Out-Law Analysis 6 min. read
23 Feb 2021, 4:59 pm
There has been a growing interest in biotech companies since the onset of the Covid-19 pandemic. Over $13 billion was invested worldwide in biotech companies in 2020 alone.
As a result of this increased flow of capital into the sector, biotech companies are becoming more selective about the investors with whom they choose to partner, taking a longer term view than might have previously been the case in a sector in which the cash burn rate from R&D is well known.
This theme of the discerning biotech was a central focus at the recent LSX World Congress. This annual event brings together life sciences industry executives – from those involved in start-ups to those leading the world's biggest pharmaceutical companies – and the investment community.
Investors without any particular insights into the sector are naturally drawn to the human stories behind products, and in the biotech sector there is no shortage of narrative that companies can play on
Specialist healthcare investors know that investment in biotechs requires a long-term view, recognising that it can take years of research and substantial capital for companies to develop new products and deliver meaningful returns on their investment. The risk involved in picking the correct companies to invest in, and at the right time, has meant that the sector has been the domain of specialist investors who understand the science.
This changed with the onset of the pandemic when a growing number of investors recognised that, with so many biotechs pivoting ongoing trials to test whether existing products in development had application to coronavirus, any good news from those companies could lead to substantial bumps in share prices, often in excess of 100%. The potential size of these returns suddenly outweighed the risk that had previously made non-specialist healthcare investors wary of the sector. Moreover, driven by the turmoil in sectors such as retail, hospitality and airlines, companies in the life sciences sector felt like a relatively safe place for institutions to invest.
A McKinsey study highlighted at the LSX World Congress indicated that, while biotechs listed on the public markets did experience a downturn in share prices in spring 2020, that downturn was short-lived, with average share prices rising 39% in Europe, 37% in the US and 106% in China between 1 January 2020 and 19 January 2021. As a result, much of the recent investment interest in the biotech sector has been from non-specialist investors whose attention has been drawn by the sector's resilience to the Covid-19 pandemic.
Industry success stories also help to raise the profile of the sector. The rise to international prominence of German biotech BioNTech, following its partnership with Pfizer and development of a Covid-19 vaccine, is an example of the attention the sector is gaining for its innovation and real-life impact.
The increased flow of cash into the sector is prompting competition between investors about the timing of their investment
Investors without any particular insights into the sector are also naturally drawn to the human stories behind products, and in the biotech sector there is no shortage of narrative that companies can play on. For instance, with recent advances in the use of data and technology, companies have been able to focus their innovation around a 'patient-centric' approach to medicine, with personalised medicine, including cell and gene therapies, which show such promise in the treatment of rare diseases, coming to prominence. Increasingly, the 'story' behind, or theoretic potential of, a product is more important than the data behind it, particularly for non-specialist healthcare investors.
This growing interest in the sector has resulted in many of the equity fundraisings conducted by publicly traded biotechs being significantly over-subscribed, as more investors have sought to put their faith in biotech stocks. Two of the most recent examples are the placings by Evgen Pharma plc, the clinical stage company focussed on the treatment of cancer and inflammation, and Synairgen plc, the respiratory drug discovery and development company, both listed on AIM. These biotechs are suddenly in the enviable position of having to choose between scaling back allocations or only accepting the money on the table from specific investors.
In addition, the increased flow of cash into the sector is prompting competition between investors about the timing of their investment, with an increasing number prepared to invest earlier in the life cycle of a biotech, often at the 'Series A' funding round. Certain funds that traditionally have been focussed on public markets are re-assessing this focus and looking more closely at early stage biotechs. Marshall Wace and Third Point are two big hedge funds that are currently raising money – $400m and $300m, respectively – to invest in privately held healthcare companies that are between six months and two years out from IPO, with a view to holding on to those companies after they list.
While the recent returns on many investments in listed biotechs is impressive, some investors are recognising that even they can be dwarfed if they give their backing to the right company early enough in its development. Those investors know that the best value will come from investing early in a company at cheaper valuations, with the rewards coming if that company has a product approved. The risk/reward analysis has been tipped in favour of reward by the evident strength of biotechs over the last 12 months.
Biotech investment is, and always has been, about the long term, and companies are being increasingly selective about whose money they take. They want investors who will invest in their ideas, knowing that there is currently plenty of interest in the sector and therefore lots of cash to go around. This unexpected surge of capital into the sector has been gratefully received by companies whose cash runway tends to be short, principally because of the cost of progressing clinical trials.
Biotechs' approach is that patient capital is now preferable to having capital at any cost
The interest in the sector from non-specialist healthcare investors shows no sign of abating. From a position where biotechs often lamented the relatively small pool of specialist investors in the sector, there are lots of investment options to ponder. However, biotechs have to choose carefully: taking too much cash from too broad a base of investors just for the sake of increasing cash reserves can cause companies to become distracted by the competing demands of those investors, some of whom may be looking for returns in the short term rather than understanding that the real value of a biotech is most likely to become apparent in the longer term. Far from being a positive, then, too much investment from too many sources has the potential to hold a company back. Many biotechs are increasingly wary of this scenario, and the potential negative impacts it could have on their longer term goals.
An investor who is willing to put cash on the table without expecting an immediate return is the most welcome type of investor for all companies, but never is it in sharper focus than with biotechs, where progress through the R&D process is rarely linear. Adapting to this new environment, biotechs' approach is that patient capital is now preferable to having capital at any cost.
There is hope that the increased investment will help what is an ongoing challenge for the sector: funding the cost of R&D. Indeed, in interviews that were conducted with industry experts from across Europe as part of research carried out on behalf of Pinsent Masons last November by Meridian West, access to funding was the most commonly identified barrier to innovation.
In relation to the UK market, 87% of those interviewed said targeted fiscal incentives such as R&D tax credits or grants would encourage research and development into new indications for existing drugs, while more than four in five gave their backing to more funding for the UK's Biomedical Catalyst (83%) and for additional entrepreneurs' relief as a means to "best encourage investment in innovation more broadly".
The Biomedical Catalyst was established by the UK government late in 2011 as an initiative to help medical scientists win finance to develop their research. The programme was developed in order to bridge a funding gap known as the "valley of death". The term refers to the difficulties some early stage biotech and medtech companies have in obtaining enough finance to develop their research and development programmes to a stage where they can attract meaningful amounts of private investment and/or license those research programmes to a larger pharmaceuticals manufacturer.
However, while fiscal incentives are to be welcomed, the reality is that the finances of governments around the world are stretched to breaking point as a result of the pandemic. The most realistic way to bridge the funding gap, at least in the medium term, is private capital. So, while the ability to be discerning about investors is a welcome change for biotechs, the bottom line is that some biotechs can afford to be more selective than others.
02 Oct 2020