Alnylam). These companies are mastering new modalities and technologies before big pharma can get there. This has been caused by hyperinnovation, open external capital markets, democratization of technology access and execution of drug discovery and clinical trials. A report published this week in Nature Reviews Drug Discovery documents, for example, that only 28% of new drugs approved in the 2015 to 2021 period at large pharma originated internally. With a few exceptions, most big pharmas are highly dependent on the biotech ecosystem for survival.

What Other Forces Will Matter Over the Very Long Run?
We believe that the pharma sector will change much more in the next twenty years than it did in the last twenty due to acceleration of innovation. Some of the interconnected themes to keep an eye on include:

1. Generative AI. Without any great effort at optimization, generative AI is already better with patients than doctors and massively better at diagnosing patients. You would be too if you could scan and analyze everything on the internet in microseconds. We are likely to see the care system reorganized with massively improved AI approaches that combine diagnostics and care over time. If you will, in the old days, pharma worked on “companion diagnostics” and “digital health” tools. In the future, the administration of pharmaceutical products will be driven by machine learning. It’s hard to understate the importance of generative AI for our sector.
2. Algorithmic Care. Breakthroughs in proteomics, metabolomics, transcriptomics and genomics, now make it possible to screen much more effectively for disease. With advanced diagnostics and machine learning, it will be possible to design much better forms of precision medicine than we have today. We predict that proprietary care algorithms start to become more important than drugs themselves at some point. This movement will be driven by value-based care which is asking care providers (and, ultimately, pharma) to bear risk on behalf of their patients. Pharma companies that ignore this movement risk long-term irrelevance.
3. Consumerized Care. Today, almost all medical decisions are made by physicians. We see the consumer becoming far more important in medical decisions in the future. We have already highlighted the consumer’s growing interest in areas like obesity drugs. We are going to see this coming at us from disruptive entrants on the provider side (think Amazon and CVS). The implications for pharma are profound. It may be possible to develop direct branded relationships with customers (something that is rarely done today). Also, the therapeutic area share of sales may shift once again – this time towards the type of drugs that customers want to pay for (e.g., family care, aesthetic medicine).

Equity Capital Markets
U.S. biotech IPO’s have been few in 2023 to date - with three companies raising more than $50 million in the market (Mineralys, Structure and Acelyrin). On an annualized basis, IPO volume in 2023 is down 87% from 2021.
The three U.S. biotech IPO’s this year have been in immunology (I&I) or cardiometabolic. The market is open to high quality issuers in those sectors.
These IPOs came at a median step-up to last round valuation of 1.5x. After-market performance for the 2023 IPO class has been good which bodes well for more IPOs in the second half.
We have not seen any pre-clinical or a platform companies go public in 2023. In contrast, half of the IPOs of 2020 were for pre-clinical or platform companies.
The China IPO market has remained open in 2023 to commercial stage pharma companies while biotech offerings have been few.
This may be changing as Laekna went public last week on the Hong Kong exchange and this week Kelun Biotech is schedule to go public with excellent investor support.
China biotech offering levels in 2023 on an annualized basis are down 82% from 2021.
The European biotech and commercial pharma IPO market has been quiet since 2021. Volumes in Europe are quite low as many issuers there have shifted to U.S. exchanges where the market is more liquid and has more specialty investors.
Slightly over half of all IPO dollars in the 2020 to 2023 period were raised on the NASDAQ. Another 36.2% were raised on the Chinese Exchanges (Shanghai, Shenzen and HK).

Follow-On Equity Activity
Last month saw follow-on volume in the U.S. equity markets for biotechs exceed $1 billion a week for the first time this year. The biotech equity capital markets are clearly improving.
Investors have been making money on follow-ons in 2023. The average current to offer is over 10% and stocks are up from offer price over 70% of the time. This is a big positive for the market going forward.
The follow-on market in 2023 has been almost exclusively open to companies with data. Our analysis shows exceptionally little follow-on activity by companies at the pre-clinical or Phase 1 stage of development.

Private Venture Equity Market
June equity privates' volume was the highest in a year’s time reflecting an increase in larger rounds getting done.
We are on track to do $38 billion in venture-stage equity deals in 2023. Compare this to $50 billion last year and $70 billion in 2021.
This year has seen a blend of very strong platform stories via large Series A financings, particularly in the RNA field. Other companies such as Alkeus, Upstream or Carmot have instead been able to finance around high potential clinical stage assets.
The share of capital going into Series Seed and Series A deals went up in 2023 while the share of money going into Series B rounds held steady. In contrast, Series C and later rounds saw less activity in 2023 versus earlier years.
The fraction of venture dollars invested in later stage molecules went up in 2023. However, over a longer period, we saw distinctly less late-stage investments after 2019 (presumably because these companies could go public).
Platform investment levels fell slightly in 2023. However, the popularity of investing in platform companies is a relatively new thing, taking off in a meaningful way only in 2016, peaking last year when over 45% of all venture dollars went into discovery stage deals and platforms.
We have seen venture investments into oncology companies hold steady in 2023, investments into immunology companies have risen in 2023. In contrast, investments into neuroscience companies continue a long-term decline (on a relative basis).
Small molecule type investments are down while biologics’, particularly RNA therapeutics, investments is up. Cell therapy investments are holding steady while investments in genetic medicine, particularly gene editing, were down in the first half of 2023.

The Private Debt and Royalty Monetization Market
The private debt markets in the life sciences have also been softer in 2023. Dollar transaction volume on an annualized basis is down 35% from last year.
Interest rates were much lower in 2021 and many issuers were getting locked out of the equity market towards the latter part of the year. Hence, the debt market boomed. We are now in a higher rate environment with tighter credit underwriting conditions which have put the brakes on borrowing activity in 2023.
The royalty monetization market, in contrast, remains quite strong this year and has been influenced less by interest rates.

Venture Funds Raising More Capital
Venture funds continue to raise capital at a breakneck pace in 2023. We are on track to see funds raise $28 billion in total this year – roughly the same level as in the 2020-2022 period and far above levels of previous years.
The pace of fundraising in 2023, if annualized, would lead 2023 to be the third largest year in venture fundraising for our industry.
The venture ecosystem backing biopharma companies is large and growing. Growing LP interest from wealthy families, the Middle East and non-profit organizations have helped to fuel this capital formation.

Corporate Partnership / Licensing Environment
We are seeing fewer biopharma licensing deals and less money being paid upfront in the first half of 2023 (annualized) relative to 2022. The annualized count of deals is only down 4.8% from 2022 although the average upfront per deal has dropped since the Pandemic’s peak.
As we exit the Pandemic, licensees are much less focused on platform/discovery type access deals. We don’t have specific insights as to why but would speculate that large pharmas have fuller pipelines and are more tooled up on new modalities.
When we dug into the data more deeply, with the highly useful deals database from DealForma, we found out that the decline in licensing activity this year has been largely driven by a pullback by biotechs with market caps under $1 billion.
We are seeing more licensing activity in cardiometabolic, neuro and ophthalmology this year than last.
The fraction of partnership deals done in oncology has been on a long-term uptrend since 2008 and appears to have peaked in 2022.
Six of the twenty-two large pharma players have announced five or more transactions this year. Merck has been the most active player by far. Traditionally active players such as AbbVie, Amgen and BMS have been relatively quiet this year.
Looking over the last 16 years, the most active pharma dealmakers have been Merck (28 M&A deals, 291 partnership deals) and Roche (39 M&A deals, 278 partnership deals). The next most active pharmas have been J&J, Pfizer, AZ, BMS and Sanofi.
Transactions for China territorial rights have fallen off quite a lot as the Chinese geopolitical situation has worsened. In addition, the shares of listed biotech companies in China have fallen giving these companies fewer resources with which to in-license assets.
In a challenging geopolitical climate, China has invested massively in its own biotech infrastructure. The investment is paying off as Chinese biotechs have become significant exporters of rights to pharmaceutical products. This is the first year that more upfront dollars from licensing deals have flowed into China than out of China.
Times are changing.
Transactions for Japan territorial rights have fallen off quite a bit as Japanese companies increasingly globalized and the economics of operating in the domestic market worsened. This said, the six deals YTD 2023 put this to be the most active year since 2020.
Transactions for European territorial rights have held steady over time. With four deals done in the first half of 2023 we are on track for a somewhat normal year from a deal count perspective.

M&A Environment
June 2023 was the second most active M&A month of the year. The M&A market has clearly picked up over the last four months.
We saw $93 billion in announced biopharma market M&A deals in the first half of 2023. This puts us on track to have the third busiest year for industry M&A in history. Not bad, given how restrictive the antitrust authorities are at present.
Three of top ten M&A deals thus far in 2023 have been in immunology, two have been in oncology and the other five have been spread out across a range of areas. These deals involved traditional modalities, and all were Phase 2 or later.
This year’s M&A market is relatively “plain vanilla” with pharma scooping up attractive assets in a down market. Notably, eight of ten transactions did not have a contingent payment (a sign of agreement on price between parties). Also, it’s worth noting that all targets were public. Presumably, private targets have been less willing to acknowledge the valuation realities of today’s marketplace.
This year, 55% of M&A deals have been for companies with clinical stage assets (Phase 1 to Phase 3). Compare this to an average of 47% in the 2019 to 2022 period. The fraction of M&A deals for approved assets is down as is the fraction of deals for platforms and preclinical assets.
We count $655 billion of comfortable M&A firepower at big pharma today – up substantially in recent years. If one looks at “stretch firepower” there is well over $1 trillion in buying power available today.
Not surprisingly, given this circumstance big pharma has taken back share in M&A from specialty pharma buyers in 2023. Private equity buyers have also been very important this year.