Innovation in drug development and biology, as well as demographics, makes the biotech sector an attractive investment target. Several factors are driving this opportunity, specifically large pharma’s outsourcing of innovation to biotech companies. In fact, since 2009, 52% of projected peak sales (or $160 billion) are from venture-backed FDA approved drugs. In looking at the chart above, 63% of approved drugs originated from small biotech companies in 2018 (<$100 million in revenue). Venture-backed biotech companies now account for the majority of drug approvals on both an absolute and relative basis.
This trend seems likely to continue. A 2019 report from Lazard notes nominal research and development (R&D) spending has increased from approximately 12% of sales in 2000 to 17% in 2018, but has largely been flat in real terms at the top five pharma companies. Couple this with the fact that between 2019 and 2024, the top 10 large-cap pharma companies are expected to lose exclusivity on drugs with $170 billion in sales, representing 50% of their 2019 revenue, and as a result large pharma needs to look to acquire more innovative therapeutics. Cowen analyst Phil Nadeau noted, “Large caps are cash rich but pipeline poor. We think they'll look to the small- and mid-cap to fill those pipelines.”
This idea is supported by a Lazard survey of biopharma executives on the best approaches to mitigate current challenges in the sector. The top two responses cited by the executives were bringing in new technology through in-licensing and collaborations, as well as greater investment in science and technological innovation. In response to these sector trends, there is an opportunity to fund R&D of innovative treatments for disease. Additionally, big data and digital therapeutics offer the opportunity to improve clinical outcomes and reduce drug development costs.
Drug trials can benefit from enhanced diagnostics, allowing for trials to more effectively target patient populations. Big data and predictive modeling have the potential to spot possible adverse drug reactions before they occur. Patients can be monitored remotely and more cost effectively, while analytics can help drive clinical decisions once a drug is approved. These innovations have the potential to reduce the cost of development and commercialization. Some therapeutics that not only treat, but cure disease may offer significant savings to the healthcare system relative to the management of chronic disease.
However, a discussion on biotech and pharmaceuticals would be remiss if it didn’t address the regulatory risk that is present today. Many of the current legislative proposals appear focused on more transparency (particularly in the supply chain), increasing competition and eliminating bad actors. The drug supply chain seems to be facing increased scrutiny as it adds a significant cost to the system. While this cost is difficult to quantify, Merck CEO Ken Frazier recently stated that as much as 50% of drug spending is associated with the supply chain. Most of these measures would have limited impact on innovative treatments that truly offer demonstrated improvement in patient outcomes. Other proposals would have a more direct impact on biopharma pricing, including Medicare for All and rebate reform, especially as it relates to Medicare Part D.
Innovation is accelerating in the biotech sector. Changing demographics and the loss of drug exclusivity make the search for new treatments increasingly important for both the population and large pharmaceutical companies. Investing with skilled early-stage venture investors who have a strong track record of drug development should continue to represent a lucrative investment opportunity.
 Silicon Valley Bank, “SVB Mid-Year 2019 Venture Investments and Exits”
 Lazard, “Future of Biopharma 2019”
 Lazard, “Future of Biopharma 2019”
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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