(Sorry for the long hiatus, I’ve been occupied with other projects)
HBM Healthcare Investments ($HBMN.SW) is a Swiss permanent capital vehicle which invests in both private and public companies globally in the human medicine, biotech, medtech and diagnostic sectors. Founded in 2001 and originally known as HBM BioVentures (it was renamed in 2012 to reflect its broader focus), it’s managed by HBM Partners and listed on the Swiss Stock Exchange since 2008.
The investment portfolio is currently made up of stakes in ~70 companies (31 private and 38 public, 70% of which are below US$2 billion in market cap): its two largest investments account for 15% and 10% of the portfolio, respectively. It also has participations in 11 healthcare-dedicated funds to diversify outside of its core expertise.
Biggest shareholder with a 16% stake is Nogra Pharma Invest (Mario Giuliani’s investment vehicle: he is a board member but not part of either the management or investment teams), CEO Andreas Wicki owns less than 1% and the rest is free float.
Investment strategy: Long-term, patient investor
HBM Partners is a specialist healthcare investment manager with teams focusing on direct public and private investments, and established relationships with private equity fund managers around the world. Many of the managers have professional or research backgrounds in healthcare, and have expertise across a range of clinical indications. The investment approach is long-term, with private holdings often retained even after IPO, and some stocks having been in the portfolio since the fund’s inception in 2001.
The availability of permanent capital means HBMN can invest in later-stage private companies and can add to investments at IPO and, if a public company experiences difficult times that might see less specialised investors withdrawing support, it can add to investments on weakness, a key differentiating factor compared with pure private equity investors: operating as an evergreen fund, HBMN has the flexibility to engage in multiple follow-on financing rounds.
Some of the private equity allocation is undertaken via funds (9% of the portfolio at 31 December 2023), a policy that dates back to HBMN’s inception and began as a way of accessing the US market, with the team making investments in leading funds on the East and West coasts with different strategies. As HBM Partners has grown, it has built its in-house expertise in these markets, but still retains the exposure to funds in order to access very specific areas of opportunities, for example “company builders” (the MedFocus II Fund) and HBM Genomics (which work with leading research universities to invest small amounts in promising start-ups). It also allows HBMN to gain exposure to select geographies such as China and India.
While HBMN sees itself as primarily a private equity-style investor, the proportion of the portfolio held directly in private companies has fluctuated significantly over time, largely as a result of market cycles. When publicly quoted healthcare stocks are in high demand, there is greater appetite for initial public offerings of private companies, so the proportion of the portfolio in public companies tends to rise as holdings move over from the private segment.
Holding public companies also gives the managers flexibility regarding the financing and timing of investments. Currently, around a third of the portfolio is invested in earlier-stage companies that may have higher funding needs (7% in pre-clinical, 8% in Phase I and 16% in Phase II), but where such needs arise, cash can always be raised from the sale of public holdings.1
Investment process
The investment approach is bottom-up, with the teams employing fundamental analysis to construct a portfolio of 60-100 investments with solid long-term growth potential, from a universe of around 1,000 companies.
Private companies. The private equity team sources deals through its own networks, as well as via investment banks, other venture capital investors and directly, with the aim of making typically around 8 to 12 deals a year. HBMN seeks to be an active lead or co-lead investor, with board representation, and to share entrepreneurial responsibility along with the management team. All private investments are made with a clear expectation of an exit, which may be via an IPO or trade sale. In recent times many of HBMN’s new private positions have been taken specifically as pre-IPO investments, with the expectation of flotation in a matter of months, although some private holdings have been in the portfolio for a number of years.
The team focuses on companies with innovative platforms and drug candidates. Even when private investments are made at earlier stages of development, a successful clinical proof of concept is a non-negotiable criterion. With a significant proportion of the listed companies having started out in the unlisted portfolio, the fund manager has recently begun reporting its listed investments in two segments (those originating as private holdings, and those bought as public companies).
Over the last decade, HBMN has executed more than 60 trade sales and IPOs.
Public companies. Public investment accounts for the bulk of the current portfolio (approximately 46%) due to several successful IPOs originating from the private investment portfolio. Once listed, HBMN can remain invested in these companies if the near-term value potential is still intact.
The universe of potential investments encompasses more than 1,500 listed biotech or medtech companies. Before each investment, thorough due diligence is carried out, including a stakeholder assessment and intellectual property review. The portfolio construction phase assesses various exposures (geographic, therapeutic areas, stage of development) and the size of each investment made.
The overall portfolio is diversified by clinical focus, development stage and geography. Follow-on investments often occur during the later stages of clinical development, particularly when companies are either profitable or cash flow-neutral and require expansion capital: 39% of the portfolio is made up by companies which are already profitable and a further 23% already have a product commercialised.
Geographically, the fund’s activities span Europe, Asia, and North America. Direct investments are biased towards developed markets, while the private equity funds portion has a significant tilt to emerging markets where it may be harder for the investment team to make an assessment of individual private companies.
Healthcare: still an attractive investment universe…
Key drivers for the sector are demographic trends (population growth and ageing), medical progress and the resulting innovations, rising prosperity (especially in emerging markets) and improved access to medical products and services. In addition, there is a great need for new therapies for a steadily increasing number of diseases.
The industry remains above-average growth and largely independent of economic cycles.
… but with many challenges
The biotech sector has been in the doldrums over the last couple of years, with the Nasdaq Biotechnology Index down ~25% since its peak in September 2021.
The IPO market is a compelling indicator of the rapid shifts in macroeconomic conditions, transitioning from the abundant availability of cheap capital for nearly any biotech company in 2020-2021 to a considerably more stringent environment: while those two years broke records in both the number of IPOs completed and the volume of funds raised, the subsequent periods have witnessed some of the lowest activity of the past decade. In addition, the vast majority of the companies floated between 2020 and today are now trading below their IPO prices, scaring away many generalist investors.2
One (maybe?) positive point is that many big pharma companies are currently facing an upcoming patent cliff, with the risk of losing significant revenue generators in the next decade. To offset this risk, these firms are likely to seek external growth opportunities to replenish their pipelines with promising new blockbusters. M&A could serve as an effective catalyst to rejuvenate the biotech market.
Over the past two decades, licencing and M&A with biotech companies became a tool used by Big Pharma to refill their pipelines. The broad range of biotech companies allows pharmaceutical companies to strike deals that go from a couple million dollars up to multibillion-dollar deals depending on their strategy and available capital. Indeed, the large pool of small and very specialised companies offers many opportunities for larger companies to acquire promising assets while de-risking and reducing their internal R&D expenses.
Several biotech companies have been able to reach big pharma status and are now active players in the never-ending consolidation of the sector. In that regard, the five biggest M&A deals in the last five years all involved biotech companies.
As a generalist investor with no biopharma expertise at all, I have little knowledge of molecules, gene therapy or immunology. However, I do like to pay attention to capital cycles, industry structure, competitive dynamics, capital flows and likely returns on capital. According to Deloitte’s annual report on drug discovery by large biopharma companies, over the last ten years the mean return on investment in R&D has fallen from 6.5% to almost zero, owing to ballooning research spend and lengthening time required to take drugs through trial to market, as well as lower forecast revenues. One way to compensate for this falling ROI is therefore for large biopharma companies to acquire commercially proven drugs from earlier stage investors.
Recent events at HBMN do confirm this trend. In 2022, four portfolio companies were acquired by larger global pharma companies:
Turning Point Therapeutics by Bristol Myers for US$4.1bn (2.0x exit multiple for HBMN)
ChemoCentryx by Amgen for US$3.7bn (1.9x exit multiple)
Biohaven Pharmaceutical by Pfizer for US$11.6bn (2.4x exit multiple)
Sierra Oncology by GSK for US$1.9bn (2.2x exit multiple)
Similarly, in 2023 Chinook Therapeutics (kidney diseases) was acquired by Novartis for US$3.2 billion and Prometheus Biosciences (immune-mediated diseases) by Merck for US$11 billion. In December 2023 AbbVie acquired ImmunoGen (specialised in ovarian cancer treatment) in a US$10 bn transaction at a 90% acquisition premium: HBMN has been invested in ImmunoGen since May 2023 and the initial US$18m investment could be worth up to US$39m. Last but not least, in January Ambrx Biopharma (a formerly private portfolio company now listed on the stock exchange) agreed to be acquired by Johnson & Johnson for US$2 billion at a 105% takeover premium: the transaction will generate a US$23 million inflow for HBMN (vs US$10 million fair valuation at end 2023).
Financials & results
Financial prudence is a cornerstone of HBMN strategy, as it maintains sufficient short-term liquidity to meet all its commitments. According to its by-laws, with board approval the company may resort to debt financing, capped at 20% of net assets: currently it only has a CHF 100 million bond outstanding (coupon 1.125%, maturity in 2027), equivalent to less than 7% of the value of portfolio assets.
On the more important issue of NAV, HBMN takes a conservative approach. Listed companies are valued at market prices, and will thus reflect positive or negative developments as they occur. In the private portfolio, most positions are valued at acquisition cost, adjusted up or down only when a new financing round with a third-party lead investor effectively establishes a new “price”. Positions will be written down in steps of 25%, 50%, 75% or 100% in response to negative clinical or regulatory developments as they occur. However, positive developments are only reflected in valuations at the point of a liquidity event, such as an IPO, trade sale or third-party financing round.3
NAV is published fortnightly, with monthly summary factsheets and full portfolio valuations available quarterly.
Current 10 largest investments
For the 5 and 10 years ending in December 2023, NAV has grown in CHF by 9.3% p.a. and 13.0% p.a., respectively (while share price has appreciated by 6.9% and 15.3%).
Mirroring the biotech industry, the stock price has been declining since late 2021, and is currently down -53% from its peak.
However, over the last year the stock has been more on less in line with its more direct peers (Blackrock Health Science Trust and Worldwide Healthcare Trust are more tilted towards larger public companies, and BB Biotech as well).
HBMN is overseen by a non-executive board (mainly made up of pharmaceutical industry specialists), with the fund management team being led by chief executive officer Andreas Wicki and chief financial officer Erwin Troxler.
The fund aims to achieve long-term capital growth for its investors, but has also a high and stable distribution policy, paying out 3%–5% of NAV each year as a capital distribution. It measures its performance with reference to the MSCI World Health Care Index.(*) HBM Partners is paid an annual management fee of 0.75% of NAV plus 0.75% of market cap, calculated and paid quarterly. A 15% performance fee may also be levied if the year-end NAV per share (before accounting for any performance fee) is more than 5% above the previous high-water mark.4
There are relatively few specialist closed-end healthcare and biotech funds. HBMN has the highest exposure to private companies in its peer group and – for this reason - also the highest exposure to small caps (below US$2 billion).
Syncona is probably the closest comparable (more than fellow Swiss pharma investor BB Biotech), as it has around half of its directly invested portfolio in private companies and is similarly trading at a wide discount to NAV (same for RTW Biotech Opportunities, which is however much smaller).
HBMN’s current discount to reported NAV (28%) is the widest gap since 2017: the chart below shows – again – how things were much different in 2020-2021, when HBMN traded at premium to NAV.
Following the recent decline in the share price, the company announced in October 2023 that it has activated the share buyback programme authorised at the Annual General Meeting in June 2023 for up to 10% of outstanding shares.
Some conclusions
As usual, my personal pros and cons of an investment.
PROs
An active but long-term focused investing philosophy: permanent balance sheet capital gives HBNM a structural advantage over the venture capital funds it competes with
A good track record of value creation, including bringing private companies to the market
A well-diversified portfolio by type (private/listed), therapeutic area, development phase and geography
Profitable and products-in-the market companies represent over 60% of current portfolio
Currently a significant discount to conservatively calculated NAV, greater than the historical average
Dividend-friendly policy
CONs
Mixed performance over the most recent years together with the entire biotech sector
Venture is an industry that does not scale well
Sector rotation with healthcare outflows
Idiosyncratic risk in the top holdings: the largest two accounts for 25% of the portfolio, and the biggest is a Chinese company
Management remuneration is not exactly shareholder friendly: both half management fee and performance fees are calculated on NAV (not fair for shareholders as they do not benefit directly from calculated NAV)
Discount from NAV is – per sè – a good reason to invest: on the contrary, it is very common in most investment/holding companies (especially those with “difficult-to-value” assets) and alone is not an indication of undervaluation. Price/NAV should only be an input to the investment process, not a thesis in itself, as the gap could never close or, worse, NAV could go down. Discounts to NAV tell you more about the fundamentals of the markets a company operates in than expose some glaring inefficiency in share prices. Investors should develop a vision of the future that either justifies the discount or gives cause for it to close.
I see HBMN more as a “thematic” allocation in a portfolio rather than a long-term compounder, an alternative to an investment in a healthcare/biotech ETF or mutual fund, with the additional bonus (and corresponding risk) of focusing more on private companies and start-ups rather than the established giant pharma companies. On the other hand, it does not have the same potential as investing in a pure biotech venture capital fund (but it has better liquidity than a private fund).
The final decision rest very much on your view on the sector.
Clinical development is an important and costly step in the development of new drugs. It begins after the so-called preclinical development, i.e. the search for a suitable active compound. Phase I studies are conducted on volunteers to investigate how the active substance interacts in the human organism and to assess any side effects. Based on these results, an optimal dosage form for the active ingredient is developed. In Phase II, the active ingredient is being used as a drug in patients for the first time, with the focus on testing tolerability and establishing the dose. Phase III includes studies that provide information on the mode of action which are crucial for approval. In randomised double-blind studies, proof of a comparable effect must be demonstrated against other drugs as well as superiority as compared to placebos. Once the first three phases of clinical development have been completed, usually the drug's approval process begins.
One of the main reasons for this is that many of these companies were extremely early-stage and capitalised on market enthusiasm.
The exception is where an unlisted company has significant revenues and profits, in which case it will be valued based on appropriate price/sales and price/earnings multiples.
Do not expect performance to track the index, given the significant proportion of HBMN’s portfolio invested in private companies, and its complete lack of exposure to the ‘big pharma’ companies that dominate the index.