IBB - A Clearer Runway Ahead

Introduction

The Biotechnology cohort has finally made up much of the lost ground during the pummeling from both sides of the political aisle during the 2016 presidential race. Tweets and excerpts during the campaign trail from Hillary Clinton, Bernie Sanders and Donald Trump put the biotech cohort through the wringer via aiming for drug pricing. The sustained sell-off lead to the entire cohort to sell off from all-time highs of $400 to $240 or 40% in only 6 months as measured via the iShares Biotechnology Index ETF (NASDAQ:IBB). From February of 2016 through June of 2017 IBB traded in a tight range from $250 to $300 while Donald Trump continually fired shots against the healthcare sector. Any healthcare related stocks became volatile on the heels of any statement or tweet from Donald Trump. Shortly after the inauguration, Trump stated that drug companies are “getting away with murder” when speaking to the drug pricing issue. As the proposed healthcare legislation appears to be dead as of now, a level of certainty has entered the picture, and the drug pricing threats are not perceived to be as bad as initially feared. Recently the index has had a resurgence moving to a 52-week high of $335 with a much clearer runway ahead as the political headwinds continue to abate. As the confluence of abating political threats, drug pricing certainty, and continuity of the current healthcare backdrop, I feel the index has room to continue its upward trend and retrace its 2015 level of $400.

Difficult 2016 Presented Buying Opportunity

After a banner year in 2015 for the biotech ETF, the cohort sold off in a dramatic fashion falling from $400 to $249 or a 38% haircut. The healthcare sector had been faced with an uncertain and volatile political backdrop. As President Trump vowed to bring down drug prices, IBB found its footing and set a floor near the $250 level. The ~$250 level was tested a handful of times in 2016, and it was evident that many of these political threats were being priced-in after its sharp and sustained sell-off. This sharp decline and subsequent floor coincided with heated political rhetoric aimed at the collective cohort of healthcare and more specifically biotech companies. I strongly felt that these events were extraneous and would eventually subside without any significant impact on the underlying stocks within IBB. I felt this politically induced sell-off presented a great buying opportunity considering the ~40% decline and extraneous pressures. I had written about such occasions throughout 2016, and I personally purchased two tranches of IBB at a strike price of $250 in February and June of 2016 during the market sell-off and the Brexit, respectively (Figure 1). I felt that these are excellent entry points for any long-term investor that desired exposure to the biotechnology sector. Ostensibly, many of these stocks were trading at multiyear low P/E ratios and as a cohort (gauged via the IBB proxy) looked to be less sensitive to tweets/threats as IBB continued to test the $300 barrier throughout 2016.

Figure 1 – IBB price activity and the resilience throughout 2016 before the uptrend with pronounced volatility that coincided with political rhetoric against drug pricing

The Drug Pricing Transparency Coalition Catalyst

Throughout 2016 and moving into 2017 some industry leaders formed a consortium to voluntarily cap drug pricing increases. Industry leaders aimed to get out in front of this drug pricing debate and articulate discipline in future increases while providing transparency on past price increases. This effort was to separate themselves from a handful of egregious price increases to contend with Trump’s aim at the drug companies. A select handful of companies were being used as a proxy for the entire industry. This consortium aimed to dispel this common misconception about drug price increases. This seems to have been an effective checkmate to the new administration and its efforts towards lowering drug prices and erroneously accusing companies and labeling them as price gougers. A group of big pharma companies (domestic and foreign) is unofficially banding together to address the price increases that the public and government officials have been angered over. Allergan (AGN), J&J (JNJ), Novo Nordisk (NVO) and AbbVie (ABBV) have committed to limiting any annual drug pricing increases to less than 10%. J&J went further and published an annual report regarding its portfolio and the price increases they’ve implemented. Merck (MRK) becomes the latest pharma to join this drug pricing transparency coalition.

Proposed Healthcare Legislation

As of recent, any proposed modified healthcare bill has been completely killed by Congress. However, ostensibly at first pass, the proposed healthcare legislation was perceived as favorable for the entire biotechnology cohort, specifically about drug pricing. The Trump administration’s attempt to reign in drug prices may not be as harmful as initially feared per a NY Times report. This report cited a draft of an executive order on drug pricing that appears to focus on easing regulatory hurdles for the industry and “largely leaves the drug industry unscathed.” This is a far departure from all the strong rhetoric on the campaign trail from Donald Trump. Regardless, continuity of the current healthcare framework provides certainty throughout the industry. Further, as the drug pricing paradigm remains largely intact along with the drug pricing coalition effectively self-governing, this cohort will be less constrained and allow to rise.

M&A and Repatriation Catalysts

The M&A catalyst is very much in play as the broader biotech cohort remains at depressed valuations compared to 2015 highs. Some notable acquisitions include J&J’s acquisition of Actelion in an all-cash offer of $30 billion to acquire the Swiss drug maker. Pfizer acquired Medivation for $14 billion, Allergan acquired Tobira for $1.7 billion and J&J’s acquired Abbott’s Medical Optics unit for $4.3 billion. Ariad (ARIA) Pharmaceuticals was acquired by Takeda Pharmaceuticals for $5.2 billion. The most noteworthy acquisition as of late was Gilead’s (GILD) purchase of Kite (KITE) for $11.9 billion. Repatriation of overseas assets and decreases in corporate taxes are very much in play and could serve as a catalyst for M&A and a tailwind for the industry. The political stance on M&A activity may loosen up with the new administration. Potential repatriation of overseas assets decreases in corporate taxes, and the loosening of M&A pushback may bode well for the industry in the intermediate term. Despite the current uptick in IBB, many prospective buyout candidates with beaten down valuations in concert with appealing pipelines remain. As this acquisition activity heats up, be on the lookout for stocks that have been rumored as takeover targets to heat up and possibly take IBB along for the ride.

Summary

The Biotechnology cohort has finally made up much of the lost ground during the pummeling from both sides of the political aisle during the 2016 presidential race. After its 40% slide over this period, iShares Biotechnology Index ETF (NASDAQ:IBB) began to demonstrate its resilience in the face of Donald Trump as he continuously threatened to overhaul drug pricing. The 40% sell-off, newly formed drug pricing consortium, political threats abating and the freshly proposed healthcare legislation being defeated is providing an ideal environment for the biotech cohort to appreciate. The drug pricing debate has been put to further rest with certainty surrounding the continuity of the current healthcare landscape thus a much clearer runway is ahead for the cohort.

Noah Kiedrowski
INO.com Contributor - Biotech

Disclosure: The author currently holds shares of IBB and the author is long IBB. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of stockoptionsdad.com a venue created to share investing ideas and strategies with an emphasis on options trading.