It is often said that “cash is king.” That is particularly true in the biotechnology universe where research and development, real estate and talent acquisition costs can run on the high side compared to slower-growing, less technology intensive industries.
The history of publicly traded biotech companies is littered with examples of firms that ran out of cash before getting a drug or therapy to market. Costs and a biotech company’s ability to manage those costs are critical when considering that roughly nine out of every 10 drug trials that are commenced do not result in a viable product coming to market.
While the importance of cash, cash burn rates and drug development costs are widely known among the biotech analyst and investor communities, traditional biotech equity indexes do not incorporate cash burn rates in their weighting schemes. The Poliwogg Medical Breakthroughs Index (PMBI) does. Constituents in the Poliwogg Medical Breakthroughs Index must have enough cash to survive at least 24 months at current burn rates, a trait that takes on added importance when considering that index only includes stocks with market values ranging from $200 million to $5 billion.
Cash And Where Biotech Stands
At the end of the third quarter, members of the Poliwogg Medical Breakthroughs Index had a weighted average cash burn rate of 35 months, easily exceeding the benchmark’s requirement and nearly double the cash burn rate of 19 months on the large-cap Nasdaq Biotechnology Index.
Cash burn in the biotech space is taking on added importance because, well, many biotech companies are rapidly burning cash. Over the past five years, biotech companies raised an estimated $128 billion from initial public offerings (IPO), secondary offerings and via other sources, but $85 billion of that total is already gone, according to Endpoints News.1
Leerink analyst Geoffrey Porges examined 222 biotech companies, finding that, on aggregate, the cash burn is comfortable and indicates the average company can last well over three years at current burn rates. However, 30% of those companies do not have enough cash to survive another 18 months, a figure that jumps to 50% in a year.2
With equity markets faltering, biotech companies that need to raise cash may need to find alternative sources, including cost cutting or issuing convertible bonds. A year from now, the cash burn situation for some biotechs could be bleaker than it is today.
“This means that without further capital, and assuming constant, not growing expenses, then by the end of Q3 2019, or one year from now, 45% of these companies will have only one year of cash, and ~60% will have only 18 months of cash available,” said Porges.
Some data points indicate 2019 could be a slack year for IPOs in general, including biotech. Across all industries, there were just six IPOs in the U.S. last month and as of Monday, Dec. 17th, December IPOs totaled just four.3
Capitalizing On Cash
The ALPS Medical Breakthroughs ETF (SBIO) tracks the aforementioned Poliwogg Medical Breakthroughs Index. In addition to the requirement of at least 24 months of cash at current burn rates, that index only includes companies with drugs and therapies in Phase II or Phase III clinical trials. Clinical trials become progressively more expensive as companies move through the process and those costs vary by therapeutic area, but by focusing on companies in Phase II or Phase III trials, SBIO avoids companies that could spend up to $6.6 million on a Phase I trial.4
1 Source: Endpoints News Nov. 28, 2018 https://endpts.com/the-flip-side-of-the-hot-ipo-market-a-chill-could-trigger-a-sudden-cash-crunch-in-biotech-followed-by-more-deals/
2 Source: Seeking Alpha Nov. 28, 2018 https://seekingalpha.com/news/3412790-biotechs-face-cash-crunch-next-year-leerink?dr=1#email_link
3 Source: CNBC Dec. 17, 2018 https://www.cnbc.com/2018/12/14/get-ready-for-the-200-billion-ipo-shakeup-in-2019.html
4 Source: Igea Hub Aug. 28, 2018 https://www.igeahub.com/2018/08/28/evaluation-of-clinical-trial-costs-and-barriers-to-drug-development/
Important Disclosure & Definitions
An investor should consider the investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus which contain this and other information call 844.234.5852 or visit www.alpsfunds.com. Read the prospectus carefully before investing.
Standardized performance for the ALPS Medical Breakthroughs ETF (SBIO) can be found here. Current holdings for SBIO can be found here.
Shares are not individually redeemable and the owners of shares may purchase or redeem shares from a fund in creation units (blocks of 50,000 shares) only.
ALPS Advisors, Inc. (AAI) has engaged IRIS Werks, LLC (IRIS) to produce analysis and commentary on ALPS-advised ETFs. IRIS currently has a compensated business relationship with AAI. AAI is not affiliated with IRIS.
The content and opinions expressed in this article are that of the author and not the views and opinions of ALPS Advisors, Inc. In addition, ALPS Advisors, Inc. assumes no responsibility to ensure the accuracy of the content written by the author.
The author is not an investment professional and this article should not be considered investment advice. While the information and statistical data contained herein are based on sources believed to be reliable, the author takes no responsibility to ensure the accuracy of the content. Additionally, this article should not be relied on or be the basis for an investment decision. Information that is historical is not indicative of future results, and subject to change.
This fund may not be suitable for all investors. There are risks involved with investing in ETFs including the loss of money. The Fund is considered non-diversified and as a result may experience great volatility than a diversified fund. The Fund’s investments are concentrated in the pharmaceuticals and biotechnology industries, and underperformance in these areas will result in underperformance in the Fund. Investments in small and micro capitalization companies are more volatile than companies with larger market capitalizations.
Companies in the pharmaceuticals and biotechnology industry may be subject to extensive litigation based on product liability and similar claims. Legislation introduced or considered by certain governments on such industries or on the healthcare sector cannot be predicted.
Companies in the pharmaceuticals industry are subject to competitive forces that may make it difficult to raise prices and, in fact, may result in price discounting. The profitability of some companies in the pharmaceuticals industry may be dependent on a relatively limited number of products. In addition, their products can become obsolete due to industry innovation, changes in technologies or other market developments. Many new products in the pharmaceuticals industry are subject to government approvals, regulation and reimbursement rates. The process of obtaining government approvals may be long and costly. Many companies in the pharmaceuticals industry are heavily dependent on patents and intellectual property rights. The loss or impairment of these rights may adversely affect the profitability of these companies.
The development of new drugs generally has a high failure rate, and such failures may negatively impact the stock price of the company developing the failed drug. Biotechnology companies may have persistent losses during a new product’s transition from development to production. In order to fund operations, biotechnology companies may require financing from the capital markets, which may not always be available on satisfactory terms or at all.
Poliwogg Medical Breakthroughs Index – The Poliwogg Medical Breakthroughs Index is designed to capture research and development opportunities in the pharmaceutical industry. PMBI consists of small and mid-cap pharmaceutical and biotechnology stocks listed on US exchanges.
Nasdaq Biotechnology Index – The NASDAQ Biotechnology Index is a modified market capitalization-weighted index designed to measure the performance of all NASDAQ stocks in the biotechnology sector. The index was developed with a base value of 200 as of November 1, 1993.
One may not invest directly in an index.
ALPS Portfolio Solutions Distributor, Inc. is the distributor for the ALPS Medical Breakthroughs ETF.
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