Is there any of that party feeling left?
The start of 2012 witnessed the tides turning in favour of small and mid-cap names in the European Life Sciences sector. Major global biotechnology indices like the NBI, BTK, and BIOTK are up over 15% year to date. The pace of the pick-up has been so rapid that those who were already positioned in small-cap names started thinking of taking profits, and those who had positioned themselves in big pharma to avoid anticipated market volatility were left second-guessing their defensive strategy. On the one hand, small-cap long-only funds are happy that their thesis seems to be working, and on the other hand long/short hedge funds see the opportunity to short the names which have rallied on newsflow that otherwise would not have impacted share prices. Now, the biggest lingering question is whether the party is over or if there is something left for latecomers.
Despite the general market rally, at Kempen & Co we believe 2012 will be a year for stock picking when it comes to either beating the benchmark or generating an absolute performance in contrast to macro driven 2011 performance. The two major trends in 2012 that will benefit small- and mid-cap names in the Life Sciences sector will be partnering of clinical candidates and cost-cutting/outsourcing. The promise of products with external validation will drive valuations as long as the company has a cash runway of over 12 to 18 months. In partnering scenarios, there will be huge interest for potentially “best-in-class” and “first-in-class” candidates. To illustrate this point, Galapagos has seen its share price double in the last two months on the back of its potentially best-in-class JAK inhibitor. 4SC has seen a recovery in its share price after 2011’s vidofludimus disappointment in rheumatoid arthritis (RA) as its second drug resminostat reported data showing the potential to treat liver cancer where no other therapy seems to work. It is assumed that the market usually prices-in anticipated partnering deals into a share price after a key positive data point is achieved; however, at Kempen we believe that the companies with best-in-class or first-in-class drugs stand a fair chance of beating those expectations, leading to the share price jumps for which the biotechnology sector is known.
Acquisitions have always taken centre stage in the Life Sciences sector, and we believe 2012 will see Big Pharma cherry-picking in small- and mid-cap space rather than mega-mergers. Antibodies will remain hot, as has already been seen with Amgen’s recent acquisition of Micromet. As far as earnings are concerned, FY11 performed well on a backdrop of positive macro developments, however Q1 guidance has not been as upbeat from corporates as one would expect. A cautious stance from corporates warns of volatility for the coming few months, but Big Pharma’s ever-growing hunger will pave the way for extraordinary returns for small and mid-cap Life Sciences firms.