The rumblings of a biotech bubble are getting louder as the Nasdaq Biotech Index (IBB -1.44%) has declined about 14% from its peak of $275.40 on February 25th. The recent volatility is a phenomenon that has not been seen in quite some time in the space. So is now a good time to sell, or will it prove to be another buying opportunity? There are good arguments to be had for both bulls and bears. Let's look at why the bears might be right this time.
Anatomy of a bubble
Its always important to study the history of previous bubbles in order to ascertain whether or not one exists today. The last major bubble occurred during the financial crisis and was predicated on a massive buildup of risky mortgage loans to borrowers that could not afford to pay for homes. While this was clearly a bubble in hindsight, it was not easily recognized by everyone, nor did it translate to a classic parabolic up move in the stock market (the crash, however, was felt by everyone). Contrast the financial crisis with the dotcom bubble (and the last biotech bubble) in 1999 and 2000 and you have a vastly different situation. In 1999-2000, the market was dominated by insatiable demand for new IPOs affiliated with the tech and Internet space. Stock prices doubled on a regular basis after their IPOs and it was a very visible situation in which people were making fast money on a daily basis by trading. There was a blow-off top that occurred in March of 2000 and the downward crash lasted over 2 years from peak to trough, finally bottoming in 2002.
Why a biotech bubble might exist:
One concerning area of the biotech space today is the IPO market. According to IPO investment firm Rennaissance Capital, the average one day return for all Healthcare IPOs is 20.7% in 2014 YTD. 73 health care companies (mostly biotech) have come public since the beginning of 2013, which is more than the total number of health care deals from 2008-2012 combined. There have been 30 health care deals already in 2014 aven after the sell off in the last two weeks, the average gain is still over 20%.
While IPOs coming to market is not a bad thing by itself, many new companies are coming to market with only early clinical or in many cases preclinical assets. One stock that might represent this market better than any is Dicerna Pharmaceuticals (DRNA), which priced its IPO at $15/share on January 29th and closed up 207% on its first day. Dicerna operates in the red hot RNAi space, with a focus on a rare genetic disease of the liver called Primary Hyperoxaluria and also in liver cancer. While Dicerna has two interesting product candidates, neither are in clinical trials yet. Dicerna expects to launch its first cancer phase 1 trial for DCR-M1711 in non-HCC tumors in the first half of 2014. On their first ever earnings conference call on March 24th, they explained that there will be no human clinical data until 2015, and this will be coming from a phase 1 trial. Dicerna should have a second candidate selected for trials in the first half of 2014 for Primary Hyperoxaluria The excitement from Dicerna's opening day pop exemplifies this market quite well, and the substantial drop in price since then serves as a wake-up call to investors buying into biotechs with no revenues and major clinical data points or approvals years away. While Dicerna has plenty of cash on hand due to its IPO, there will be a long road ahead before any drug might be approved. Investors will need to show plenty of patience.
Like the IPO market, certain areas of biotech, such as RNAi and immunotherapy stocks, have seen a lot of speculative activity. A few small marketing and partnership deals created short term buzz among a few small cap companies. For example, Tesaro (NASDAQ: TSRO) recently struck a deal with privately held AnaptysBio for multiple targets in the "checkpoint" inhibitor space, including antibodies that inhibit PD-1, LAG-3, and TIM-3. Checkpoint inhibitors have been all the rage ever since Bristol Myers, Merck, and Roche announced positive data in several cancer trials for their respective drugs that target PD-1 (or PD-L1 in Roche's case). News of Tesaro's deal sent its shares up over 25% the day the deal was announced. The deal, though, was only $17 million upfront for AnaptysBio, with the majority back-loaded with milestone payments. Additionally, not one of assets is in the clinic yet. Tesaro does have a late-stage drug in Niraparib, which is being tested in breast and ovarian cancer. Additionally, it expects to report data at ASCO this year on rolapitant, which is used to treat chemotherapy induced nausea and vomiting.
Similarly, Agenus (AGEN 11.46%) struck a deal to buy privately held 4-Antibody Ag out of Switzerland for $10 million in shares and another $40+ million in potential milestones. 4-Antibody Ag is also developing various checkpoint inhbitors. Agenus' stock quickly climbed 73% after completing the deal, only to give it all up shortly thereafter. Again, this deal was for pre-clinical assets only. Agenus has had a longer history of developing vaccines, which have so far put up disappointing results. Just yesterday, its partner GlaxoSmithKline announced that its MAGE-A3 vaccine, for which Agenus supplies its QS-21 Stimulon Adjuvant, was being discontinued in lung cancer. The MAGE-A3 vaccine already failed in melanoma as well, which could be a major blow against QS-21, Agenus' only phase 3 product. While the checkpoint inhibitors are perhaps the most exciting area for Agenus, the drugs are not even supposed to enter clinical trials until 2015, so again investors will need plenty of patience.
Final thoughts
The last two plus weeks have been difficult for biotech investors, especially for those that have bought into recent IPOs or tried to play the hot themes of the day like RNAi and immunotherapy. Ultimately, these areas may prove very fruitful, but as investors have witnessed, rapid declines in stock prices can be difficult to stomach.
While it is possible that many of these recent IPOs will be successful, many of them are coming to market with untested drugs still in early clinical trials, or in some cases even in preclinical studies. Most importantly, it is positive data from clinical studies that are most important to future biotech returns, and many newer companies have none or very little. Given the risky nature of drug development and earlier life-cycle of many of these programs, there are likely to be many set-backs.
