A Reversal of IPO Fortunes in 2014?

Maybe this will be the year. Maybe, after languishing hopelessly and helplessly on the sidelines for the last half-decade, the medical device IPO market finally will reclaim its former glory in 2014.

Industry analysts are optimistic for a recovery, their hopes buoyed by a surging national market that raised $55 billion for 222 companies last year. IPO activity in 2013 reached its highest level in 13 years as low interest rates, reduced volatility and a steadily rising stock market boosted generosity among wary investors. Benefactors mostly favored companies in the energy, financial and healthcare sectors, lavishing a collective $29.5 billion on first-time public traders.

Financiers were particularly generous with healthcare firms last year, distributing $8.6 billion in 54 offerings—a 350 percent rise in deals and a staggering eight-fold spike in total proceeds compared with 2012, data from global IPO research firm Renaissance Capital indicate. Such gargantuan gains were unmatched last year, though the communications sector came close by quadrupling its number of offerings and boosting investments eight-fold. Business services was a top performer as well—proceeds jumped seven-fold, but the number of offerings remained flat at three.

Much of the surge in healthcare IPO activity was driven by the red-hot biotechnology sector, which ended a decade-long slump with its best performance since 2000. The industry generated 37 offerings worth more than $2.7 billion in proceeds, far surpassing the $1.9 billion dispersed among 26 companies at the height of the genomics bubble, various reports show. Moreover, the number of 2013 deals eclipsed the 1991 and 1996 windows, with total gross proceeds exceeding the amount raised in biotech IPOs in the previous five years combined.

“Big pharma has clearly concluded that it’s cheaper to buy than to build, so there’s a big appetite for acquiring biotechs, and that’s helped to bring generalist investors into the biotech market,” Burrill & Company CEO G. Steven Burrill told The Boston Globe in mid-January.

Those “generalists” are no stranger to the biotech market, but they haven’t been the most loyal bunch, either. They spent much of the swinging 1990s floating in and out of the sector (naturally hobnobbing with biotech firms in boom years) and making only occasional visits since the turn of the millennium. Last year, however, generalists returned in droves, most likely lured by promising clinical trial results, accelerated U.S. Food and Drug Administration approvals, a better appetite for risk, and the sector’s overall strong performance.

Insiders, conversely, kept their distance from biotech firms, participating in less than half of the deals in 2013 (down from 91 percent the previous year), Renaissance Capital data show. Typically, offerings without strong insider commitment have trouble pricing. But last year’s market was a peculiar beast: Many of the biotech sector’s strongest offerings were conducted with little or no insider venture capital participation. In fact, the typical IPO in 2013 had only 17 percent insider participation and at least nine deals had none, Britain’s Financier Worldwide magazine reports.

The lack of insiders didn’t affect IPO pricing or performance, though. A considerable number of companies priced their stock well above range, reversing a five-year trend of disappointingly low valuations. The strategy paid off handsomely for some companies, as investors became more willing to support firms with experimental (clinical trial stage) drugs or treatment. Ophthotech Corporation, for example, sold 7.6 million shares of stock at $22 apiece during its Sept. 24 offering. Its $167.2 million haul is more than double the $85 million the New York, N.Y.-based ophthalmics firm sought to raise from public stakeholders when it first outlined its IPO in August—an impressive feat considering the company enrolled the first patient in its Fovista Phase III clinical trial for wet age-related macular degeneration only weeks before the offering. Moreover, Ophthotech upsized its stock price and twice boosted its projected range—on Sept. 9, it contemplated selling 5.72 million shares at $16 to $19 apiece, then amended its IPO prospectus the day of the sale, estimating it would disseminate 7.6 million shares at $19 to $20 each.

Similarly, Cambridge, Mass.-based Foundation Medicine Inc. raised $106 million after pricing its shares above the $14-$16 range. Investors who supported the company’s IPO are banking on the success of its FoundationOne cancer diagnostic, which launched in 2012. The diagnostic test is a sequencing-based assay that scours 236 cancer-related genes to match patients with ideal treatments. The firm has not yet secured federal reimbursement for the diagnostic, but some large drug developers have expressed interest in collaborating on the test.

Indeed, above-range pricing has become a viable IPO valuation strategy in recent years. But timing—the right timing, really—also was a likely contributor to Ophthotech and Foundation Medicine’s lucrative debuts. Biotech’s IPO bubble, which had been expanding all summer, was about to burst.

Xconomy biotech editor Luke Timmerman was one of the first to warn of impending disaster. “This IPO party won’t last long, probably no more than a few months,” he wrote on July 22. “There are only so many good private [biotech] companies worthy of graduating to the public markets. If the past is any indication (remember the genomics craze of 2000?), there will be a hangover when it ends. Quite a few investors, big and small, will lose money and lose interest.”

Timmerman’s prediction was spot-on. Interest in the biotech sector began waning in early fall, not long after Ophthotech and Foundation Medicine went public in late September. Shortly thereafter, investors began leaving the party and taking their money with them: Between Oct. 1 and late November, the average total return for the year’s deals plunged from 55 percent to 14 percent. By Thanksgiving, many of the early-stage companies that posted fruitful first-day returns had experienced precipitous drops in their stock prices, and a string of postponed IPOs littered the market like leftover party confetti.

The half-dozen casualties included San Diego, Calif.-based Celladon Corporation, a developer of heart disease treatment therapies; cardiovascular genomic diagnostics firm CardioDx Inc. (Palo Alto, Calif.); and clinical stage biopharmaceutical company Trevena Inc. (King of Prussia, Pa.). All three companies cited “market conditions” as their main adversary.

Only time will tell whether Timmerman is correct and biotech’s once-in-a-decade IPO party truly has ended. Analysts are divided, with some convinced the market will return to normal this year and others expecting a repeat performance. Burrill predicts 30 biotech firms will go public this year as “companies continue to take advantage of the JOBS Act’s provisions and valuations become tied more to a company’s present value than its prospects.”

Leerink Swann & Company Vice Chairman Daniel B. Dubin is a bit more sanguine, envisaging as many as 40 offerings. Like Burrill, he is basing his forecast on the Jumpstart Our Small Business Startups (JOBS) Act provision that already has prompted dozens of companies to confidentially file IPO-related documents with the U.S.

Securities and Exchange Commission. The secretive filing process, analysts claim,allows private firms to control the all-important timing of their announcement and helps them maintain investor interest regardless of their finances.

David E. Redlick, however, doesn’t share Dubin’s optimism. The co-chairman of the life sciences practice at Boston, Mass.-based WilmerHale law firm warns the number of biotech IPOs could drop to 20 nationally if the Federal Reserve begins—as expected—to taper the bond purchases that have pumped cheap money into the economy to drive the recovery. “My own view is it’s being driven by the Fed,” he said.

Redlick is right, of course, but other factors also will help determine whether biotech’s Class of 2013 was an anomaly or a trendsetter. The large cohort of deals last year cleared much of the growing backlog of IPO-ready companies, thereby limiting the number of mature firms ready for public debut. On the other hand, market performance could benefit from increased M&A activity and investor enthusiasm.

“I don’t think the number [of biotech IPOs] will change dramatically in 2014,” John Babitt, partner, life-sciences transactions at EY (formerly Ernst & Young), told Orthopedic Design & Technology. “We are not likely to see the velocity this year except for the first half because a number of filings still have to be done. But overall, I expect the number of [biotech] IPOs to dwindle because I don’t think there are a lot of companies ready for that next step.”

Regardless of this year’s class size though, biotech IPOs are still likely to outnumber medical device offerings, Babitt and other analysts contend. Despite renewed investor fervor in biotech and plenty of its own promising technologies, medical device companies failed to attract investor interest last year—the industry recorded only 10 public offerings, most of which raised less than $50 million. Only two generated significant capital to the tune of $120 million and $86.3 million, respectively from investors interested in the company’s technology and the sale of shares.

The disparity between biotech and medical device IPOs is not a new phenomenon. The two industries historically have had lopsided IPO totals, with one thriving at the other’s expense. In 2004, for example, the medical device industry enjoyed a banner year, recording 25 offerings to biotech’s 16, according to National Venture Capital Association (NVCA) data. History repeated itself two years later when device IPOs exceeded biotech offerings by a 2-1 margin (26 device vs. 13 biotech).

The number of offerings evened out somewhat during the financial crisis, but biotech took the lead in 2011, outperforming its medtech brethren by a 3-1 margin (10 biotech vs. 3 medical device), NVCA statistics indicate.

One of the main reasons for such huge discrepancies between the two industries is the nature of the sectors themselves. An impressive cancer study can quadruple a biotech company’s market value, while “blockbuster” medical devices require long-term relationships with doctors, painstakingly slow negotiations with the Center for Medicare & Medicaid Services, and a costly investment in manufacturing. In addition, medical device firms have not embraced clinical evidence medicine as well as biotechs.

“We still see a number of challenges in the medtech sector. There’s still a lot of pricing concerns there—whereas with new and innovative biopharmaceutical therapies, there is a lot less resistance to pay for life-saving medicines, particularly if they’re focused on the right outcomes like oncology and pediatrics,” Babitt explained. “Medtech is a little behind its brethren in biotech in demonstrating clinical evidence medicine. They’re doing more to embrace that now but historically, medtech has tried to advance efforts through more features or some type of new technology rather than a cost savings to the entire healthcare system. We will still see medtech IPOs but they won’t keep pace this year with biotech. You won’t see a high level of filings made, even with the robustness of what is out there now.”