Have the engines started for the next mergers & acquisitions cycle?

We note that there have been some interesting moves amongst the largest biotechnology stocks over the past couple of months. Indeed, it has been an eventful few years for many of these companies. The pandemic has given cause to accelerate research & development programmes and a successful result can generate significant upside for shareholders (though as we have seen in the case of vaccine winner Moderna, whose shares are down year to date, these gains can be volatile). While Moderna and others remain some way off their pandemic highs, they have experienced strong share price gains over the past three months (as the chart below shows), and we note that aside from Biogen - which has had successful clinical trial results - most of these share price gains have come about on little news flow.

Why might this be reason for hope? While the sentiment around the wider market is not great as economies slow down with signs of a potential recession ahead, the biotech sector’s share prices are not immune to this sentiment. However, investors may have noted that the underlying biotechnology business cycle and corporate sales aren’t in sync with the rest of the market. There are several drivers behind this sector such as ageing populations in the developed world, greater wealth in developing countries, and the increasing number of clinical trials being conducted thanks to the impact of better technology on clinical trial turnaround times. We question whether these share price gains amongst the mega-caps could signal a turning of the tide for the wider industry. While they can be volatile too, returning confidence amongst the larger names could trickle down the market cap spectrum coinciding with an increase in mergers and acquisition activity, especially as valuations within the industry are low by historical standards and large pharmaceutical companies are fast approaching some significant patent expiries for their existing drug products.

When we spoke to the managers of International Biotechnology (IBT) recently, they were of the belief that we are in the second stage of a five-stage cycle where mergers & acquisition activity kickstarts and valuations begin to recover (the IBT portfolio has itself experienced seven merger or acquisition deals in the last year). Indeed, there is some good news for the sector as the NASDAQ Biotechnology Index rose by 6% while the S&P 500 fell by 1.7% between 31/08/2022 and 25/11/2022. We also note that the discount on IBT has narrowed significantly in recent months from high single digits to roughly 2.5% at close on 25/11/2022.

If this is the start of better times for biotech, then IBT is one of few pooled funds offering exposure to it, and the team – which includes vaccine tsar Kate Bingham – has few rivals in terms of experience. It offers exposure across all company sizes, but the managers have lately been more focused on mid and small sized companies where growth potential is higher and merger & acquisitions activity could boost returns. The team have kept a balance between profitable companies that offer resilience with approved drugs on the market, and high revenue growth companies with transformative drugs in the later phases of testing. The team take a highly disciplined approach to risk management, too, reducing their exposure to drugs as they approach ‘binary result’ inflection points like drug trials – to avoid the very real risk of being caught out by a failed trial and the collapse in banked up share prices that usually accompanies these occasions.

Meanwhile, there is the attraction of a high dividend yield for the sector, which is calculated at 4% of the latest financial year end NAV (as at 31/08/2022 NAV was 697.2p, which equates to a 4.1% prospective yield at the current price).

Past performance is not a reliable indicator of future results

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