The Bull Case for Biotech in 2017

The first conference of 2017 is also one of the largest and most important. Still taking place in the hopelessly inappropriately sized Westin St. Francis, in San Francisco, the JP Morgan Healthcare Conference helps to set the tone for the year for investors.

Setting the tone for this year, however, might be more challenging. Because, as we are learning rapidly, through a series of tweets, president-elect Trump has an insatiable desire to set the agenda for, basically, anything that is going to transpire under his watch. This includes ObamaCare, which will certainly be repealed this year, with a very undetermined (at this time) replacement coming soon.

Investors can be fairly certain, however, that the agenda will contain several key ingredients, which will certainly spice up the healthcare pool as the year progresses. These include a campaign to lower costs, particularly drug pricing, and a revamping of the FDA approval process. The latter is certainly a positive for biotechnology…I believe the former is as well, which is why small cap biotech is my investment pick within the healthcare universe heading into 2017.

It’s been a bear market for biotech for going on nearly two years. Peaking in July of 2015 at almost $400, the IBB (the best biotech-tracking ETF) rapidly retreated to below $300 and was stuck in a trading range of $250 to $300 for all of 2016.

Fundamentally, biotech is a great industry. With rapid changes in medicine and drug discovery taking place, this industry is poised to produce many breakthrough technologies over the coming years and even decades. That being said, in 2015, the stock prices had gotten way ahead of the fundamentals. The subsequent correction was overdue and well deserved.

Going into 2017, I believe that the correction has run its course and biotech is poised to be a big winner. Here are several reasons why I’m a believer in biotechnology as we look out over the next year, along with several of my favorite picks in the space.

  1. Sentiment is overly bearish. Looking at the fund flows, 2016 was a disaster as investors bailed on the space. Interestingly, the stocks had a rather range-bound year despite the weak fund flows. This is because the group was oversold and has bottomed. Investor sentiment towards biotech has only one direction to go from here, and that’s higher.
  2. Drug pricing is coming under pressure…which puts an onus on the large pharma companies to stock their pipelines. Let’s face it, there are many competing therapies in the large cap portfolios. How many PDE4 inhibitors (Viagra, etc) or cholesterol lowering medications should there be? I don’t know, but once you have competing drugs, shouldn’t pricing become rational? Yes. Margins have to come down on non-novel drugs and this will lead to drug companies more aggressively seeking to pad their pipeline with high margin, unique drug candidates. This makes small cap biotechs more likely acquisition targets.
  3. Speaking of acquisitions, 2016 was a very slow year for this space. This was likely due to the bearish sentiment in the space. However, with that set to change and the aforementioned issue large pharma has with pricing, expect M&A activity to increase dramatically in 2017…helping to drive prices higher across the board, especially for small cap biotechs.
  4. FDA reform: to quote Donald Trump, “Reforms will also include cutting the red tape at the FDA; there are over 4,000 drugs awaiting approval, and we especially want to speed the approval of life-saving medications.” Expect a more drug developer friendly FDA. Expect this to be a big positive for biotech in terms of lowering the hurdles, and the associated costs and accelerating the timeline for getting a new drug to market.

Biotech is never a sure thing and this space will always be cyclical in terms of investor favor/disfavor. However, based on the aforementioned reasons, I believe 2017 will be a good time to look at biotech, especially in the smaller cap companies.

Which ones am I looking at? Well, I have my eye on several at this time. What I am looking for are companies with many possible drugs (I like to avoid “all your eggs in one basket” companies”), that have their solid funding, and have upcoming catalysts that are, hopefully, easily achievable, yet meaningful.

Here’s the list of my top choices:

  1. biOasis Technologies (BTI.V). This company has a lot going for it as it flies below the radar by virtue of being a rarity; a Canadian biotech. Their Transcend platform has been very successful in pre-clinical trials and should be entering humans in the near future. Meanwhile, as a platform, they have recently landed three licensing deals and have
    many more potential licensing opportunities. As their CEO stated, expect more partners in 2017. Finally, they are funded as their existing partnerships are expected to throw off cash starting in Q1…more than enough to cover their minimal burn rate. Lots of catalysts, huge addressable market, no need to dilute. Biotech doesn’t get much better.
  2. Xenetic Biosciences (XBIO). A recently completed financing with strong partners, along with an uplisting to NASDAQ, has somehow managed to escape widespread public knowledge. This company has a robust pipeline, including an agreement with Shire that looks set to pay them multiples of their current market cap over the next few years. Many clinical and regulatory milestones await XBIO in 2017.
  3. iBio Inc. (IBIO). Another platform company, iBio has a proprietary technology for producing biopharma compounds both cheaper and better. 2017 should be a big year for the company as it lands contract manufacturing business, advances its own proprietary therapeutic product indented to treat systemic scleroderma, idiopathic pulmonary fibrosis, and other fibrotic diseases, and lands and advances existing licensing partnership arrangements. Funded by Ken Dart, this company trades below the level at which he just invested. Meanwhile, a quality team with a platform that has multiple potential partners in the wings, makes iBio a rather compelling risk/reward in my opinion.
  4. VBI Vaccines (VBIV). And yet another platform company. I love platforms as successful development of a platform leads to much larger market opportunities than one single drug could ever do. VBI has a nex-gen platform for vaccine creation that looks compelling. Equally interesting, they have a HBV vaccine that has been used in many countries globally; a lot of data, low risk pathway through the FDA. They will need to raise money in 2017, but should have some good milestones prior to this which could goose the valuation.

And, there you have it. My reason for liking biotech heading into 2017 and my top 4 picks in the small cap biotech world. I would love to have feedback on these names and any others that you think I’m overlooking. Please feel free to email me at Daniel@tailwindsresearch.com with any comments or suggestions.

Tailwinds' Disclaimers & Disclosures: For a full list of disclaimers and disclosures, please visit http://tailwindsresearch.com/disclaimer/.