BioPharma Credit: a risky punt on promising new drugs

David Tennant doing some acting © Rex Features
Like Hamlet’s sorrows, defaults tend to come in battalions

BioPharma Credit offers a tempting yield, but the dangers may be high when the credit cycle turns

Having raised $762m in its stockmarket debut in early 2017, BioPharma Credit (LSE: BPCRwent on to raise another $154m in December and $164m in April, taking the total to well over $1bn. Admittedly, half of the initial money came from existing investors in a private fund who converted their holdings into listed shares, but that still makes this one of the biggest cash raisings in the investment-funds sector in recent years.

BioPharma Credit, as the name implies, lends money to the life-sciences sector. It invests in “corporate or royalty debt secured by the cash flow derived from the sale of approved life-science products”, but up to 35% of the portfolio can be unsecured. The firms it lends to may still be lossmaking and so would struggle to raise conventional debt from banks or investors, but anticipate a significant increase in cash flow, perhaps from new products.

Expensive capital

BPCR analyses the prospects for these companies and judges whether it is prepared to lend, how much to lend, and for how long. The fund projects return for investors of 8%-9%, out of which it plans to pay a 7% dividend. Given that its management fee is 1% per
year plus a performance fee, and that there are other corporate costs, the gross return on investment needs to exceed 10%, though Alexander Perfall, the fund’s public affairs spokesman, won’t confirm this.

For the companies that borrow, this is very expensive capital, implying that the loans are risky. Yet Perfall doesn’t see this as risky “unless you don’t know what you are doing”. The managers, Pharmakon Advisors, have invested $2.3bn since 2009 in 30 transactions and have suffered no defaults or re-pricings, he points out. This is encouraging, but these have been good times for credit. As Claudius warns in Hamlet, “when sorrows come, they come not single spies but in battalions”. One day, the risk implied by these high returns may be all too apparent.

The loans are for between five and seven years, but BPCR is looking to be repaid early. Proceeds from repayment would then be recycled into new loans, subject to BPCR’s continuation votes. Loans are typically for less than half the appraised value of a new product, but the portfolio is concentrated, with up to 30% invested in a single credit.

Of the initial amounts raised, $339m was invested in a seed portfolio of already acquired assets. Further investments have reduced the cash to $149m, but two investments account for nearly half the assets and four for nearly 75%. The largest is the $322m committed to oncology-focused biotechnology company Tesoro. Its main product was approved last year in the US and the EU. If predicted sales figures are achieved, the loan will probably be repaid early. In April, $194m was committed to private pharma firm Sebela – the loan appears to have been taken out to fund an acquisition.

Reckless borrowers?

The fact that management own 10% of the equity provides some reassurance, but this is a concentrated portfolio of risky investments trading at a premium to asset value. The loans are mostly secured, but security has a tendency to vanish when the going gets tough. Why doesn’t Tesoro slow investments until revenues roll in or Sebela raise money in a public listing? These firms appear somewhat reckless.

The 7% yield looks attractive, but the dividend outlook isn’t certain. Future loans could be at lower returns as easily as higher ones (implying a dividend cut) unless the fund takes on riskier loans. Overall, investors would do well to remain cautious.