Biotech’s Vital Signs: A Pulse on Recovery and Growth Opportunities

Sector Starting to Show Signs of Life

The biotech sector, particularly small-cap biotech, is showing a positive outlook as multiple macroeconomic factors align to create a conducive environment for growth. After facing the headwinds of rising interest rates and economic uncertainty for several years, the sector is beginning to recover, signaling potential opportunities for investors and stakeholders.

Interest Rate Stabilization Sparks Recovery

Throughout much of 2023, macroeconomic conditions and interest rate movements significantly impacted small-cap biotech stocks. A sharp rise in 10-year U.S. government bond yields led to a downturn for unprofitable small-cap tech stocks, including emerging biotech. However, a shift occurred in November 2023 when the Federal Reserve signaled the end of its rate hikes, suggesting potential cuts were on the horizon. Now, well into 2024, interest rate cuts have already begun and are slightly larger than anticipated, providing a boost to the biotech industry. This drop in rates has lowered the cost of capital, strengthened operations, and generated renewed momentum in small-cap equities, ultimately catalyzing a recovery and a marked uptick in performance.

Key Drivers of the Positive Outlook

Several factors are contributing to the growing optimism in small-cap biotech:

Valuations Recovering from Historic Lows: After a significant decline in valuations that began in early 2021, small-cap biotech companies are seeing signs of growth. The rebound is supported by a trend towards normalization as valuations move closer to historical levels. Many biotech firms are still trading below their net cash positions, suggesting room for further recovery.

Innovation in Emerging Biotech: Smaller biotech companies continue to drive innovation, accounting for roughly two-thirds of the total biopharmaceutical industry pipeline The recent valuation correction has not fully reflected the underlying innovation, which leaves further room for more growth and more innovation.

Robust M&A Activity: The current environment presents compelling valuations for biotech companies, attracting significant interest from larger pharmaceutical companies. This has led to a surge in mergers and acquisitions (M&A), as larger players seek to acquire innovative assets that align with their strategic focus areas. In 2023, biopharma accounted for 58% of healthcare deal value, indicating strong ongoing interest in bolstering pipelines and product portfolios.

Regulatory Climate Remains Favorable: The FDA continues to support the approval of novel drugs, especially those addressing unmet medical needs. In 2023, drug approvals reached record highs, with around 65% of approvals using expedited processes. This constructive regulatory environment is expected to persist and fuel further innovation and development within the biotech sector.

Patent Cliff Pressures: Big Pharma faces a significant “patent cliff,” with an estimated $270 billion of blockbuster drug sales at risk of generic competition by the end of the decade. This has heightened the urgency for large pharmaceutical companies to acquire smaller biotechs with promising pipelines to offset revenue losses and strengthen their portfolios.

Future Opportunities in Small Cap Biotech

The positive outlook for small-cap biotech is reinforced by several emerging trends:

Continued Interest Rate Declines: If interest rates continue to decline in the coming months, the performance gap between small-cap and large-cap biotech stocks is expected to narrow, creating an even more favorable investment environment.

Pipeline Expansion and M&A Boost: As large pharmaceutical companies face revenue pressures from patent expirations, they will continue seeking acquisitions to strengthen their pipelines. Small-cap biotech firms with promising assets, particularly in areas like cardiometabolic health and oncology, are well-positioned for significant interest.

Overall, the sector’s recovery points to a promising future, driven by a strong pipeline of innovation and numerous growth opportunities ahead. In light of this, PRISM MarketView has identified 4 emerging biotech companies currently trading below cash, which may be of interest to investors looking to make a play in microcap biotech.

Achilles Therapeutics : Through utilizing AI, Achilles Therapeutics (ACHL) is focused on developing precision T cell therapies targeting unique protein markers on cancer cells. In its most recent strategic update, the company reported it intends to discontinue its development of TIL-based cNeT therapy and reported its cash position is $95.1M as of June 30, 2024. Achilles shares have traded up 16% YTD.

Galecto, Inc.: Clinical stage biotech Galecto (GLTO), is developing treatments for cancer and fibrosis. Recently, Galecto announced its first patient was dosed in an investigator-initiated Phase 2 trial of GB1211 an oral galectin-3 inhibitor, in combination with pembrolizumab (Keytruda®) in patients with metastatic melanoma and head and neck squamous cell carcinoma.

LAVA Therapeutics: LAVA Therapeutics (LVTX) is a clinical stage immuno-oncology company whose lead platform, Gammabody, uses bispecific gamma delta T cell engagers to treat cancer. In its second quarter financial release the company reported continued progress in its Phase 1/2a dose escalation for LAVA-1207, including the monotherapy arm, now enrolling in dose level 12, and the pembrolizumab combination. LAVA anticipates its next data update for LAVA-1207 program to be reported in Q4 2024. Additionally, mentioned was the company’s strong balance sheet with cash of $86.8M to support its runway into mid-2026.

Kodiak Sciences: With ophthalmology at the forefront, Kodiak Sciences (KOD) engages in the research, development, and commercialization of therapeutics to address retinal diseases. In their second quarter financial release the company provided an update on its three clinical programs of tarcocimab, KSI-501 and KSI-101 and stated they are making strong operational progress. Victor Perlroth, M.D., Chief Executive Officer of Kodiak Sciences stated, “The Phase 3 GLOW2 study of tarcocimab in diabetic retinopathy continues to enroll. The Phase 3 DAYBREAK study of tarcocimab and KSI-501 is now actively enrolling patients. DAYBREAK features an innovative study design that includes parallel investigational arms of tarcocimab and KSI-501 against aflibercept in wet AMD, and if successful, could support the marketing authorization applications for both investigational medicines. We have also activated the Phase 1b APEX study of KSI-101 in patients with macular edema secondary to inflammation, and the APEX study is now enrolling patients.”