2017: Above Average VC Investment, Maybe a Record for M&A
I’m breaking with tradition and publishing my own predictions for the life sciences sector in 2017. I do research like this all the time for clients, but I never put it out under my own name.
I’m taking the plunge this year because with the regime change in Washington politics is going to play an outsized role in the health care sector this year. While I provide clients with insights to financial trends, I don’t share my political musings with them. So I need an outlet to put the coming year into perspective.
2016 was a mixed bag for biotech. Election-driven rhetoric about drug prices and another round of health care reform took its toll on the public company valuations, but venture investment remained strong by historic standards, and fundraising was robust.
Venture investment in healthcare totaled $11 billion in 2016. While that was a 7.5% decrease over 2015’s record level of almost $12 billion, the sector fared better than venture investment as a whole which suffered a decrease of nearly 20% in 2016 according to the PwC/CB Insights MoneyTree report.
On the fundraising side, Bruce Booth reports in his LifeSciVC blog that life sciences VCs are starting 2017 with $7 billion in the kitty which is not only on par with 2016, but also well above historic averages.
As for 2017, it’s going to take awhile for markets to adjust to the Trump administration policy – longer than is usual when a new party takes control in Washington. A large part of this delay is due to the fact that the Trump team is particularly opaque about their plans. Markets don’t like uncertainty, and we are going to have a lot of it in the short-term. Furthermore, the inside-the-beltway crowd does not like unorthodoxy, and they are going to get plenty of it from Trump. So pundits are stumped and stymied as to what to expect next.
There is enormous hew and cry in the public square about the repeal of the Affordable Care Act (Obamacare) particularly when there is nothing on the table to replace it. However, I would bet that Trump will make good on his promise to repeal and replace virtually simultaneously sooner rather than later, which will be good for markets.
It appears the strategy is to continue down the road of repealing ACA while crafting a replacement out of the public eye. Once the repeal is imminent, the leadership will take the wraps off of the new plan leaving Congressional Democrats little time to tinker around the edges and negotiate the kind of compromises that made the ACA problematic.
With the repeal and replace debate off the table potentially by the end of the first quarter and $7B of fresh VC dollars waiting in the wings, I think the rest of the year should be better than average for biotech investment.
Furthermore, if the new administration creates a workable repatriation holiday, another $100B of assets held overseas by biopharmaceutical companies will be available to fuel another strong year for pharma M&A according to EY.
EY predicts that there will be more ex-US companies doing deals in the first half of the year and then a flood of US companies doing bigger deals in 2H. But biotech M&A is driven by much more than financial strategies. Pharma R&D is increasingly expensive and unproductive. Deloitte reports that returns on R&D investments by Big Pharma has decreased from 10.1% in 2010 to 3.7% in 2016.
With no sign of this trend reversing, “buyer” biopharma companies will continue to be dependent on innovation that comes from smaller nimbler biotechs. This dynamic will eventually lead to a fundamental realignment of the roles of big biopharma and innovative biotech.
The most intriguing thing I heard at Biotech Showcase this year was when Art Pappas speculated that pharma companies will ultimately spin-out their R&D operations to independent companies in an effort to replicate the productivity of R&D focused biotechs. He noted that the industry has already outsourced clinical trials to clinical research organizations (CROs).
Pappas’s vision leaves the “deconstructed” pharmaceutical companies focused on development and commercialization. I think that’s a good bet. The deconstruction of pharma is a few years out, however, this long-term trend will fuel investment in small companies, and earlier stage companies in the short-term.
Back to 2017, I think it will be a better than average year for biotech markets with the momentum picking up in the second half of the year. But it won’t be a record-setting, which is fine with me.
I’m not a fan of the boom and bust cycles that have characterized the sector as it came of age. While there might be the chance for a big score by some in a boom year, the bust end of the cycle drives away the generalist investors who are the key to the sector’s long-term stability.
So here’s to a better-than-average-but-not-over-the-top 2017!