March 2017 investor update
We are pleased at LifeSci Partners to announce the official launch of our new venture fund, LifeSci Venture Partners I, LP. We created this fund to capitalize on a highly favorable environment for investing in privately-held healthcare innovators, particularly in the biotechnology and medical device sectors where our expertise lies.
Company valuations are low as a result of the recent turmoil among healthcare stocks, with the small cap biotech indexes falling by more than 50% from July 2015 to February 2016. Biotech investment funds suffered dramatic fund outflows and IPO activity has stalled. Despite the turmoil in the capital markets, the pace of scientific and medical discoveries across the industry is at an all-time high and we see promising startup companies with dramatically lowered valuation expectations.
With the broad resources and network of the 35+ employees, including 5 MDs/PhDs, at LifeSci Partners’ affiliated business units, we are actively sourcing and evaluating investment opportunities with compelling risk/reward ratios. We appreciate this opportunity to share our current views on the industry and our fund strategy.
Our industry views
Beginning in the summer of 2015, healthcare reformers became increasingly vocal in criticizing high prescription drug costs. Much of the media attention was focused on a handful of bad actors, notably Valeant, Mylan and Turing Pharmaceuticals, which in some cases raised prices on old products by more than 1,000%. With a spotlight on drug prices cast across the entire industry, even the less aggressive but fairly standard industry practice of annual price increases of 7%+ has become difficult to defend. For example, products used to treat chronic conditions such as rheumatoid arthritis and multiple sclerosis can cost more than $50,000 per year. The industry’s justification – that high prices are required to finance high risk and lengthy drug trials – falls on unsympathetic ears. As a consequence, the entire biopharma industry has paid a steep price. Biotech stocks tumbled indiscriminately with high volatility, financing markets dried up and the industry has faced significant layoffs.
Fortunately, in early 2017, the tide has begun to turn for pharma companies and investors. Biotech indexes are rebounding and the Trump administration has shown a willingness to engage in open dialog with healthcare executives (albeit with the periodic jarring “drug prices will come down” tweet). Healthcare reform is focused less on lowering drug prices, but more on structural shifts, including expanding health savings accounts, allowing competition among health plans across state lines, and reducing bureaucracy and roadblocks at the FDA. Within this backdrop, companies with innovative technologies and strong business plans will thrive.
A singular focus on drug prices is misguided
The criticism of drug prices can be broken down into two parts: (1) the annual inflation in drug prices and (2) the percentage of our paychecks spent on drugs and healthcare.
The annual increase in per capita spending on prescription drugs, or the “cost trend”, has been remarkably low. In January 2017, Express Scripts, the largest pharmacy benefit manager in our country, reported a 3.8% increase in the cost trend for calendar year 2016. Over the last 10 years, the cost trend has averaged +5.1%, and in only one year did it hit the double digits when in 2014 the reported cost trend of 13.1% was heavily influenced by several monster biotech drug launches including Gilead’s Sovaldi and Biogen’s Tecfidera. Looking at the big six US pharma companies (J&J, Pfizer, Merck, Bristol, Lilly and Abbott), we see a similar picture. Average revenue growth among these companies in 2016 was 3%.
Not long ago, drug cost trend was ALWAYS double digits. The graph below from Express Script’s 2005 annual report on drug pricing shows unthinkable numbers, with cost trend averaging 15% per annum from 1996 to 2005. In its 2006 drug trend report, Express Scripts wrote “Overall trends [in 2006 rose] only 7.2%”. We have made substantial progress since in only ten short years.
A second misconception is how much of our paychecks is slotted for pharmaceuticals. Healthcare spending is a very substantial part of our nation’s GDP – 17% in 2015, according to the National Health Statistics Group. That was $9,990 per person per year. Most would be surprised to find out however that drug spending represented a relatively small portion of healthcare spend – only 10% or $999 per person. We argue that the drug industry has delivered exceptional value for dollars spent, when considering reductions in other healthcare costs, increases in life expectancy and improvements in quality of life.
Rather than solely focusing on drug pricing (although this remains a major focus), we are encouraged that the current administration seems more broadly focused on healthcare reform and on driving innovation. One surprise during the President’s State of the Union Address last week was when he introduced 20-year old Notre Dame undergrad Megan Crowley, the daughter of biotech entrepreneur John Crowley and a rare disease survivor who was not expected to live past the age of 5. The cost of drugs to treat rare disorders like Megan’s Pompe Disease can easily exceed $500,000 per year and developers of orphan drugs such as Alexion, Ultragenyx and Sarepta have been vulnerable to media and political criticism. Despite the cost of these life-saving medicines, the President provided a strong defense of these business models and even called out the “slow and burdensome approval process at the Food and Drug Administration [which] keeps too many advances, like the one that saved Megan's life, from reaching those in need.”
State of capital markets for clinical stage biotech companies
This is a challenging environment for biotech companies seeking funding. The media tends to focus on the big winners and successes -- unicorns such as Intarcia, Moderna and Grail which have each raised more than $1 billion as private companies. These exceptions aside, the vast majority of promising young biotech companies struggle to fund their proof-of-concept trials and typically confront decreased valuation expectations. Fortunately, financing activity is cyclical. During the IPO window of 2013 - 2015 (see IPO tables below), capital rushed into the sector and a record number of companies went public.
Today’s investor is far more discerning. In 2016, more than $7 billion of funds flowed out of public biotech funds in the US as the Nasdaq Biotech Index fell by 21%. (One standout biotech fund was the BioShares BBP ETF which was up 6% during the year.) But there are signs that the worst is behind us. The biotech IPO class of 2016 has rebounded to an average of +28% from IPO price and the three biotech IPOs of 2017 have averaged a 33% gain (through 3/7/2017).
While conditions may well improve, we do not expect activity to return to the record levels of 2014 and 2015 in the near term. Our affiliated broker-dealer unit, LifeSci Capital, is engaged in daily dialogs with private and public companies seeking financings and investors clearly hold the upper hand in financing discussions. This environment has created low private valuations which favors the strategy of venture funds like ours.
Fund Update and Strategy
Almost immediately following the March 1st launch of the fund, we have made our first investment – into the Series B financing of Rocket Pharma Ltd. Rocket is a high-quality gene therapy company which has all the qualities our fund seeks in deploying capital. First, the company has attracted a world-class group of biotech-specialist institutional investors. Second, the management team is brilliant, highly experienced (ex-Novartis, ImClone, Bluebird Bio) and extremely motivated. Third, the company is on track for an IPO well within our targeted 3-year timeframe. Other factors that make this investment attractive are the breadth of their pipeline (six different programs), a focus on devastating rare diseases with little competition from other companies, and a strong platform to in-license or acquire additional programs.
Our affiliated business units (LifeSci Advisors, LifeSci Capital, BioShares and the newest - LifeSci Public Relations) continue to expand to record revenue and activity levels. We are thrilled to bring the collective resources and networks of our healthcare research, capital markets, IR and sales professionals – many of whom have worked in the healthcare industry for 15-20 years – to bear to the benefit of our fund investors through differentiated idea generation and due diligence.