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These Investors Think There’s a Biotech Bubble That’s About to Burst

The Nasdaq Composite Index’s advance toward a record is renewing the debate over whether the value of its stocks is inflated -- and not just for technology companies.

Biotechnology had the biggest weight Thursday of any industry on the index at 11.2 percent, edging out both Internet companies and computer hardware makers, according to data compiled by Bloomberg. The 269 biotech companies have been one of the biggest contributors to the Nasdaq’s gain, with a more than 500 percent return over the past four years, compared with 166 percent for hardware and 97 percent for Internet.

Now there are signs that the biotech industry’s fortunes could change. One key measure of investor pessimism, the short interest ratio, has about doubled for the Nasdaq Biotechnology Index since 2013, according to data compiled by Bloomberg. The ratio, a measure of how many trading days it would take for short sellers to cover their positions, has been reflecting increasingly more bearish sentiment than the broader composite index since last year.  

The Nasdaq Biotechnology Index trades at 10 times the annual sales of its companies, compared with 2.3 times for the broader composite index.

Driving the boom until now have been blockbuster initial public offerings and multibillion-dollar market valuations for biotech companies that don’t yet have a single product for sale. Spark Therapeutics Inc., for example, has only one therapy that has reached late-stage testing. On its first-ever day of trading in January, the stock doubled to make it a $1.2 billion company.

“My initial reaction wasn’t, ‘Wow, this is great,’” Carole Nuechterlein, head of the Roche Venture Fund, said at a Feb. 25 panel at the Biocom Partnering Conference in San Diego. “It was more, ‘The end is coming.’”

Pharmacyclics Deal

Mergers have also boosted the value of biotech companies. On Wednesday, AbbVie Inc. agreed to buy cancer drugmaker Pharmacyclics Inc. for $21 billion, or about 40 times revenue, according to Joshua Schimmer at Piper Jaffray Cos. Buyers paid an average of 31 times revenue for $1 billion-plus drug deals in the past three years, according to data compiled by Bloomberg.

 The Nasdaq Composite Index rose 0.3 percent to 4,982.81 Thursday, within 2 percent of its all-time high of 5,048.62 on March 10, 2000.

Lost Decade

While investors have profited during biotech’s rise, the concern is that a handful failures in clinical trials -- which isn’t out of the ordinary in this industry -- could send investors fleeing. The last downturn followed a two-year boom that started in 1998 and saw the Nasdaq biotech index rise fourfold. When it crashed, it took a decade for investors to get excited again. 

Heath Lukatch, a partner at Novo Ventures, said he’s “inherently nervous” to see investors who don’t specialize in health care join the boom, and who may one day leave and take their dollars with them.

“These generalists aren’t going to be here forever,” Lukatch said in a telephone interview. “Biotech will go out of favor at some point in time. One or two failures won’t rattle the markets, but a string of failures across high-profile companies could be damaging.”

‘Very Unusual’

In the last two years, boosted by the influx of capital, companies have started going public earlier and earlier in the drug development process, according to data from Baird Global Investment Banking.

Before 2013, it was “very unusual” for a pre-clinical or phase 1 company to go public, said David Schechner, a managing director in life sciences investment banking. Yet in 2014, 10 did, compared with four in 2013. Those early stage companies might not have even considered selling stock a few years ago, he said.

“I don’t think that there’s anyone who’s recently gone public where they’re going to have a product that’s commercialized within a year of going public,” he said in a telephone interview.

The early stage biotechs are also doing well. Among biotechs that went public in 2013, those with drugs in the first stage of human testing or still in the lab are all trading above their offer prices, according to data from Baird. Yet of later-stage product companies that that went public the same year, only half to three quarters are trading above than their offer price. 

Believe the Boom

There are reasons to believe in the boom. Biotech’s current stock rise has been matched by an impressive pace of scientific achievements. New treatments in cancer, hepatitis C and genetic disorders are advancing in the pipeline or are approved and on the way to commercial success. 

Large biotechnology companies are “delivering top line revenue, they’re delivering earnings, and ultimately it seems that the science if playing out commercially,” Novo’s Lukatch said.

It’s also gotten cheaper and easier for startups. The Food and Drug Administration approved 41 new drugs last year, the most in at least a decade, according to the agency. Drug developers are also able to get cheaper access to cutting edge equipment, and outsource clinical trials to contract companies, said Amir Nashat, a managing partner at venture capital firm Polaris Partners LP.

“From 2002 to 2012, it was hard to get a break,” Nashat said in a telephone interview. “The FDA was really conservative, and a lot of companies had to do extra trials.” Now, Nashat said, the agency moves faster.

Still, general investors need to understand the inherent risk in the biotech industry, said Nancy Hong, a principal at BioMed Ventures. She said she worries particularly about immuno-oncology valuations, where enthusiasm is soaring for drugmakers making new therapies that harness the body’s immune system against cancerous cells. 

“You’re dealing with cancer tumors, which are devious, and the immune system, which is dynamic and constantly changing,” said Hong. “There will be some negative trials, given the number of trials in the space. It’s a matter of time before some don’t hit the endpoint.”

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