Authored by Karl Simpson
Depending on which theory you follow as to the significance you place on remuneration as a primary mechanism for staff retention and how closely correlated this is to individual job motivation. Today, equity participation often forms a significant part of this staff compensation and with rapid escalation in biotech equity prices, we take a look at the impact this has on recruitment dynamics and how employee ownership is driving recruitment trends.
This year we have seen incredible gains in the equity prices of many of the hallmark biotechnology names with whom we are greatly familiar. This has become an asset class that investors have come back to with stronger appetites for higher risk investing again. Currently, the Nasdaq biotechnology index for the past 3 months is up some 45% (01 June ‘13), meaning that broadly the companies which comprise this composite index are enjoying a rich vein of form in the equity markets. This investor support is partly driven by the ‘rising tide floats all boats’ principle with global equity markets rising beyond pre-recession levels. What has been encouraging for investors is improved liquidity too, enabling people to trade out of their positions and benefit from price rises in the stock.
This is in general alignment to the pharmaceutical sector as a whole, as many large pharma companies have shown very good returns for owning their equity, as investors have begun to see the chink of light which emanates from the post ‘patent-cliff’ era.
But while large pharma have been busy putting their houses in order, having previously driven at speed straight off the patent cliff into the abyss of declining sales and thin pipelines, biotechnology companies have been enjoying a high degree of success. However, it is incorrect to suggest all biotechs have been doing well, they haven’t, but many have. The growing class of companies who have mushroomed in recent years to become permanent features of the biotechnology / biopharmaceuticals landscape seem here to stay. These include Gilead, Biogen IDEC, Celgene, Allergan, Shire and Amgen. When you look at the aforementioned companies, they are generally characterised by increasing market penetration, growing pipelines, good revenue growth, positive cash flows, decent product patent protection and growing market capitalisation.
When you consider how far the stock markets plunged during the early days of the recession, equity prices have staged a remarkable comeback despite weak economic growth in most of the developed economies. The fact that investors have come back into the biotechnology sector has helped drive prices to above average returns and created new liquidity in biotech investing. So much so in fact, that it would seem the IPO (initial public offering) market, in the USA at least, has opened up again to biotechs as another source of financing. Given the emergence of these companies as committed global, fully integrated players in the life sciences community, they have grown extensively through expanded operations and new developments throughout their pipelines, either through in-house proprietary products or those products licensed or purchased.
But what does this mean for recruitment?
Since employers decided that employee remuneration should take multiple forms and they could reward employees with equity in the company, through various share schemes which engender a sense of ownership, we have seen these employee rewards act increasingly as golden handcuffs.
Clearly, improved equity prices help all the company’s shareholders, from retail investors to institutional funds. Those shareholders also take the form of employees. The investment they make through their expertise and knowledge is frequently rewarded in equity allocations which rise in price as they and their colleagues build value for the company. If you are a long-serving employee of the company, maybe you just timed the pricing right, or the value climbs rapidly post-appointment, your personal reward can be considerable as those equity holdings mature and vest. This creates a strong financial bond with the company, as penalties are imposed upon resigning a position.
All of this creates barriers for recruiting people who have these equity positions. Sure, a new employer can try to provide compensation to account for these losses, but you have been rewarded for building value for your existing employer and the new one is unlikely to want to assume full liability for your losses, apart from in exceptional circumstances, as they might not materialise the same value.
Given the listed companies in Figure 1 have really been the growth stories of the past few years, it is worth recognising the significant impact these current prices have in keeping senior executive talent locked up in these companies. Think back to the instability created when Carl Icahn tried to force a sale of Biogen IDEC in 2007. At the time, the company was given a ‘for-sale’ sign with a price tag of around $20-25bn, today they are carrying a market capitalisation of around $56bn. Depending on whether you use this or the enterprise value, the cost of buying this company would almost certainly cost in excess of $75bn based on recent premiums. Indisputably a job well done by George Scangos, however, he would almost certainly attribute the success to the employees of the company who today remain a part of the growth story. Their value is recognised by their improved wealth from the equity they hold.
Conversely, the impact of value destruction is illustrated well by Genzyme. The issues this company encountered with manufacturing destroyed some value of the company, despite the underlying business being fundamentally sound, resulting in Sanofi making an offer and acquiring the company. This declining value in stock and accelerated vesting which results from acquisitions, unlocked the tremendous talent that was in this company. Today, look across many of the companies in Figure 1 and you’ll find Genzyme employees contributing their expertise. Investigate the management teams of companies which populate the landscape of the rare diseases and orphan drug community, an area in which Genzyme led its contemporaries, and you’ll find Genzyme executives in abundance, playing a part in a majority of these ventures.
Despite this directly proportional relationship between rising equity and improved staff retention, the companies which feature in Figure 1 can still expect to lose good people. But why?
Well, because owning equity in an employer who’s stock is rising faster than the spring blooms, is all very rewarding. However, the attraction of a tranche of pre-public equity in a promising private biotech is highly tempting. This is accentuated by the fact that some of the small public biotechs have returned phenomenal gains this year, perhaps best illustrated by Sarepta who are currently sitting at 1 year returns of 856%. This perhaps has provided the stimulus for Prosensa, a competitor to Sarepta, to announce their plans for a $60m IPO. This announcement followed telegraphed plans by PTC Therapeutics, another biotech wanting to use this IPO window to raise funds. And they are not alone, there is a veritable queue. Bluebird Bio plans to raise in excess of $80m for their gene therapy business and only this month we’ve seen Epizyme and Kamada both go public.
The pharmaceutical and biotech markets are now reliant, above all else, on innovation. This innovation will be achieved through greater collaboration between companies of all sizes. For this to happen, we need an industry which is healthily regenerating through new innovative companies. The mid-size global biotechs have grown significantly due to great new innovative products and as they have done so, talent has flowed to them from large-pharma due to the shrinkage caused by patent expirations. The prosperous outlook and performance of these companies shows signs of keeping the best performing people locked up in these companies. However, a strengthening outlook of liquidity events in the form of public offerings and potentially greater levels of M&A will draw people from across the sector to form or accelerate the start-up and early stage innovators.
There are multiple factors which drive the interest of any candidate to take a new job and it is typically wise to avoid citing forces which temporarily impose upon the market. However, for now, biotech and pharma share prices have raised the barrier between recruiting companies and prospective employees by adding a financial jeopardy to any potential move. While the last 12 month gains have been big, the gains on offer elsewhere will also prove alluring and with improved confidence in the sector as a whole, people will again be prepared to splinter off towards that next big career challenge.