By
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A new worry has emerged for biotechnology stocks just as a bumpy year comes to a close: Interest rates are going up.
At first glance, this wouldn’t seem to be a big problem for biotech. The sector doesn’t immediately spring to mind as sensitive to rates. After all, few development-stage companies fund their operations with debt. And higher yields won’t preclude the largest pharma companies, which generally have very strong balance sheets, from buying up smaller ones if they so choose.
But higher rates are problematic for sector valuations because small biotech companies without a drug on the market are unprofitable operations with a big theoretical payoff. That payoff can be several years away if the drug is in early-stage clinical trials. Discounting that payout with a higher interest rate results in a lower value of that payoff today.
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That serves as a force to push share prices lower. For example, a payoff of $1 million five years from now is worth about $680,000 today discounted at an 8% interest rate. Bump that interest up to 10%, however, and the present value of that future payoff shrinks to about $620,000.
That glorious era seems like ancient history. This year has seen high-profile clinical-trial failures and worries over the sustainability of high drug prices, pushing the Nasdaq Biotechnology Index down 20%.
Rising rates are just another potential headache for biotech investors in the new year.