After two days of Federal Reserve Chair Janet Yellen’s sometimes heated testimony before Congress, we can be sure of two things. The first is that our capital markets weigh every comment made by financial regulators, and each comment is quickly reflected in the value of the assets mentioned. The second is that our new Fed chair may not comprehend the implication of her words when disjointed industries like biotech and social media are placed in the same bucket with no follow-through to explain how they are connected.
During her statements, Chair Yellen noted “valuation metrics in some sectors do appear substantially stretched, particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year." She gave no further details of her analysis or the period of time she was conflating, and without giving any of her rationale, Chair Yellen moved on to other topics. A more nuanced analysis from the former president of the San Francisco Fed with keen awareness of the difficulties of biotechnology and Silicon Valley would have been appropriate, and candidly, expected.
While certainly some biotech companies are overvalued relative to assets and market potential, social media companies and biotech companies should not be analyzed with the same lens. Their valuations and life cycles are not comparable. While biotech companies traverse well-understood pathways and markets, the underlying business models of social media companies like
Biotech analysts and investors understand the biotechnology sector is a capital-intensive space fraught with high-risk, high-reward characteristics. One of the many challenges of biotech investing is that valuations are frequently based on a company’s potential, and not on its actual returns. This is especially true for small-cap biotechs which may have nascent or even nonexistent earnings as they begin their commercialization processes. Quite simply, it is a game of expectations for calculating investors. Chair Yellen should have understood this and adjusted her remarks accordingly.
Society often depends on struggling biotech companies to develop and commercialize new drugs and therapies, and the capital markets are their lifeblood. As biotechs attempt to reach their potential, they need a considerable amount of investment capital that they derive from institutional and retail investors. By some estimates an average of $1 billion in capital is spent for every newly approved drug. By other estimates it is much more. For every ten drugs that begin the clinical trial process, which is the gauntlet that must be traversed before applying for approval, nine fail.
Until the recent resurgence in the biotech sector, biotech companies were ravaged as the capital markets shut down during the Great Recession. It would be difficult to quantify today the long-term damage to future progress during that time. In fact, as a sector, the biotech market only recently overcame a long drought with the resurgence of the IPO market that contributed to the return of our equity capital markets as a whole.
Even though she compared “some” social media with “smaller” biotech companies, Chair Yellen’s words had ramifications for the entire sector - from microcap biotech stocks to sector bellwethers like
