Investing in drug development is becoming more difficult
A third thought piece on the landscape of biotech venture
This article discusses various aspects of investing in drug development. I believe that efficient capital allocation in the biotech sector is critical for successful drug development. There needs to be an alignment among stakeholders, in which investors can realize tremendous returns for enabling the risky discovery of effective therapeutics. This requires a deeper understanding of what makes drug development profitable, and why it is becoming more difficult to invest in. I also discuss multiple examples of financial transactions in drug development.
Read my other thought pieces on the landscape of biotech venture:
A war between proponents of founder-led and VC-led venture models
Founders of drug discovery engine companies need to kill four major risks
Highlights & Takeaways
Recent macrotrends that make drug development investments more difficult
Intensifying M&A activity is focused on therapeutic products
Royalty monetization as another avenue for biotech investing
Important macrotrends to know
There are at least 5 macrotrends rendering drug development investments more difficult:
Increasing spending on getting drugs through the regulatory process
Declining profitability of biopharma companies
Mimetic pursuit of therapeutic targets
Collapse of the biotech IPO frenzy
Inflationary pressures driving down risk appetite
Over many decades, R&D efficiency and profitability for drug development has been steadily decreasing (ref). Drug development is a highly regulated process involving significant amounts of capital, time, and participants. Decades ago, $1B of R&D could produce dozens of drugs. Now, it is not sufficient for even a single drug (although possibly improving in the most recent decade). The profitability, scaled by total assets, has been steadily declining and been consistently negative after the turn of the century. This broadly lossmaking industry is held up by the successful companies in the 95th percentile, which generate significant revenue from approved products. Drug developers can achieve a monopoly after getting through the regulatory process.
Trends in the R&D efficiency of drug development
Trends in the profitability of pharma (left) and biotech (right)
There is a tendency for companies to invest resources towards the same therapeutic targets, and this herding effect is particularly strong in oncology (ref). For the most sought after targets, there could be dozens of drug candidates in clinical trials. This mimetic pursuit indicates greater risk aversion to novel biology, and thus further deteriorating R&D efficiency. Another explanation could be that modality innovation (e.g. gene, protein, cell therapies) is being used to create new drug formats for the most validated targets.
Trends in the number of clinical-stage drug candidates for therapeutic targets
There has been a considerable shift in capital availability, which caused a dramatic crash in the number of biotech companies going public in the past year (ref). IPOs represent a significant exit route for biotech startups. The closing IPO window means that venture investments will be even more illiquid, and thus less attractive until public markets recover. Furthermore, inflationary pressures and rising interest rates will continue to render capital raises to be more difficult. The rising cost of financing, alongside currency devaluation, makes investing more risky. The ongoing investment deficit will slow the progress of biomedical innovation and drug development.
Trends in the IPOs of biotech companies
M&A activity
An alternative exit to IPO is M&A. Big pharma’s acquisition targets tend to be focused on biotech companies with clinical-stage or commercial-stage products, rather than those with just preclinical products or discovery platforms. The odds of regulatory and commercial success are easier to calculate for drug candidates with robust clinical data. In an inflationary environment with high interest rates, clinical-stage products are increasingly more attractive than preclinical products due to the time value of money. Moreover, drug sales have grown tremendously in recent decades, much of which can be attributed to dealmaking between big pharma and biotech companies (ref). In 2000, the #1 blockbuster was Prilosec marketed by AstraZeneca, which generated $6.2B in sales. Back then, the vast majority of drugs were internally developed. In 2018, the #1 blockbuster was Humira marketed by AbbVie, which generated $20.5B in sales. At this time, around 50% of the top 30 blockbusters originated from the R&D efforts of biotech companies.
M&A between big pharma and biotech companies is encouraged by at least three drivers of drug sales: commercial moats, commercial rollout, and drug pricing.
Regulation enables two types of commercial moats: patents and market exclusivity (ref). Patents create monopolistic markets by granting its owner the legal right to exclude others from making, using, or selling the invention in certain territories for a limited period of time. Most patents expire 20 years after the filing (and a provisional patent application could extend this by an extra year). Regulatory agencies like the FDA also provide market exclusivity for approved drugs, such as 7 years for orphan drug, 5 years for new chemical entity (NCE), and 3 years for new formulation of an existing drug. After this period ends, generic versions of the drug can be competitively introduced. To bolster its revenue, big pharma is eager to partner with biotech companies that can offer valuable patents and market exclusivity.
The robustness of commercial rollout is a key factor in the success of drug sales. Selling drugs is a complicated process, involving manufacturing, distribution, reimbursement, label expansion, etc. Established big pharma and their network of service providers are well equipped to efficiently market drugs across the globe. Biotech companies tend to focus their efforts on discovery and early development and partner with big pharma on later development and commercialization.
Drug pricing is not well regulated in the US, and thus drugs are sold at an average 2.5x more expensive than in other developed countries (ref). This allows for drug developers to achieve massive revenues in the US. In 2020, the total drug sales in the US was $533B and in the next 9 countries was $629B. Drug developers are highly incentivized to commercialize its drugs in the US. However, it is important to note that unbranded generics actually sell at a discount in the US compared to other developed countries. The potential of having enormous sales facilitates high value M&A activity.
Here are a few examples of M&A. Roche acquired the remaining 44% of Genentech for $47B in 2009 (ref). This was the culmination of 2 decades of collaboration and the acquisition valued Genentech at $100B. At the time, this single acquisition by Roche would match the combined total of acquisitions by Merck and Pfizer. In 2008, Genentech’s top drugs included Avastin, Rituxan, Herceptin, and Lucentis, which collectively generated $7B in revenue (ref). In 2018, these drugs generated $21B in revenue for Roche.
Last year, Pfizer generated $100B in revenue, of which $37.8B was attributed to its COVID-19 vaccine and $18.9B was attributed to Paxlovid (ref). Pfizer anticipates its revenue to drop by 33% as the COVID-19 pandemic resolves. To mitigate this loss in revenue, Pfizer has arranged over $60B in acquisitions of companies with marketed products. In March 2023, Pfizer announced the acquisition of Seagen for $43B (ref). Seagen was set to pull in $2.2B in revenue this year from its antibody-drug conjugates Adcetris, Padcev, and Tivdak, and other collaboration and license agreements. Pfizer predicts that Seagen will contribute over $10B in revenue in 2030. In August 2022, Pfizer announced the acquisition of Global Blood Therapeutics for $5.4B (ref). GBT received approval for the use of Oxbryta to treat sickle cell disease in 2019, which generated $195M in net sales in 2021. Pfizer predicts that GBT’s pipeline and Oxbryta could achieve revenues exceeding $3B. In May 2022, Pfizer announced the acquisition of Biohaven Pharmaceuticals for $11.6B (ref). Biohaven’s Nurtec and Vydura were recently approved for the treatment of migraines.
Big pharma M&A can also become big flops. In 2016, AbbVie acquired Stemcentrx for $5.8B, of which $2B was in cash and the remainder was in stock (ref). Stemcentrx investors were also eligible to receive $4B in regulatory and clinical milestone payments. Stemcentrx was developing Rova-T for small cell lung cancer with promising clinical data. It also had other clinical-stage programs and a discovery platform leveraging stem cell biology. In 2019, AbbVie announced the discontinuation of Rova-T because it showed no survival benefit in phase 3 (ref). This was a terrible loss for AbbVie.
Royalty monetization
Evidently, there is great value in acquiring biotech companies for its future revenue on drug sales. An alternative investment approach to buying equity is royalty monetization. Licensing deals usually include royalty rates that are either fixed or tiered percentages of product sales. The capital for royalty exchange is often put to work in supporting clinical development or commercial rollout. Royalty monetization can be a very profitable asset class.
Royalty Pharma is one company capitalizing on royalty monetization and has a market cap of $15B. It has a royalty portfolio of 45 approved and clinical-stage products across rare diseases, cancer, neurology, cardiometabolic, hematology, and immunology. These royalties currently generate over $2B in revenue. This is a great example of how royalty monetization can offer exposure to blockbuster sales without being a drug developer.
Another firm to keep an eye on is DRI Healthcare Trust. In March 2023, DRI acquired MacroGenics’ royalty interest in the sales of Tzield for an upfront payment of $100M (ref). Tzield was recently approved for the treatment of type 1 diabetes, and is marketed by Provention Bio and Sanofi through a co-promotion agreement. The royalty interest was single-digit percentages on Provention’s net sales of Tzield. DRI was also obligated to pay MacroGenics additional payments of $50M for regulatory milestones and $50M for commercial milestones. Just weeks after the transaction, DRI announced the sale of its royalty interest and milestone payment obligations to Sanofi for $210M (ref). In a single month, DRI secured a >2x return on $100M investment. This was extremely impressive.
Author information
Ergo Bio closely follows innovation in the biotechnology space and evaluates interesting drugs and deals. It is run by Vandon T Duong (LinkedIn), feel free to connect! I am a biotech enthusiast and a molecular engineer by training. I am also an avid consumer of news and research around precision medicine.
Apply to join our investment syndicate and help support incredible founders and their startups! Read our related notes about community building in biotech venture, biotech venture models, and due diligence in biotech investments. We will make a societal difference by syndicating high-conviction investments in impactful startups and supporting their incredible founders!
Ergo Bio pages
Disclaimer
This article serves informational purposes only and should be treated strictly as educational material, not as investment recommendation or legal advice. The information presented may be inaccurate or out-of-date. The contributing authors and editors disclaim liability for any errors or omissions. Any opinions expressed may change without notice. Ergo Bio LLC reserves all rights to the content generated through this resource hub (Ergo Bio Insights).