Baird Analyst Discusses Politics and Performance
The future of healthcare legislation and the ongoing debate over drug pricing has kept the biotech and pharmaceutical sectors in the hot spotlight. Baird sat down with Senior Research Analyst Brian Skorney who covers biotechnology to discuss how political uncertainty is impacting the space and whether biotech's current rebound is expected to continue. He also shares perspective on what the recent appointment of a new FDA commissioner might mean for biotech stocks and whether an uptick in M&A activity might be on the horizon.
What impact is the volatility of the current political climate having on the biotech sector? How do you see this playing out for the balance of the year?
Politics has had an outsized impact on the biopharma sector over the last few years due to the extraordinary backlash the industry has faced over the perception of high drug prices and the capitalization of politicians on this superficially easy target. In reality, drug pricing is an incredibly complex issue – it is very difficult to provide a short counter argument to the simple statement that a $1,000 per pill drug is expensive when there are many factors at play. The sector also continues to battle an image problem given the media attention shown to a few of the personalities at the center of pricing abuse claims. This, combined with a significant movement of capital towards passive management (making daily market moves dependent more on rebalancing than fundamentals), has led to very substantial volatility in the sector. We believe this dynamic is likely to continue as uncertainty feeds volatility, and the political climate and future direction of healthcare legislation seems as uncertain as ever.
What is impacting the sector's current strong performance and do you expect it to continue?
I think a good portion of the strong year biotech has had so far is as a rebound from about 18 months of underperformance. I am not a big believer in continued outperformance for the sector, as I think the primary issue for the group is the relative absence of blockbuster drug launches that exceed expectations since the days of Sovaldi, Tecfidera and Eylea.
Biotech saw a boost when Vertex recently released its cystic fibrosis data set. Is that positive development enough to quell concerns that biotech stocks are at risk for a reversal? What other catalysts might be on the horizon for the sector?
Vertex Pharmaceuticals, Incorporated's data was certainly a big win for the company, given the size of Vertex's market cap and attention investors were placing on this data set. It was a major catalyst for the sector, so having it go in the right direction and arguably be better than the most bullish expectations is certainly a confidence booster.
With that said, I am not expecting another event that could have quite this big of an impact for several years, which does put a sector dependent on momentum at risk for a reversal. The result from Intercept Pharmaceuticals, Inc.'s Phase 3 study of Ocaliva® to treat nonalcoholic fatty liver disease is probably the next one that could be similar in impact on a market cap basis and that will probably not occur until early 2019. We are keeping an eye on Phase 3 Alzheimer's data from Axovant Sciences Ltd.'s lead program intepirdine, which is expected to be released soon. Additionally, Phase 3 asthma data from Sanofi and Regeneron Pharmaceuticals' Dupixent® will also be available in the third quarter. This is probably the most highly valued drug launching this year, so there will be a high level of focus on the details of these results as the expectation is the drug already has enough of an effect to be approved for asthma and exceed results from other recent drugs approved for this indication.
How big of an impact is a new FDA commissioner having on the sector? Do you anticipate that biotech companies will have an easier time getting new drugs to market moving forward or are they facing other obstacles?
While it's too soon to tell, there is a view that new FDA commissioner Scott Gottlieb has been very active in his role. So far he has made a number of efforts to help companies seeking to promote generic alternatives, and has been an outspoken critic of bureaucratic hurdles to generic drug entrants and new drugs. He may also be playing a role in accelerating getting new drugs to the market, although there is a reasonable argument that the FDA had already been making progress on this front for several years.
The U.S. seems to be in an interesting period and moving a bit more towards a dynamic that has been present in the European Union – where regulatory approval hurdles have come down but payer hurdles have gone up, so the net impact on the sector remains to be seen. Time and time again, we've seen that approval can lead to significant headwinds from commercialization and not every drug can provide the revenue needed to justify having a sales force behind it. It's becoming more critical than ever for investors to have an understanding of the dynamics of the payer market for any new drug, because it's no longer as simple as once the FDA approves it, insurers will cover it.
There's currently a perception that biotech assets are trading at high levels, in part as evidenced by two major deals from last year: Johnson & Johnson/Actelion and Pfizer/Medivation. Outside of cancer treatment, however, high valuations aren't nearly as apparent and M&A volume is down over the past two years, although valuations are up slightly. Is the industry at large undervalued and what implications are there for M&A later this year and heading into 2018?
I don't think there is a good argument that the industry in undervalued on a fundamental basis. However, I think there is an argument that the industry trades at low price-earnings values relative to other industries it has traded in line with in the past. I think part of that is the maturation of the industry into something more like pharma. It may be as much an implication of the exuberance supporting other industries, as it is a highlight of negativity on the biotech sector.
It is curious that the primary fundamental argument in favor of the group's outperformance is the view that M&A is going to accelerate. The potential is certainly supported by the fact that large biotech and pharma, across the board, have massive cash positions and are in dire need of top-line growth drivers. While there is certainly no shortage of companies to buy, that doesn't mean it's going to happen. There seems to be a valuation gap between buyers and sellers, and truly unique assets do seem to be few and far between.