Looking at Market Capitalizations as an Investment Tool for Biopharma Companies
Purpose of Report
This report looks at the market capitalizations of 6 big pharma companies, 14 large biotechs, 24 mid-size commercial stage biotechs and 64 pre-commercial biotechs. It provides a picture of how the market values a broad range of biopharma companies at very different levels of maturity. It gives an insight into how the collective wisdom of market participants comes together to assign value to companies. This is most informative in my opinion for emerging biotechnology because in their early stage of development, there are no hard valuation metrics to use for making investment decisions.
Investing in an emerging biotechnology company is perplexing. How do you value companies with no sales or earnings and in which the value of the company depends on products in development that fail clinical trials in a meaningful percentage of cases. Emerging biotechnology companies usually are operating with significant operating losses so that measures of value such as earnings and cash flow are meaningless. Also, because of the extreme difficulty in projecting the outcomes of clinical trials and future earnings flows, discounted cash flows of an estimated future earnings stream are of limited value even though this is widely used by Wall Street analysts.
If you believe as I do that the market is smarter than its individual participants, looking at market valuation can be a guide for zeroing in on the best fundamental situations which are often the best long term investments. Let me hasten to add that this does not mean that you just go out and buy those companies with the highest market capitalization. However, it can be a useful tool in your investment toolbox. Additionally, investors can look at valuations of peer companies against which to gage the appropriateness of the market capitalization of a company in which they are interested.
I wrote an article on May 11 Announcing A Strategic Change in Coverage Approach at SmithOnStocks that previewed my decision to change my coverage approach at SmithOnStocks. As the first part of this strategy I did an overview of recombinant DNA and monoclonal antibodies, the two technologies that have had a transformative impact on the biopharma industry over the last 40 years. This was followed by three new reports on the emerging technologies of RNA interference, gene therapy and regenerative medicine that will transform the industry even more over the next forty years. These five reports hopefully give investors a basic understanding of each of these complex technologies which is essential for biotechnology investing. This report is the next step in that strategy that is intended to give investors an insight into relative market capitalizations.
The Biotechnology Industry is Exploding with Innovation Which Has Caused A Change in My Investment Approach
Wall Street has totally embraced the commercial promise of the new technologies by showering the biotechnology industry with capital. This has led to a staggering number of companies coming public with large valuations. This prompted my shift in strategy. In my previous approach, I focused on a few companies and did extensive research in an effort to become one of the most informed analysts covering the company. Generally, I sought out smaller companies not well covered by Wall Street. I believe that this approach can’t capture the explosion of knowledge that is taking place. I am now changing to cast a much wider net of coverage. This will meaningfully increase the number of companies that I write on with the tradeoff that my research will be less in depth.
As the next step in my new approach, I compiled a list of the pharma and biotechnology companies of which I had some knowledge. In doing so, I came across a large number of other companies which I knew little about or had not even heard of. I was frankly amazed by the sheer number of companies in the biotechnology space and the amount of money that investors have poured into them. There seems to be an inexhaustible number of ideas fueling an explosion in the formation of new, intriguing companies.
It is my hypothesis that that there will be a large number of home run investments emerging from the 64 pre-commercial biotechnology companies listed in this report. Most will likely come from larger companies acquiring them for their technologies, often before they have gained regulatory approval. I think that a much lesser number will emerge as fully integrated companies. However, these are likely to be better long term investments.
The thinking behind this compilation was to simply list as many companies as possible to get an idea of how investors looked at these companies and assigned market valuations.
In this report, I list four groups of companies:
- Big pharma (6 companies)
- Larger biotechnology (14)
- Emerging biotechnology companies with meaningful sales (24)
- Pre-commercial biotechnology companies (64)
This list is by no means comprehensive. Over time, I will expand the list meaningfully.
Although all of these companies are drug companies, they are at different stages of business development ranging from big pharma to pre-commercial biotechnology companies. There is an amazing amount of disparity in product lines and research focus. It is an extremely heterogeneous group of 108 companies and trying to draw comparisons is frustrating. So as a first screen, I have looked at market valuations for these 108 companies.
Why Look at Market Capitalizations?
Why do this? Valuing emerging biotechnology companies is an imprecise exercise. These companies don’t lend themselves to conventional valuation techniques such as price to earnings, dividends, cash flow et al. They are unique in that the value of the company is reflected in the promise of developing a new drug or a pipeline of new drugs. While doing this they spend aggressively on research and as they strive to bring drugs to commercialization, they burn through huge amounts of cash. In the pre-commercialization stage, they need to raise significant amounts of equity capital sometimes combined with licensing revenues.
Valuing these companies is hardly an exact science. Some analysts will put together models projecting sales and earnings streams out several years and then discounting the projected flow of earning back at some discount rate. This is highly imprecise as the failure rate of drugs in development is quite high and the projection of sales and earnings even if a drug is approved is highly imprecise. To be honest, there is no really good mathematical way to value a pre-commercial biotechnology company. I guess what most investors are looking at is the promise of the technology of a company and its products if they are successful. One investment in a company that brings a commercial blockbuster can offset several unsuccessful or less successful investments. What it all comes down to is that a lot of the valuation of a pre-commercial biotechnology company is a comparison to the valuation of other pre-commercial companies.
Market Capitalizations of Commercial Stage Companies
In Table 1, I show the market capitalizations of 6 big pharma companies, 14 larger biotechs and 24 mid-size biotechs that have reached a commercial stage. Each category is sorted from largest to smallest.
In Table 4 in the appendix, you will find statistics on price and fully diluted shares that underlie the calculations of market capitalization based on year end closing prices for 2018, 2018 and 2019 as well as the closing price on June 18, 2020.For reference, I also show product sales and royalties for the same periods. I did not include any foreign based companies in this compilation at this time. I used EDGAR as my data base and it was not as easy to gather the data. This results in the omission of a number of very good big pharm and commercial stage biotech companies. I plan to include these at some future date. Here are the resultant market capitalizations for these 44 companies.
Market Capitalizations of Emerging Biotechnology
I next calculated market capitalizations for 64 emerging biotechnology companies. For reference, I have also included their research spending, cash burn from operations and cash positions. These are all important metrics for these earlier stage companies. In Table 2, I show the market capitalization based on closing prices for 2018, 2018 and 2019 as well as the closing price on June 18, 2020. As previously noted, I did not include foreign companies at this time.
Market Capitalizations for All 108 Companies
Just for fun, I show market capitalizations for all 108 companies sorted from largest to smallest.
Appendix
Categorized as LinkedIn, Smith On Stocks Blog
Given this market-wide approach and the change in your strategy of coverage, does something like Royalty Pharma make sense to investigate?
Also this was in their s1, that I thought you might find interesting:
The significant pace of biopharmaceutical innovation and growing cost of drug development has been reflected in the level of capital markets activity that has been observed over recent years. Between 2015 and 2019, more than $170 billion has been raised by biotechnology companies in the
U.S. public capital markets. This includes $21 billion raised by companies across more than 180 initial public offerings, reflecting an average of 36 IPOs
of biotechnology companies per year over the last five years. By comparison, the technology sector has seen an average of approximately 34 IPOs
annually, and no other sector has seen an average of 15 or more IPOs annually over the same period. There are now approximately 500 public
biotechnology companies in the U.S. with a market capitalization of less than $20 billion.
From a macro standpoint, this makes sense. It would take a great deal of analysis to understand it at the micro level. It is not a situation that i would look at, but that doesn’t mean that it is not a good idea.