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Volatility ahead for the healthcare sector, says healthcare specialist

11 January 2023

Too much money entering the markets during the rally of 2020 and 2021 could lead to a mass of failed product launches, according to one analyst.

By Tom Aylott,

Reporter, Trustnet

The overfunding of weak healthcare companies during the market rally of 2020 and 2021 could create volatility in the sector for years to come, according to Marshall Gordon, senior research analyst for healthcare at ClearBridge Investments.

Billions of pounds worth of fresh capital entered the sector during the rebound after Covid, but Gordon said that much of this financed companies that will not be able to deliver good performance.

“There were a lot of companies that should not have gotten the funding that they did to run their clinical trials and you may see a trend towards an increasing number of trial failures,” he said.

“Because it was so easy to get funding, I think that some projects that should not have been funded got funded, so clinical trials may be even weaker than historical averages for the next couple of years.”

There were 669 initial public offerings (IPOs) in the healthcare sector in 2020 and 2021, raising a total of $101.3bn (£83.2bn), according to S&P Global Market Intelligence.

Gordon said that “it’s not a healthy number of companies that went public” over that period and many of them “have to get cleaned up” over the next few years.

“A lot of those small-cap biotechs have been crushed already and a lot of the others are 70-80% down from their highs, so a lot of that pain is taking place now,” he added.

Indeed, this fresh flow of investment mostly supported small-cap ventures, many of which will not be successful in creating the products they currently have in development.

Clinical trials determine whether a new drug works and is able to enter the market, so a higher volume of failed tests could bring sector averages down and lead to blanket deratings.

The success of these trails has an important role to play in valuations, with the outcome having a significant influence on share price movements.

Gordon said: “The way you make money in biotech is through clinical catalysts, meaning a company develops a good new drug, develops the clinical data that gets the drug approved and makes it competitive in the marketplace.

“All of that creates a lot of value in the stock market. When they do report good data, they're going up and they're going up a lot.”

However, retreating from small-caps and into large-caps isn’t necessarily the best option, with some of the largest companies in the sector facing long-term problems.

Many large-cap healthcare companies will have their most profitable drug patents expire by 2029, so there will likely be a scramble to buy mid-cap companies developing new drugs.

Amgen has already started, buying ChemoCentryx for $3.7bn (£3bn) in October last year with another bid to buy Horizon Theraputics in the works for $26bn (£22.9bn).

Its patent on its Prolia and Xgeva drugs, which accounted for 21% of all Amgen’s sales in 2021, will expire in the US in 2025 but will end as soon as June this year for most of Europe, so the race is on to replace them with new products.

Gordon said: “These companies are coming off patents that could be a pretty substantial blow, creating a need to do these deals.”

Nevertheless, the wave of failed clinical trials among small-caps and long-term structural issues of large-caps could create appealing opportunities in the mid-cap space, according to Gordon.

Some companies at the stage are more established than their small-cap counterparts and have more drugs in the pipeline that are likely to enter the market.

Likewise, mid-caps creating new drugs will make them appealing to the large-caps seeking products to replace their expiring ones, so they could benefit from acquisitions.

Gordon added that seeking out good companies in the healthcare sector is easier now than it has been in recent years as it is easier to distinguish stronger companies now that that the post-Covid rally has subsided.

Gordon said: “If you can sort through which ones are good and which ones are bad, you can definitely make money whereas a couple years ago it was much harder to do that.”

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