As early-stage biotech investors, we cannot help but keep an eye on the public markets, but opening our stock app has lately become a painful experience. The Nasdaq Biotechnology Index (NBI), which tracks the value of biotech companies publicly listed on the stock market, is down more than 30% this year. And it’s not just biotech stocks that are crashing: the value of high growth companies with negative cash flow (e.g. software, tech, crypto) is falling hard, in some cases down by 90% from pandemic highs.
Echoes of the dot-com bubble
Why the crash? Well for starters, inflation and quantitative tightening in the US have had dramatic effects on valuations of growth companies. But the factors are many: the pandemic was rife with speculation in growth stocks, SPACs, and crypto, not to mention the war in Ukraine and supply chain shocks have all dented investor sentiment. Since valuations in Europe were never as lofty as in the US, the effects are slightly more muted on our side of the pond but present nonetheless.
To find a comparable decline in the biotech sector, we need to go back to the burst of the so-called ‘dot-com bubble’ in 2000-2002. The crash was preceded by a period of excessive speculation in internet-related companies the late 1990s, where venture capitalists poured money into startups in what essentially amounted to fad-based funding. When many of these ‘dot-com’ companies failed to turn a profit, the bubble burst. Dot-com, tech, and biotech stocks all nosedived, taking the whole market with them: by the time it had bottomed out, the Nasdaq index had fallen by nearly 80%.
This crash means less focus on new deals, and less support for new startups and spinoffs in the biotech sector.
Memories are short: the majority of investors working in the sector today weren’t around for this catastrophe and have never know anything but a bull market. But the stock market crash triggered by the burst of the dot-com bubble reverberated across the world, triggering a period of a bear market. Until today, it marked the worst period ever for biotech stocks. The Nasdaq itself took 15 years to regain its peak. As a direct result of the crash, many companies went bankrupt and numerous jobs were lost.
Consequences of the current crash
Should we be panicking? How will this drop in the value of biotech stocks affect people in the life sciences sector? And will the problems faced by public companies on the stock market trickle down to the privately owned companies and startups in the private markets?
It bears mentioning that, although the overall market and tech shares are both down, there are marked differences between the current situation and that of the early 2000s. A big brake on the panic pedal is that many of the most valuable publicly traded tech companies today are actually turning a profit, contrasting with the dot-com era companies that were just promising to do so eventually. Although tech giants like Facebook, Google, and Amazon have all seen their shares tumble, it doesn’t mean they are going bankrupt – investors simply aren’t finding their growth prospects as compelling as before.
Founders and CEOs are being told to reduce spend, stretch their cash further, and survive until the market recovers.
As a result of the current crash though, we are already seeing a change in the general atmosphere, with stories of inflation and supply chain shocks making front page news. These effects also go beyond general sentiment – the public and private markets are inextricably linked. Generalist investors typically retreat from specialized sectors during a downturn. Crossover investors (active both pre- and post-IPO) have covenants on public-to-private market ratios, so with their public portfolio decimated, they are often not allowed to increase their investments in the illiquid private market. Private investors (like many venture capital funds), with less support from their crossover co-investors, consequently need to make reservations to ensure their existing portfolio companies weather the storm. Subsequently, this crash means less focus on new deals, and less support for new startups and spinoffs in the biotech sector.
Of course, funds have limited time to deploy their money, so new deals will still get made. But they might take longer than before and the conditions to invest will likely be less attractive than a year ago. This all means the pool of investors for later-stage private companies will be smaller, reducing the number of term sheets and syndication options. Founders and CEOs are being told to reduce spend, stretch their cash further, and survive until the market recovers. Companies with less than 18 months of cash on the balance sheets might face difficult choices. Indeed, we have already begun seeing quite a few restructurings and layoffs in the tech and biotech sector.
Not all doom and gloom
Is it all bad news? Of course not. In a booming environment, capital allocation tends to be a bit messy and undisciplined, with certain ideas getting funded that probably never had a good chance of panning out. This distracts capital – both financial and human – from the good businesses worth supporting. This current cycling in the market allows for the redistribution of money and talent towards ideas that have been vetted more rigorously. The result will likely be fewer, but more successful, outcomes for patients.
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These value cycles occur more regularly than you might think, and they are not always linked to market sentiment. For example, the huge boom in immune-oncology drugs a few years ago has already abated somewhat. In those heady days, a huge number of new targets were proposed and funding to tackle them was secured. Now, we are starting to see the clinical evidence for these targets, where some shine (e.g. LAG3) and others have fallen by the wayside (e.g. IDO). This type of shake out – although painful when you’re in the middle of it – is healthy. It forces us to separate the wheat from the chaff. The coming months will certainly not be easy, but in this volatile climate, seasoned executives, well-run companies, and good ideas will no doubt excel.
