Head of Equity Strategy
Summary: The biotechnology industry has outperformed the general market since 2004 and is generally perceived as being on the forefront of the future of medical treatments. The industry has evolved over many stages and recent technologies such as cell and gene therapy have matured to a degree where investors can now see the commercialization potential. This future has been turbocharged by the Covid-19 pandemic paving the way for the new mRNA technology to deliver a breakthrough vaccine in record time. Investors are now driving high demand for these new advanced biotechnology companies.
Beginning last year, we discussed many different themes starting with the green transformation which we defined as one of the most important ones in the coming decade. However, the green transformation theme as become extremely expensive, something we look at in the soon to be published Q1 Outlook. Throughout 2020 we also discussed bubble stocks, e-commerce and ‘misery industries’. Starting this year, we introduced our Commodity Sector basket as we believe reflation will be the most important theme over the next 12-18 months.
Explanation of theme and the selected biotechnology companies
Today we are launching our next theme called NextGen Medicine containing companies which are working on the next generation of medical diagnostics and treatment, such as analysis of DNA and RNA, immunology, and within cell and gene therapy. The use cases are spanning widely – ranging from treating rare genetic disorders or skin diseases to fighting cancer and viruses with a new and improved line of defense.
We have selected 30 companies for this theme with a global selection universe of biotechnology companies but filtered on the percentage of institutional ownership. Our hypothesis is that high percentage of institutional ownership is a validation as this category of investors has more access to knowledge about these frontier treatments and can thus more informed decisions. This filter has unfortunately removed many Asian biotechnology companies. We have also filtered on cash and equivalents relative to free cash flow, and if the latter is negative we can calculate what we call a burn rate, which is essentially how many years of funding the company has left under current operations. We have removed biotechnology companies with relatively stressed funding situation. Finally, we have sorted on market capitalization in USD and also tried to balance the list across various treatment technologies and geographies although the US is heavily concentrated in this theme because the country has a deeper financial market for absorbing these types of risks.
| Name | Domicile | Mkt cap in USD mn | R&D in % | 12M Rev in USD mn | Burn rate | Insti % |
| Illumina Inc | US | 54,947 | 1.2 | 3,239 | NM | 106.4 |
| Moderna Inc | US | 51,304 | 1.4 | 247 | NM | 58.6 |
| Seagen Inc | US | 33,492 | 2.4 | 1,864 | NM | 90.3 |
| Genmab A/S | DK | 29,132 | 1.5 | 1,656 | NM | 56.5 |
| Exact Sciences Corp | US | 24,632 | 0.6 | 1,321 | 3.5 | 89.8 |
| BioNTech SE | DE | 24,623 | 1.0 | 122 | 2.2 | NA |
| Grifols SA | ES | 17,751 | 1.8 | 6,039 | NM | 51.1 |
| CRISPR Therapeutics AG | CH | 14,774 | 1.6 | 77 | 5.7 | 79.1 |
| Argenx SE | NL | 13,217 | 2.0 | 54 | 6.2 | 53.1 |
| Mirati Therapeutics Inc | US | 10,918 | 2.6 | 12 | 1.7 | 103.1 |
| Fate Therapeutics Inc | US | 10,385 | 0.9 | 18 | 4.5 | 102.6 |
| Natera Inc | US | 10,258 | 0.8 | 362 | 3.2 | 115.3 |
| Invitae Corp | US | 9,293 | 2.4 | 245 | 1.6 | 86.9 |
| Ultragenyx Pharmaceutical Inc | US | 9,096 | 4.0 | 215 | 4.3 | 116.7 |
| Twist Bioscience Corp | US | 8,817 | 0.5 | 90 | 1.9 | 107.3 |
| Denali Therapeutics Inc | US | 8,758 | 2.4 | 24 | 2.8 | 89.6 |
| Arrowhead Pharmaceuticals Inc | US | 8,297 | 1.6 | 88 | 2.9 | 74.1 |
| Iovance Biotherapeutics Inc | US | 7,490 | 2.7 | 0 | 1.4 | 117.2 |
| Pacific Biosciences of California Inc | US | 6,869 | 0.9 | 80 | NM | 89.4 |
| Galapagos NV | BE | 6,669 | 8.9 | 574 | 10.8 | 54.7 |
| Beam Therapeutics Inc | US | 6,552 | 1.4 | 0 | 0.9 | 71.5 |
| Swedish Orphan Biovitrum AB | SE | 5,867 | 2.6 | 1,649 | NM | 115.9 |
| Sage Therapeutics Inc | US | 5,326 | 5.7 | 7 | 2.2 | 116.4 |
| Abcam PLC | GB | 5,292 | 0.9 | 328 | NM | 130.5 |
| Intellia Therapeutics Inc | US | 5,266 | 2.7 | 62 | 6.4 | 99.5 |
| Editas Medicine Inc | US | 4,773 | 2.8 | 92 | 4.3 | 92.0 |
| PTC Therapeutics Inc | US | 4,673 | 9.4 | 358 | 4.4 | 116.5 |
| Allogene Therapeutics Inc | US | 4,544 | 4.2 | 0 | 2.4 | 115.2 |
| CareDx Inc | US | 4,342 | 1.0 | 169 | NM | 109.2 |
| MorphoSys AG | DE | 3,693 | 3.6 | 339 | NM | 76.2 |
Table explanations: R&D in % is the 12-month R&D expense in % of market cap, Burn rate is the number of years the company can sustain current negative free cash flow (NM means not measurable and is used for those with positive free cash flow), Insti % is the institutional ownership of the floating shares (those that are tradeable, so if all shares are not publicly available then the ratio can be above 100%) in %.
The long-term drivers of this theme are the maturing of promising technologies within cell and gene therapy, monoclonal-antibody therapy, and small-molecule therapy, which will attract the necessary funding to complete all trial stages of the treatment development. Ageing populations in the developed world will drive demand for treatments of many diseases ranging from cancer to brain disorders. These new treatments also have the possibility of having fewer side effects compared to the old pharmaceutical drugs. Gene editing holds the possibility to make antibody therapies to work better and in general many of these companies likely represent the future of medical treatment and thus they will most likely become acquisition targets of major pharmaceutical companies.
Performance, selection bias, and survivorship bias
The biotechnology industry was for many years viewed as a pure lottery ticket. Great ideas but many were too expensive to pursue relative to the risk capital available and many disappointing trial data made it unattractive to investors. In the period 2004-2010 the biotechnology industry lived a boring life (see chart) with little outperformance or investor attention. But starting in 2011 and 2012 a new class of biotechnology companies entered public markets with better results and increasingly more interesting technology. More mature biotechnology companies such as Gilead Sciences saw enormous growth rates in its hepatitis C treatment. This started a positive feedback loop of strong returns in public markets creating more risk appetite in the venture capital market and the industry enjoyed a spectacular bull market in the years 2011-2015. In the following years from 2016-2019, the industry entered a new ice-age period driven by slowing growth by the mature biotechnology companies and many bad FDA reviews in clinical trials. But the Covid-19 pandemic brought renewed attention to biotechnology but more importantly the smaller more advanced and next generation biotechnology companies using mRNA, gene editing technology, and antibody drug conjugates. The companies that we feature in our inspirational list, but there are so many more interesting companies that we could not add, so we encourage investors to research wider in the hunt for good long-term potential winners.
Our NextGen Medicine basket has done well up 897% since December 2015 compared to 78% for the MSCI World. Past performance is no guarantee of future performance, and in this basket since we sort on market cap and the segment has experienced a strong bull market, we explicitly select recent winners. This naturally creates a selection and survivorship bias in the basket. Investors should therefore focus less on the long-term returns of the basket and more about the overall theme and what will drive it in the future.
The NextGen Medicine basket has an interesting outlook, but the high growth expectations come with valuations. The basket has a price-to-sales ratio of 22.4 and non-measurable price-to-earnings ratio as most of the companies are not profitable. The price-to-book ratio is 9 making it one of the most expensive segments in the entire equity market. The future does not come cheap these days.
Biotechnology is a very high risk
The risks associated with the theme are the high valuations which is dominating the biotechnology industry in the beginning of 2021. High valuations correlate with high expectations which can be difficult to meet and on average high valuations have historically meant lower future returns. Furthermore, companies in the research phase have high event risk around trials for approval of their products, which leads to potentially large single day drops in individual biotechnology positions. Other biotechnology companies are also trying to solve the same diseases and the ones that gets an approval for a treatment first often gain the momentum and most of the market value. A short-term risk for some of these biotechnology companies is manufacturing delays due to Covid-19. Historically, the biotechnology industry has gone through long periods of low or flat returns, so investors getting exposure to biotechnology stocks should have a long-term horizon.
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