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Health & Biotech
A leading Australian biotech investment fund reckons the sector is poised for a significant upswing but the country lags in the race to capitalise on potential growth.
Returning from one of his regular trips to the US, HB Biotechnology managing director Charles Williams told Stockhead that biotech in Australia is a sector which has historically been overlooked and misunderstood.
However, Williams says today there’s an urgency around changing biotech’s image because the sector is poised for a significant upswing.
“While globally the economic environment remains uncertain as we recover from the fallout of the end of easy money post GFC and Covid-19, biotech presents an increasingly appealing investment opportunity for several reasons,” he says.
Williams says these reasons include:
Innovation and Breakthroughs
“Never before have there been so many tools at our disposal to fight disease,” Williams says.
“Globally, biotech companies are focusing on cutting-edge research and development in areas from gene editing, RNA therapeutics, to personalised medicine and novel radiotherapeutics.”
High Growth Potential
“The sector often experiences rapid growth, driven by advancements in medical science, increasing demand for healthcare solutions, and a growing aging population,” Williams says.
Unmet Medical Needs
“In harnessing new technologies and new financial incentives, many biotech companies are dedicated to addressing unmet medical needs, including rare diseases and conditions that lack effective treatments,” he says.
Diversification Potential
“Using listed biotech indices as a proxy, the biotech sector has one of the lowest correlations with broader market indices compared to any other sector, a characteristic that is enviable in any diversified investment portfolio.”
Williams believes the Australian biotech ecosystem is less sophisticated than the US and Europe – and is likely to remain this way.
“The Parkville Biomedical Precinct in Melbourne is one of the world’s top five biomedical research centres, yet Australia still fails to compete with the likes of the United States when it comes to commercialisation,” he says.
“Per capita, Australia is the most productive biomedical research nation in the world.”
Williams says across all forms of funding for commercial biotech entities from private to listed, they are vastly underfunded.
“Yet when it comes to commercialisation, the Australian investment ecosystem invests only 4 cents in biomedical companies for every dollar invested in the US, a stark 25-fold difference,” he says.
Williams says this underinvestment stifles the growth of the local biotech sector, resulting in lost value and missed opportunities.
He says while the Australian Government has taken steps to address the funding shortfall, through the establishment of the $20 billion Medical Research Future Fund (MRFF), 70% of the $2.8b distributions to date have flowed to funding academic research rather than addressing the commercialisation gap.
“The structural barriers of Australia’s capital markets further exacerbate the challenges faced by the biotech sector,” he says.
Unlike the US, where venture capital firms regularly commit to financing portfolio companies through multiple investment rounds, including private, crossover (pre-IPO) and IPO rounds, this is largely absent in the local market.
“Compounding this issue, Australian listed market funds tend to be generalist investors, lacking both the expertise and mandate to properly invest in a portfolio of development stage biomedical companies,” he says.
“You end up with the problem of what is known as the ‘Valley of Death’ where a biotech reaches mid-stage, proof of concept clinical trials which require significantly greater capital than early stage research and investors with the correct risk-appetite.”
HB Biotechnology run a high conviction portfolio of no more than 20 stocks in global biotech, focusing on small to mid-cap companies (<US$5b market cap). It holds just two ASX companies, which Williams would not divulge.
“In the context of a global high conviction portfolio, our weighting towards ASX biotech is actually over-represented,” he says.
“In general, there is enough innovation in Australia for the ASX to have a selection of good quality assets, however these also need to be good businesses and good investments, of which there are far fewer.”
“In general, we struggle to find a critical mass of ASX biotech companies that fit our investment criteria – this is one of the reasons why we invest globally and not just locally.”
He says even before starting to analyse the assets and business of a biotech, two of the biggest issues they find with ASX biotechs are liquidity and capital adequacy (cash runway).
“In general, we are very supportive of the ASX biotech ecosystem and wish that more of the earlier stage ASX biotechs could meet our investment criteria,” he says.
Williams says one of their investment criteria is at least 12 months cash to fund operations, ideally two years.
He says one of the reasons the fund achieved a greater than 60% return in FY23 was because they were diligent in ensuring they had companies in their portfolio that didn’t need to raise highly dilutive capital in the depths of the market in May/June 2022.
“Compared to a market such as the US, where biotechs typically maintain cash balances greater than 12 months at all times, there are numerous examples of ASX biotechs that essentially live hand to mouth, raising enough capital for ~12 months at a time,” he says.
“Drug/Device development is rarely a straight line where everything goes to plan and companies require sufficient capital buffer to work through these periods.”
He says it’s a major disservice to a biotech to have it under-funded.
“While nobody likes getting diluted, it is better to take the dilution today and have a properly funded biotech well past important clinical milestones than to delay the dilution and have partly-funded clinical trials – the dilution will almost certainly be worse.”
Williams says as a passive investor in listed assets, liquidity is an important consideration with often the only recourse you have to a company heading in a direction you disagree with is to sell.
“However, as a fund seeking to deploy a meaningful amount of cash, the liquidity profile of many ASX biotechs would have us turning into quasi-VC investors, albeit with the rights & leverage of a passive investor – not a great place to be,” he says.
“It’s a bit chicken and egg – you need the liquidity to attract funds such as ours, but if the funds don’t invest in the first place, it’s unlikely to have the liquidity required.
“Part of the issue here is that unlike in Europe and the US, there are very few industry specialists who invest in biotech here in Australia.”
Williams says Aussie biotechs are still not supported sufficiently and access to sufficient capital is still an issue for most.
However, he says there are local examples of companies that have gone about raising capital correctly. He says when Telix Pharmaceuticals (ASX:TLX) listed in 2017, it was one of the biggest ASX biotech IPOs at the time, raising $50m.
He says it had sufficient funding to operate for more than 24 months past important clinical milestones, with a pipeline of multiple assets.
“At IPO it was priced competitively with an excellent board and management team that have continued to execute on the plan they set out to shareholders,” he says,
Williams says from listing in 2017 at 65 cents/share and $130m market cap to here in 2023 at more than $11/share and ~$3.6b market cap, you can see that there are significant rewards for backing and properly funding well-run biotechs.
“We need more examples of this in the local market,” he says.
The ASX healthcare sector has been under pressure this year. The S&P/ASX 200 Healthcare index (ASX:XHJ) is down ~13% YTD.
Williams says there are several reasons the biotech sector is out of favour currently.
“It’s arguable the sector is dealing with a case of indigestion after the spate of IPOs at lofty prices back in 2021. This is not just an ASX phenomenon, the same dynamic can be seen on the NASDAQ as well,” he says.
Williams says with higher interest rates, theoretically the future cashflows from biotechs are worth less.
“Since the expected revenues and profits from the development of drugs are typically years in the future, increasing the discount factor used in a DCF model reduces the NPV of a company, which is the bread and butter of how to value a biotech.
“However, for many biotechs, prices have gone well past a small revision to the long term cost of capital and in many cases are trading at what we see as compelling value,” he says.
Williams says related to higher interest rates investors are being able to earn a risk free rate of return ~5% and, with market jitters, this seems quite compelling in the short term.
However, he says investors should consider the Warren Buffett quote: “Be fearful when others are greedy and greedy only when others are fearful.”
“I do get the sense that the market is in quite a state of fear,” Williams says.
“While we don’t know the exact timing of a rebound, what we do know is that a rebound will occur, and when it does, it is usually rapid.
“Furthermore, over the longer term we know that a well-constructed portfolio of biotech companies will deliver far greater than 5%, as our long term track record has demonstrated.”
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.
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