Another one goes.
Almost 20 years since spinning out from Massachusetts Institute of Technology (MIT), Momenta Pharmaceuticals’ agreed $6.5bn takeover by US-listed drugs peer Johnson & Johnson (J&J) last week reflects at least two important trends.
First, venture-backed success drives the market. Harvard Business School professors Josh Lerner and Ramana Nanda’s summer paper, Venture Capital’s Role in Financing Innovation, shows the importance of venture capital backing (see table). The 582 venture-backed companies still listed on the stock exchanges have a combined market capitalisation of nearly $5 trillion. The 462 other companies that have still listed in this 1995-2019 period have about $1.5 trillion in aggregate market cap.
Whether correlation or causation, venture-backed companies retain their focus and investment in research and development (R&D).
And so while it can feel a long time since the venture capital firms, including Atlas (in yet another of its partnerships with MIT’s Bob Langer), had a hand in Momenta before its 2004 initial public offering (IPO) it has worked. Momenta’s continued R&D has brought about its takeover offer.
The public markets took over after a few years of venture backing and have effectively provided the late-stage capital to fund the loss-making business over the past decade through secondary public offerings, including December’s $225m share sale.
At a sale price of about $52 each at J&J’s agreed purchase price, Momenta has delivered a 12.5% annual rate of return since 2004. This is impressive, certainly compared to the broader Russell 2000 Growth index’s 8.9% annual rate over the past decade, and reflects the buyer’s 70% premium paid to access Momenta’s new drug for autoimmune diseases.
The PitchBook Index of Venture-Backed IPOs, which tracks the performance of VC-backed IPOs for the first two years after going public, with backdated performance available from the beginning of 2008, found while biotech startups tend to be smaller and younger at the time of IPO, they constitute almost half of the equal-weighted index as of June 30, 2020 and so had outperformed companies that floated later, at higher valuations (chart below).
The report said: “This sits in stark contrast to the market-cap-weighted version in which nearly half of the index weight sits in software businesses. Startups in the software space that choose to go public have typically achieved a significant amount of scale in the private markets, which may make it more difficult to sustain growth once they transition into a public entity.
“On the other hand, healthcare ventures tend to go public earlier in their lives, which provides an opportunity to see meaningful valuation upside in the public markets if the company executes on its operational goals.”
This could prove vital given the number of flotations underway since the second quarter.
Second, successful companies can afford to pay up for innovation. J&J is paying effectively peanuts to borrow the money (and a bit more) to buy Momenta. If Momenta delivers on its potential to return $1bn per year in revenue through the sale of its new drug then it will be a very profitable trade for J&J at a time when growth is at a premium to find. If the drug falls at the final hurdle then J&J’s gearing is so low and other businesses profitable it will not affect its triple A rating. Microsoft as the other triple-A rated company is in a similar position to afford takeovers, while Alphabet, Apple and Amazon are also equally-well placed to buy businesses using cash, or highly-valued debt and/or stock.
Further consolidation could then happen if the regulators and authorities allow and the target will likely be medium-sized venture-backed businesses.
