The Life Sciences Sector - Forging Ahead Through Rough Waters

Rounding the corner from 2020 and 2021 was an exciting time for the life sciences sector. The rising tide was lifting all boats, and capital was flowing into companies at an unprecedented rate – the year was shaping up to be one for the record books. But, in February 2021, just as COVID infection rates were rapidly dropping and the Biden administration was pointing out significant progress against the pandemic, life-sciences stocks turned and began the downward trend that is still with us today. There are currently over 200 companies, or about 15% of publicly traded companies in the life-sciences space, trading at negative enterprise valuations. While this is not an all-time high, it is certainly a sign of an unhealthy market. Equally striking is the recent correlation of market capitalization to performance: smaller market caps equaled the poorest performance over the last year.

An interesting confluence of multiple trends brought us down the path to where we are now. In 2020, the pandemic brought a substantial sector rotation into the life sciences space pushing it to all-time high valuations. However, the market giveth and the market taketh away. As the end, or at least the manageability, of the pandemic appeared to be on the horizon, funds flowed back into many of the hardest hit areas at the expense of the life-sciences sector. Adding fuel to the fire were growing fears of hyperinflation, geopolitical unrest, and potential unfavorable changes to drug reimbursement leading to a rotation of capital away from riskier small-cap stocks to more stable and liquid large-cap stocks, a traditionally negative environment for life-sciences companies.

We see multiple factors coming into play that will ultimately lead us out of the current life science malaise and back into a more normalized market. The only question is: when? Despite the poor overall stock performances, the strong pace of capital raises over the last two years has left some players in the industry with substantial funds to continue operations and generate the primary currency of the life-sciences market: data. As mentioned earlier, valuations in the small-cap and microcap spaces are now low with enterprise values at or near zero for many companies, a very compelling opportunity for investors. Low valuations in the space combined with mid-cap and large-cap companies need to expand their pipelines, leaving the industry ripe for a wave of consolidation. Acquisitions have multiple benefits including a halo effect that lifts companies in similar spaces to the one acquired, and the generation of inadvertent cash, which results when investors receive a windfall from an acquisition and need to redeploy the capital.

We believe that investors will become more selective, focusing on individual stocks rather than baskets of names. This more focused investment paradigm will lead to a deepening of the have and have not divide and a more rapid recovery for companies expecting meaningful clinical data versus earlier stage technology plays. Ultimately, these changes should lead to a more rational distribution of capital and the thinning of the herd that is necessary for a broader turnaround and healthy expansion of the industry.