HOT BUTTON ISSUES
Canadian Life Science // By James Smith and Wayne Schnarr
Canadian Healthcare
in 2009: HOT BUTTON ISSUES
Survival, Success, Surrender
Public Canadian healthcare companies operate in a complex, challenging and constantly changing global environment. In 2009, some companies celebrated success, while most focused on survival; unfortunately, a few of them did not make it. Considering the combination of increased financing, partnerships, share price increases and several positive clinical and regulatory events, 2009 was a good year for the sector. However, this positive performance was overshadowed by a few clinical failures that landed in the headlines, coupled with the lack of a defining positive event in the sector. There are a number of clinical and regulatory events expected in 2010 and a series of positive results could provide some upward momentum and renew investor interest in this sector.
Sector Performance in 2009 Money is the asset in greatest demand and shortest supply in the healthcare sector. The demand has consistently grown as new companies were formed and existing companies moved on to more expensive later-stage clinical trials. Supply constraints were worsened even more by the 2008/2009 financial crisis. In 2009, the sector raised a total of about $1.28 billion from equity and convertible debt financings (see Figure 1). Excluding large financings by Biovail and SXC Health Solutions, the rest of the sector raised $654 million, which is substantially better than the 2008 total but is still far below the annual average of almost $1.05 billion for 2005 through 2007. Excluding Biovail and SXC, 18 companies each raised more than $10 million dollars, which would be sufficient to fund small clinical programs. However, many of the 2009 financings were only large enough to allow companies to survive, which means additional funding will be required soon. Partnerships are the second major source of financing for smaller healthcare companies. A series of material licensing agreements were announced in 2009 (see Figure 2) that totaled U.S.$212 million in up front payments and U.S.$1,868 million in other potential milestones. Partnerships are essentially exclusive option agreements. When clinical or market data do not support continued product development, the partners typically terminate the agreement. As an example, the cetrorelix partnership between Aeterna Zentaris and Sanofi-Aventis was signed in 2009 but, after two failed Phase 3 clinical trials, it was terminated. The average share price return in 2009 for a group of 32 larger Canadian healthcare companies was +100 per cent (see Figure 3), compared to +31 per cent for the TSX Composite Index. Advancers outnumbered decliners by 26 to six, with five of the six decliners in the Therapeutics group. Nine companies had share price returns of 200 per cent or higher. Specific events are often critical to the investment strategies of many investors in the healthcare sector. For profitable healthcare companies, the critical events are no different than those found in other sectors: the release of quarterly results; acquisitions of new products and revenue-generating assets; or new service contracts. But for companies still developing products, share price movement is triggered most often by three other types of events: clinical data, regulatory decisions and partnerships. There were a significant number of positive events of these types in 2009 (see Figure 4) for Canadian healthcare companies. 16 BIOTECHNOLOGY FOCUS MARCH 2010
Investors’ Perception of the Sector While the average share price return for the sector in 2009 was certainly positive for investors, their overall perception of the sector can be swayed by negative events. For example, when a Phase 3 clinical trial fails, the market cap of the company can drop below its cash value. BioMS certainly experienced that in 2009. The impact of other negative clinical results is also dramatic, such as the 55 per cent drop in Transition Therapeutics’ share price when it had to modify a Phase 2 trial of ELND005 due to safety concerns. These negative events and resulting large share price declines can become headlines that paint the sector in a negative light, whereas positive clinical results, regulatory approvals and solid quarterly results sometimes get little attention. Most Canadian healthcare companies must have institutional investors in order to raise sufficient capital to develop their products. However, Canadian institutional investors in healthcare are generally small-cap funds that typically do not allocate a specific portion of their portfolio to healthcare stocks and often prefer to look at natural resource companies. Therefore, Canadian companies must look to the U.S., Europe and Asia for additional funding. But attracting the attention of these investors is challenging. When a small-cap Canadian healthcare company goes to New York, it is competing with not only its Canadian peers but with more than 1,000 other public and private healthcare companies. Retail investors are equally challenging and important to small-cap Canadian healthcare companies. Many retail investors have less investment experience and access to less sector information than their institutional counterparts. Their response to both bad and good news can lead to increased share price volatility. However, they are the only source of liquidity for some stocks where institutional and venture capital ownership is too high. They are also the shareholders who stepped up and provided survival funding to some of the smaller companies during 2009. Investment strategies in the sector can vary widely. Value investors focus on dividends, distributions and business fundamentals, and are more likely to be ‘buy and hold’ investors. Another group of investors has a substantially higher risk tolerance and is focused on extraordinary capital gains. Like many investors in junior natural resource companies, they focus on data, be it clinical or drilling results, which can dramatically impact share prices. Many of these investors will have shorter investment horizons and may actually own a stock several times during the longer product development cycles in this sector.
