1Q Healthcare Investing: Still Cleaning up after the Party

The stock market and its many participants are fascinating creatures, reminiscent of a school of fish. At one moment, they are all lackadaisically drifting along, seemingly oblivious to the dangers swimming alarmingly nearby, and then, all at once, shoot off to gorge or escape threats that are suddenly universally realized. But in these disconnected, opposite, and discordant behaviors, and despite some losses along the way, a sustaining evolutionary sensibility somehow persists.

?The advancement of new therapies and healthcare technologies rely on this curious aquarium, as the markets provide a vital step along the path of innovation. Innovation often starts with an idea developed through academic research, then progresses when funded by venture capital. The public markets provide the significant risk capital that is subsequently required to prove out business models or fund expensive clinical programs. Unfortunately, for most of the last two years, despite the ever-improving likelihood of developing important new therapeutics and technologies, the markets have been largely closed to new healthcare IPOs.

?In the fourth quarter of last year and the first quarter of this year, things did pep up a bit, but with many cross currents. ?M&A activity, a true test of value in the market and which brings with it the promise of realized profits to investors, has been strong, particularly among therapeutics companies. In the fourth quarter of 2023 and the first quarter of 2024 combined, there was in excess of $90 billion in acquisition activity by large pharmaceutical companies alone. This is higher than the full year for 2021 and 2022 and very similar to the full year of 2018 and 2020. Eli Lilly and Novo Nordisk, which are both benefiting from their highly successful GLP-1 launches, were the most noteworthy. From June 2023 to present, those two companies made 11 acquisitions out of the 37 total. Novartis made four acquisitions over that period, and Bristol-Myers and AstraZeneca each made three. As is the norm, the majority of these acquisitions were for companies where the market had done its job by funding proof-of-concept human clinical trials.?

?IPO activity has also perked up. Public offerings in the first quarter of 2024 were the highest they have been in over two years. These were not all clean deals in the sense that there was normal demand. In many cases, companies needed to take investors over the wall to present new data to convince them that there was value to be gained. Nonetheless, the money flowed. Convertible offerings are still well depressed compared to the booming late teens and 2020. Still, towards the end of the quarter, several notable convertible offerings came at seemingly attractive prices for the companies that offered them. It is somewhat surprising that convertibles have not been more utilized, as convertible arbitrage players are hungry with demand for new issues and convert strike price premiums offer dilution advantages to the issuer over common equity.

?An active public market is a prerequisite for venture firms to make significant investments in new technologies, and these are collectively more positive signals than we have seen for a couple of years. For markets to be fully open, however, the clean-up of the rest of the excesses of prior years is likely necessary. In the first quarter, Invitae joined medical technology companies Nanostring and Sientra in filing for bankruptcy. While there will always be additional healthcare companies and technologies that fail to make it, companies such as Invitae represent some of the last of the highflyers to come back down to earth.?

?At the end of the day, returns are what drive market participation. In this regard, healthcare stock performance, outside of takeouts, remains unremarkable at best. In the first quarter of 2024, the Russell 2000 Healthcare index was up under 5% compared to the S&P 500 Total Return of over 10%. This adds to the significant underperformance from last year when the Russell 2000 Healthcare was also up less than half of the surging S&P 500. In part, this was caused by strong outflows from mutual fund investors, which occurred almost continuously through October of last year and, after a brief reversal around year-end, resumed in the first quarter of this year. With interest rate volatility and populist rhetoric mounting as the election cycle progresses, these fund flows are not surprising. What will be surprising is if we look back a few years hence and the evolutionary sensibility of the market has not fully recognized and rewarded the continuous, high-value innovations that are emerging across healthcare.

Deerfield Management Cure. Seema Kumar Karen Heidelberger Nicole Layton 密西根大学 The Johns Hopkins University