Here's a good article by Bruce Booth of the Life Sci VC blog discussing the heyday of IPOs in the 1991-1994 span versus, the history of these deals to date, and the current investment environment. What's the story?
IPOs of that era paid handsomely to the VC backers of the time. The average step-up in valuation over the private invested capital was -- 4x. There was a very low cost-of-capital provided by public equity investors in that period. Much lower than today. For most of the past decade, step-ups on total invested capital have typically been only 1.5x or so. Sadly, high capital intensity has been the signature of many of the past decade’s IPO stories.
The playing field has changed since then as investors realized over that time span that only a subset of the 1991-1994 IPO window have accrued real value over time. Gilead, MedImmune and Vertex might be considered notable exceptions. Most of the other IPOs have underperformed all the major indices.
Booth instructs that there is a major flaw in the former IPO model that 3 main features:
- high capital intensity funding large portfolios, requiring serial public equity, with little focus on capital efficiency
- endless cycles of “rinse and repeat” anti-shareholder behaviors where new investors are recruited to fund the promise at the expense of existing shareholder dilution
- management teams too focused on “built-to-last” company survival vs shareholder value maximization, even when the best outcome for existing shareholders, and often patients, is to sell now and access the balance sheet resources of a bigger company
These flaws have led to IPOs a less attractive means of fudning. As Booth says, if most IPOs trade down after their IPOs, why bother buying at the offering. Seems rational. So in the current environment, private backers are becoming more activist and push for strategies that maximize their return in these companies -- which includes the proposition of selling the company "realtively early" to big pharma players. This avoids the dilution problem described above if trying to go the long haul. The old IPO model is gone.
In the current situation, one of the big change drivers is Big Pharma R&D productivity issues and their increasingly active M&A interests. Big Pharma in recent weeks has tried to make deals for Human Genome Sciences, Amylin and Illumina -- but were thwarted by big shareholder interests. As described above, activist big shareholders are playing a larger role in trying to maximize their investments and have resisted these perceived "low ball" offers. With more buyers crowding into the market, the pressure to pay a premium is just going to go higher. That's a trend with which biotech investors are well attuned. See Fierce Biotech.
Posted by Bruce Lehr May 5th 2012