Assessing the Investing Landscape of the Biotech Industry
In recent years, the biotech industry has come under pressure as politicians scrutinized high drug prices and investors became more cautious about clinical data as proof of concept. Even though the industry saw a flood of new biotech companies go public amid the coronavirus pandemic, valuations have since retreated from their highs, providing investors with an opportunity to critically reevaluate this space and back innovation that could transform the health care market.
During the second annual Nasdaq Biotech Forum, Karen Snow, Head of U.S. Listings and Revenue at Nasdaq, spoke with Debra Netschert, Managing Director at Jennison Associates, and Adam Koppel, MD, Ph.D., Managing Director at Bain Capital Life Sciences, about the state of biotech and their investment process during these turbulent times.
Breaking Down the State of Biotech
The biotech industry serves as an engine for innovation and growth, with dozens of new drugs going through clinical trials. In 2020 and 2021, the industry had more than 50 new molecular entities approved by the U.S. Food and Drug Administration (FDA), a significant increase from an annual total of 29 ten years ago, according to Ernst and Young (EY). Currently, biotech accounts for a record 65% of the approximate 6,000 clinical asset candidates in active development, including more than 2,000 cell and gene therapies, EY said in a June 2022 report.
The development of these new drugs takes a considerable amount of time to go through clinical testing and FDA approval process. Netschert likened the drug development process to a toddler, saying that “they walk and fall and skin their knee,” then you clean it and get back up and try again. Therefore, unlike other industries, biotech’s value creation is not necessarily on a quarterly cycle.
“The value creation timelines in our industry are long and risky. And most things don’t work. And most things take five to seven, maybe sometimes even 10 years to come to fruition,” said Koppel. “Also, you’re on the clock, too, because of patent life and loss of exclusivity, which makes our industry both exciting and fun to analyze.”
In addition to those considerations, under U.S. regulations, publicly-traded biotech companies are compelled to communicate new findings or clinical results quarterly through earnings and other industry conferences.
“It’s hard when you’re trying to navigate a clinical study [and] competitive intensity,” said Koppel. “It’s hard to communicate in that environment.”
Despite stricter regulatory requirements for public companies, numerous biotech companies sought to tap the public markets throughout the pandemic, achieving stunning valuations. However, as Koppel and Netschert both noted, many have struggled.
“There is an appropriate time for companies to go public, and I think we ran into a situation where companies did go public prematurely. They saw the IPO as graduation when it really was a fundraising event. It’s not a graduation. In fact, life becomes a lot harder as a public company, not easier,” said Koppel.
“A lot of companies that were way too immature in their development cycle became public companies,” Netschert concurred. “We were accepting early clinical data as proof of concept when it really wasn’t proof of concept. And it was a point at which I, as an investor, was just uncomfortable.”
Koppel expanded upon this notion, suggesting that the industry “lost track of analyzing balance sheets” for a period of time. However, over the past year, the focus on biotech balance sheets has intensified, and valuations have started to recede. As valuations move to a more realistic level, Koppel and Netschert believe that the industry will see more mergers and acquisitions, especially as large biotech companies are sitting on a lot of dry powder.
“I still think from a secular perspective [that] this is among the most exciting industries to be in. This is cyclical, and I think it’s real, but I think it’s a temporary situation,” Koppel said. “From a five- or ten-year view, the innovation is so great in our industry, and the impact we’re having on the human condition is so real that I have high expectations that we will come out of this.”
Evaluating the Investment Process
As the biotech industry evolves, investors will adjust their portfolio strategies to align with the current market environment. As both a private and public investor that takes a three- to five-year investment horizon for biotech companies, Koppel looks at three specific areas when making an investment decision.
“One is management, two is the balance sheet, and three are the assets themselves,” said Koppel. “We focus most on management because we feel as if good management will somehow be attracted to the best assets, and really good management will manage both capital formation and capital allocation really well and that they will create the most value from the assets themselves.”
“The key, though—from an investor perspective that analyzes balance sheets and therefore should also be a focus of management teams that are building balance sheets and allocating balance sheets—is to always make sure that you have a balance sheet that can get you to the next major value creation event,” Koppel elaborated. “And by balance sheet, I mostly mean cash. But I don’t only mean cash. Cash is one element of a balance sheet, but so are people, processes, buildings, technology, patents, knowhow, all those things, tangible and intangible components, of a balance sheet are critical.”
Koppel continued to say that while he’s met many management teams that are quite good, some lack the experience to know how to allocate capital most efficiently and efficiently to drive assets forward. For many of those inexperienced teams, it may also be their first time in the public markets, and have difficulties communicating with public market investors.
“A management team is so incredibly important to any investment thesis because you have to be able to trust that the people who are managing this company are going to be really great decision-makers, regardless of the pressures, because there’s always going to be pressure and you have to be able to trust them,” Netschert agreed.
Meanwhile, at Jennison Associates, when Netschert is making investment decisions, she analyzes a company’s development cycle, looking 18 to 30 months out and deciding whether she sees a clear value-creating event in that timeframe.
“I find really great assets and try to build the portfolio from the bottom up,” Netschert said. “For me, it’s really important to find drugs that can truly treat and improve the human condition.”
While there has been more interest and investment attention dedicated toward precision oncology and genetic medicine over the past decade, Koppel is more focused on allocating capital toward treatments of larger diseases that affect a wider population.
“If we as an industry aren’t prepared to kind of help deal with those, that’s going to put us in a lot of trouble,” said Koppel, adding that “it does not mean that precision oncology, immuno-oncology and genetic disease aren’t important—they are.”
Raising the Bar
With hundreds of biotech companies in the public markets, Netschert noted that she “raised the bar” when assessing whether a company should be part of a portfolio.
“We just started to lower the bar of what was considered a proof of concept and how many patients we looked at and the strength of the conclusion we were willing to draw from the data we had in hand,” Netschert said. “I'm avoiding companies that don't have enough data and are not going to be able to show me any data for five years.”
Koppel emphasized that more mature companies enable investors to study clinical data and get a sense of the tolerability of a drug and the endpoints that the company will leverage to convince regulators, physicians, health care professionals and patients to use the drug.
“We have now been much more focused on companies that have assets that are truly analyzed well, as opposed to some of the platform and or concept that is interesting,” said Koppel. “As a community—as an ecosystem—we can’t fund all of the companies that are out there to get them to their ultimate goals because, frankly, the ultimate goals are never going to come for some companies, and there’s just not enough dollars out there to fund it all.”
“I encourage every investor to raise your bar and fund the real science and fund the really good people who are going to make good decisions,” Netschert concluded.
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