A wave of biopharmaceutical bankruptcies looms, raising industry concerns in 2019

Six years ago, Bind Therapeutics was riding high, never anticipating the severe blow that would follow. In 2013, this biotechnology company founded by top researchers from MIT and Harvard was highly anticipated before its public offering due to its grand scientific vision. Company executives believed that its nanomedicine platform, although only having passed Phase I testing, represented the next advancement in cancer treatment.

However, these dreams were shattered within three years. As experimental therapies faltered in clinical trials, Bind was punished by the market, and debt repayment pressures ultimately forced it to file for bankruptcy in 2016.

Bind's story serves as a cautionary tale in today's life sciences ecosystem—an increasing number of biotechnology companies are going public at earlier stages and with higher expectations.

Although bankruptcy is not common for biopharmaceutical companies, 2019 broke this trend with a noticeable increase in Chapter 11 bankruptcy filings. According to data tracked by BankruptcyData, 11 companies have filed for bankruptcy so far this year, compared to an average of only 4 per year over the past decade.

Industry experts told BioPharma Dive in interviews that this increase may signal that more companies will head toward zero, especially as the industry faces rising legal and political headwinds. After a decade of booming growth, the number of newly listed biotechnology companies has surged, but many of them may struggle to withstand market pressures.

"I think we are at a turning point now, and this model is unsustainable," said Andrew Hirsch, former CEO of Bind, in an interview. Hirsch pointed out that early-stage platform companies like Bind are going public in greater numbers and at higher valuations, which could lead to more severe downside risks.

"Things don't always succeed on the first try; that's an iron rule of the industry. Many times, companies are held to perfect expectations," said Hirsch, now CFO of Agios Pharmaceuticals. "If you're lucky enough to succeed, that's great; but if you stumble due to innovation, the public markets can be very cruel."

Legal and political threats loom

Over the past decade, the biotechnology sector has significantly outperformed the broader market, with steady capital inflows supporting more companies going public at high valuations. But the tide has turned. Since peaking last summer, a major biotechnology index has fallen more than 15%, while the S&P 500 has risen nearly 13% over the same period. The capital that funds biopharmaceutical ambitions is also retreating; one Wall Street firm calculates net capital outflows of $8.7 billion this year, comparable to a period in late 2015 and early 2016.

As investor anxiety intensifies, more companies are competing for funds than in past decades. Evercore ISI analyst Josh Schimmer said he has noticed a significant shift in investor attitudes this year.

"When companies stumble, the market is less forgiving than ever before," Schimmer said in an interview. "They no longer get second chances like they used to, which could be a factor contributing to the rising bankruptcy rate."

Small biotechnology companies are not the only ones facing high bankruptcy risk. Thousands of lawsuits related to opioid marketing have already brought down Purdue Pharma and Insys Therapeutics. Several other companies, including Teva Pharmaceutical, Mallinckrodt, and Amneal, are also at risk of joining their ranks.

SVB Leerink analyst Ami Fadia said in an interview that legal uncertainty makes these companies "uninvestable." Additionally, she added, many of these pharmaceutical companies are highly leveraged and face problems with future cash flow generation.

"Clearly, some of these companies face a high risk of bankruptcy," said Fadia, who covers several pharmaceutical manufacturers including Mallinckrodt and Amneal.

Of course, the impact of opioid-related debt is limited to a relatively small number of companies. But heading into an election year, with drug pricing as a top issue, concerns about capital fleeing the industry and legal crackdowns on opioid manufacturers could be exacerbated by political threats.

Industry lobbyists are attacking the Democratic Party's main drug pricing proposal, HR3, saying it would erode the upside of the high-risk, high-reward investment premise of biopharmaceuticals, triggering a "nuclear winter." PhRMA CEO Stephen Ubl said at a recent media briefing: "If HR3 becomes law, it would be a death blow for many very small biotechnology companies that have no revenue yet and depend on attracting capital."

Industry-specific concerns are, of course, set against broader fears of an economic slowdown. Financial analysts have pointed to signs of a U.S. recession, which, if realized, would further squeeze the industry.

"Capital itself could become scarcer," said Bob Eisenbach, a bankruptcy-focused lawyer at Cooley LLP. "When that happens, even good companies come under pressure."

Falling into a "huge abyss"

Biopharmaceutical companies are structured to avoid bankruptcy. Companies that have not yet generated revenue typically have little debt, and if their pipelines fail, there are few assets to reorganize through bankruptcy court. Private biotechnology companies can also avoid bankruptcy through acquisition by their financial backers after a clinical failure, thereby saving face for venture capitalists.

"They just disappear into the huge abyss of the biotech universe," said Kevin Kinsella, founder of Avalon Ventures and a venture capitalist, in an interview about struggling biotechnology companies. Kinsella, who has founded more than 100 biopharmaceutical companies, including well-known ones like Vertex, Neurocrine, and Onyx, said he has been fortunate not to be involved in any bankruptcy cases.

"Truly complete failures, where companies shut down and turn off the lights, are not common in our industry," he said.

Whether young or established, pharmaceutical companies derive more value from ideas and hopes than from tangible assets or resources. Just last year, early-stage platform companies like Moderna Therapeutics and Rubius Therapeutics went public with multi-billion-dollar valuations despite lacking profits and significant clinical data.

But investor sentiment seems to have shifted. For example, Rubius's stock has fallen more than 70% since its IPO. Moderna's stock has risen this month but is still 30% below its 52-week high from May.

The former CEO of Bind said market sentiment has shifted when talking about platform companies. "Investors have lost interest in companies that go public with preclinical data," Hirsch said. "In the future, you may see more situations like this: a company is at the preclinical stage, goes public, and then is left alone, having to raise additional capital from the public markets, and eventually gets into trouble."

However, even struggling biotechnology companies can survive for years or even decades. Long-time industry veterans like Xoma, Novavax, and Geron have repeatedly faced clinical failures while searching for their first drug, yet they have survived. Despite cumulative losses exceeding $1 billion, these companies have still found the necessary capital to move forward.

"There's always someone willing to bet that the next discovery is just around the corner, or the next asset, or if we can complete enrollment and finish this clinical trial, everything will be fine," Kinsella said. "There's always hope."

Besides selling hope, biopharmaceutical companies, like other businesses, also have practical options to avoid bankruptcy. Restructuring and raising cash are the main focus, say turnaround experts. Company restructuring typically involves shrinking operations through layoffs, selling assets, or terminating R&D programs. Raising capital can include licensing rights to experimental therapies, taking on debt, or accessing public markets through secondary stock offerings.

If these options are exhausted, mergers and acquisitions may be another way out for shareholders. Firms such as Deerfield Management, Hercules Capital, and Highbridge Capital Management often assist struggling biotechnology companies in such efforts. For example, Deerfield reached an agreement to fund Dynavax's R&D costs and helped finance Melinta Therapeutics' acquisition of an infectious disease business.

A last resort might be merging with another struggling biotechnology company or becoming a reverse merger shell for another company seeking a shortcut to the public markets. Both situations have occurred in just the past few weeks. Foamix Pharmaceuticals and Menlo Therapeutics merged into a dermatology company, while NewLink Genetics became the shell company for Lumos Pharma to enter the public markets.

These strategies act like a moat, protecting the high-risk industry from bankruptcy. In recent years, they have been effective. According to data tracked by Evercore ISI, of the 333 biopharmaceutical companies that went public since 2012, only 3% have filed for bankruptcy, 6% have become reverse merger shells, and 10% have exited through M&A.

But with the biopharmaceutical industry's outlook uncertain in 2019, some are beginning to wonder how the market will react.

Can biopharma weather the storm?

Investment bank Jefferies says capital raising has reached "record levels" over the past few years, with 100 IPOs and 270 follow-on offerings in 2018 and 2019, raising tens of billions of dollars in cash. Meanwhile, the number of publicly listed small and mid-cap biotechnology companies has doubled over the past decade. These smaller companies are not only more numerous but also have higher average values and burn more capital. Jefferies found that from 2010 to the present, the typical market cap of these companies has doubled, R&D budgets have tripled, and cash burn rates have quadrupled.

The annual burn rate for these biotechnology companies (with market caps between $200 million and $5 billion) has increased from $20 million to $80 million. Jefferies analyst Michael Yee attributes this to free-flowing capital, more platform companies, and an arms race in oncology.

The remarkable market performance of the biotechnology sector made all this possible. For example, since the market bottomed in March 2009, a major biotechnology index has outperformed the S&P 500 by 30%. But recently, the biotechnology sector has struggled, and the environment for raising cash has become more difficult.

"The question is whether this model is sustainable if market and macroeconomic conditions deteriorate and political uncertainty becomes more pronounced, forcing companies to tighten their belts through 2020," Yee wrote.

By some metrics, the situation has clearly worsened, such as the amount of money flowing into healthcare or biotech-specific funds. Data tracked by Piper Jaffray shows that $8.7 billion flowed out of such funds in 2019. Net capital outflows occurred in 10 of the past 12 weeks, a streak that Piper Jaffray analysts say "seems to be the new normal."

In 2015 and 2016, the biotech sector also saw billions of dollars in outflows, when many biotech stocks fell and the prospect of Hillary Clinton's presidency heightened investor concerns about drug pricing. The biotech industry weathered that storm with almost no bankruptcies and has continued to grow since. Looking ahead, the key question will be determining whether the industry is on a new trajectory or will emerge from this period relatively unscathed.

"Attracting investor attention is inherently harder than ever before," said Evercore's Schimmer. "For a company that has already stumbled, even if they do things right, it's a struggle."