Biotechs Are Booming on Wall Street Again—But for How Long?

If a flood of new startups are rushing into the public market, does it create a bubble? That questions seems to be playing out in the biotech sector, which has gone from years of inattention among investors to a sudden area of interest in the stock market.

Last year, 37 biotech companies went public, raising $2.7 billion, according to Renaissance Capital. Both figures easily surpass the totals from the previous five years combined, and even exceed the numbers from the “genomic bubble” year of 2000, when 26 companies raised $1.9 billion.

And from the looks of things so far this year, 2013 may just be the warmup act. In the first two months of 2014, 20 biotech IPOs have gone public, says Kathleen Smith, a principal at Renaissance. “That’s the strongest start to the year for biotech that we have ever seen,” Smith says.

Some are receving a warm welcome, with four members of the class of 2014 trading at more than double their offering prices: Relevance Therapeutics is up 105%, Dicerna Pharmaceuticals up 134%, Auspex Pharmaceuticals up 139% and Ultragenyx up 159%.

And more keep coming. Aquinox Pharmaceuticals, an early-stage biotech company, and Recro Pharma went public this month, raising $46 million and $30 million, respectively. Both are trading above their offering prices. According to IPOScoop, another 31 health-care companies, most of them biotech, are in the IPO pipeline, including companies like Corium International, Ignyta and Akebia Therapeutics.

The biotech sector has long been subject to booms and busts, driven largely by the uncertainty facing startups over whether drugs that look promising in development will make it through late-stage trials, find approval by the FDA and be accepted by the market.

The last boom came in 2000, as the collapse of the dot-com bubble drove investors into what they hoped would be a new flurry of drugs developed through gene-based research. But those hopes proved premature as it proved much harder to mine the human genome for breakthroughs that could create new therapies.

The past few years have borne signs that the genomic-based research may be finally delivering on marketable drugs. Technology and computing power has allowed for research impossible a decade ago, potentially shortening the development process by a matter of years.

Many of the new developments won’t be blockbuster drugs but targeted therapies for specific diseases. Companies developing targeted cancer therapies have been a particular area of interest, especially if they’ve reached late-stage drug trials, says Jim Healy, a general partner at Sofinnova Ventures, one of the few venture firms to have consistently and successfully backed biotech startups in recent years.

Another change: The FDA has been approving more drugs, sometimes fast-tracking so-called orphan drugs, or pharmaceuticals that offer limited potential for profitability. In 2012, the FDA approved 39 new drugs, the highest number since 1997. Approvals slipped to 27 in 2013, although that figure remains near the five-year average.

In general, biotech stocks have been on a tear for a while. The NYSE Biotech Index, for example, has risen 68% in the last year alone, above the Nasdaq’s 36% rise. The rally is driven by a few factors: An aging population in many developed economies will create a demand for more kinds of therapies beyond blockbuster drugs. Meanwhile, patents on their top-selling drugs, prompting big Pharma to make some aggressive acquisitions.

That bullishness has spilled over into the IPO market. But if it’s not yet a bubble, there are still plenty of signs of irrational investing. GW Pharmaceuticals went public last May at $8.90 a share and currently trades nearly nine times higher, at $77.38 a share, despite recent losses. Acceleron Pharma and Aratana Therapeutics are both trading at more than three times their offering prices.

Such rallies have stoked concerns of a biotech IPO bubble in recent months, concerns that gained steam in January when Dicerna said its insiders weren’t subject to traditional lock-up restrictions. But not all biotech IPOs have fared well. Prosensa’s stock is 49% below its offering price, having tumbled after a muscular-dystrophy drug faced a setback in phase-3 trials.

Another point argued by the counter-bubble camp is that many of the recent biotech IPOs don’t represent a gold rush, but the delayed arrival of a backlog of offerings pent-up for nearly a decade. What’s more, the average size of recent biotech offerings is relatively small, only $73 million per IPO. The total $2.7 billion raised by all 27 companies in 2013 is less than the year’s largest IPO: energy company Plains GP.

The question facing the biotech IPO market now is whether that backlog has already been cleared, or whether many recent candidates are simply going for a money grab before the window slams shut. When it does, based on previous boom/bust cycles, the market will be stingy about biotech IPOs for some time.

For now, there is reason to believe biotech startups are finding capital to finance a new generation that has been long promised and much delayed, drugs that are often too specialized for big Pharma to put its marketing muscle behind. Picking stocks in the sector can be tricky for non-experts, however, not just because of the high valuations of companies like GW and Acceleron, but because of the risk of setbacks like the one Prosensa faced.

In that case, Sofinnova’s Healy says, “the safest way to invest is in large-cap biotech that are profitable and have revenue growth rates that are at least twice that of the pharmaceutical sector.” Rennaissance’s Smith also points to companies that handle clinical trials for biotech startups. And for the saftety-in-numbers theory, there are biotech ETF’s and managed mutual funds.

And finally, there’s always pure speculation – riskiest of all and, once it reaches a large-scale, a sure sign of a bubble.