Funding Companies in Today’s Volatile Market
US financial markets had “the worst 10-day start for Wall Street in history” in January 2016, said Andrew Gitkin, managing director and head of West Coast biotechnology investment banking at Piper Jaffray, but by February/March markets had bounced back a bit. What the market is now experiencing is a “flight to safety in US-dominated assets. It’s what we call ‘FOMO,’ or ‘fear of missing out’ as the equity markets rally.”
After five quarters of net negative fund flows, funds “finally went neutral in the third quarter,” he said. In fact, Gitkin said the interquarter move in fund investment from the first to second quarters of 2016 “was the largest interquartile reversal since 1933.”
For fund managers, it created “a lot of energy” in the market to look for ways to make back the performance that had been missed by the correction. However, health care as a whole is only up 5%, making it the third-worst performing sector; in 2015, health care was the third best-performing sector.
Valeant, a long-standing “long” hold by health care investors[as meant?] “unwound and that spilled into the broader health care indices, bringing the whole sector down,” Gitkin said. For its part, however, ophthalmology “traded in line with the broader market.” In 2015, ophthalmology essentially dragged the medtech index down, but that also reversed in 2016 and those funds are now trading in line with the biotech index.
“From an investment standpoint, the underlying trends are very positive in ophthalmology,”Gitkin stated. “There continues to be a steady stream of mergers and acquisitions to fund new investments. From an IPO perspective, 60% of the companies that have gone public in the past 10 years did so in the past three. If you analyze the 12-month trailing average of the IPO class, while it’s certainly not at the 2014 levels, they’re around 10%.”
Finally, what has changed over the past few years is the magnitude of crossover insider support for companies going public, he said.
“The recent spat of deals has been around 100%, so investors are still expecting a deal to be fully covered by the time the company launches,”Gitkin said.
Andrew Gitkin is a managing director and head of West Coast biotechnology investment banking at Piper Jaffray. Mr. Gitkin has 20+ years of experience, most recently at Moelis & Company, where he was a senior vice president in the life sciences investment banking group.
Andrew Gitkin: This is going to be the eight-minute ad version of capital markets. We’re going to pack a lot of information into a quick eight minutes. So this cartoon essentially encapsulates where we were at the start of the year. You can see the gentleman on the right there – sorry, I lost my thought there. Yes, this is what I was going to say, sorry. So if you were a banker looking to raise capital or a CEO looking to raise capital, you were the gentleman on the right, and things weren’t looking too pretty. Next slide. And this is what I’m talking about. The first ten days of the year were the worst in the – there it is, now I can see it. Sorry. They were the worst ten days in the start of the year in 2016. Essentially, the US markets were down roughly 5%. The more volatile NASDAQ was down more than 20%. The key drivers behind that weakness were essentially weakness in oil prices. It peaked at around $30 in the early part of January, and then declined to the mid 20’s by the middle. We also know that there continues to be uncertainty with the Fed, and also China had a very rough start to the year. It was down 25%. Another key point is we still had a lot of aftermath from the volatility that we saw in Valeant towards the end of the year. So it really made for a very, very rough start to the first ten days of the year. The good news is, though, things quickly got better. And you can see starting in that February/March timeframe, stocks really began to bounce meaningfully off their bottom. And a number of items came together, a lot on this page, but I would just point out that importantly, there was a flight to safety into US dollar denominated assets, really as a function of risk and perceived risk that we saw overseas in a number of the different markets. And also, the third point there, what we call at Piper Jaffrey the FOMO rally, or the Fear of Missing Out, as the equity markets started to bounce back pretty aggressively in February. Investors got nervous about missing out on that rally, and that moved some cash back into equities. You saw a big change in terms of allocations in portfolios. Peeling back the layers of that rally a bit more, a point. There’s a number of factors. The two worth pointing out in a short period of time is on the left, after 5 quarters of net negative fund flows, you saw it finally get neutral in the third quarter. Now it’s early, but that’s certainly a positive indication, particularly when you look at what we saw in the first and second quarter of 2016. And then on the right, this really quantifies, if you will, that fear of missing out in a pretty powerful way. That intra-quarter move that you saw at the bottom of that first quarter in to the second quarter was the largest intra-quarter reversal since 1933. Very powerful move. And as you can tell, really put a lot of money managers on their heels. They weren’t expecting such a powerful move. You can see the separation of the two lines. The hedge fund in x’s on the bottom there in blue, and essentially creates a lot of sort of energy in the market to look for ways to make that performance that was missed by that move. From a corporate perspective, earnings trends remained positive, and therefore growth continues to remain positive. That’s a positive indicator in terms of what we expect from an earnings perspective. From an S&P perspective, although we’re a little bit higher than where we typically – where the meeting is at 15.2 times, the bulls would argue that once you adjust for earnings, we’re more in line. So from a valuation perspective, it looks like it’s not as – on an absolute basis, as significant, given the move that we saw in the first and second quarter. So where does that sort of put us from an overall perspective? The S&P, Piper Jaffrey’s expected to increase 8% from current levels. The bulls continue to cite, as we all know, low inflation and low interest rates. Bears have a whole assortment of concerns on their menu, ranging from geopolitical shocks, Brexit being an example, what we saw in Turkey also being an example, and also some concerns about economic growth, and also what the Fed might do with interest rates. So what does this mean for healthcare in 2016? So far, healthcare as a whole is only up 5%. It’s the third worst performing sector. I would put that in perspective: last year, healthcare was the third best performing sector, and the market so far is up 8% this year. But when you sort of look at it from that bottom in that first quarter, it’s about double that. There’s a lot of information on this page, but I think it’s very important. The overall performance of healthcare was really largely influenced by the performance that you saw in the subsector of biotech. And heading into this year, we’ve been enduring a sort of multi-year bull market in biotech. Investors understandingly have gotten increasingly sort of wary about the length of the bull market. And you can see that in those gray bars on that page, which basically show sort of a sequential and consecutive increase in the duration of each of the slowdowns, which really underscores the nervousness and I think lack of conviction that you saw naturally build into a prolonged bull market. And I would say that we’re still a little bit, in terms of a slowdown, in terms of where we are, really underscoring the sector rotation that we saw out of biotech as we headed into this year, which dragged down the overall healthcare indices. Another key point worth mentioning here is that a very popular trade for the past couple years amongst more of the professional money managers, particularly on the hedge fund side, was essentially globally long healthcare and short energy. And you can see energy in the black line on the bottom going down, and for the most part, the healthcare indices going up. That trade really stopped working in the third and fourth quarter of last year, in part driven by the volatility that we saw in Valeant, which was a popular long holding amongst that healthcare trade. And as that unwound, you saw that spill out into the broader healthcare indices, bringing it down. Which was not much spoken about, but very powerful ripple effect that took place in the market. Ophthalmology for the most part traded in line with the broader market. There’s not too much to tease out here, but there’s been a bit of a reversal. In 2015 you saw medtech ophthalmology essentially drag the global medtech indices, and that’s the gray line on the bottom, really due to a number of notable fundamental setbacks at a handful of companies. You saw those lines, the medtech ophthalmology index as well as the medtech index mirror up again in 2016. So that’s the reversal. They’ve been trading more in line. From a biotech perspective, essentially biotech ophthalmology has traded in line with the biotech index. You can see it doing well last year, but trading off this year with the volatility in the overall markets. From an investment standpoint, I know the previous speaker touched upon it, but from a public markets perspective, underlying trends continue to be very positive in ophthalmology. There continues to be a steady stream of M&A which provides dry powder, if you will, to fund new investments, which we are seeing. And from a fundamental perspective, a number of the trends that we continue to hear back from investors as being positive is sustained innovation. There’s a lot of exciting things going on, as we all are aware, as well as continued favorable dynamics, both in pricing and reimbursement. And from an IPO perspective, the previous speaker touched upon it. I will just say that there is clearly been a softening, but you gotta put that in context. Sixty percent of the companies that have gone public in the last ten years went public in the last three years. So it’s understandable that there’s a bit of a sort of pullback here. Notwithstanding that, companies can still go public, and we’ve seen a number of good deals done so far this year. A couple of sort of trends to sort of quantify what we’re seeing in the internals, if you will, of the IPO market. From a pricing perspective, pricing dynamics have changed. We’ve gone more from the issuer-centric to investor-centric, and you can see that in the increasing number of deals that are being priced at or below the range. And then from a performance standpoint, the chart on the right is essentially just a 12 month trailing average of the IPO class performance. And you can see, while certainly not at the levels of 2014, it’s still in a pretty good area here around 10%. So the market continues to be sort of open for IPOs. And finally, in terms of the variable, the characteristics required to go public really hasn’t changed that much in the past couple years. But what has changed is the magnitude of one very important characteristic, and that’s the one on the top in terms of significant levels of crossover insider support required to go public. We saw that in the previous presentation. I’ll just point out that the recent spate of deals have been around 100%. So investors are still expecting a deal to be fully covered by the time it launches. So with that, I want to thank you for your time and appreciate being here.