Biotech Half­time Re­port: Af­ter a bumpy year, is biotech ready to re­bound?

The biotech sec­tor has come down firm­ly from the highs of Feb­ru­ary as neg­a­tive sen­ti­ment takes hold. The sec­tor had a ma­jor boost of op­ti­mism from the suc­cess of the COVID-19 vac­cines, mak­ing in­vestors keen­ly aware of the po­ten­tial of bio­phar­ma R&D en­gines. But from ear­ly this year, clin­i­cal tri­al, reg­u­la­to­ry and ac­cess set­backs have re­mind­ed in­vestors of the sec­tor’s in­her­ent risks.

RBC Cap­i­tal Mar­kets re­cent­ly sur­veyed in­vestors to take the tem­per­a­ture of the mar­ket, a mix of spe­cial­ists/gen­er­al­ists and long-on­ly/ long-short in­vest­ment strate­gies. Head­ing in­to the sec­ond half of the year, in­vestors most­ly see the sec­tor as un­der­val­ued (49%), a large change from the first half of the year when on­ly 20% rat­ed it as un­der­val­ued. Around 41% of in­vestors now be­lieve that biotech will un­der­per­form the S&P500 in the sec­ond half of 2021. De­spite that view, 54% plan to main­tain their po­si­tion in the mar­ket and 41% still plan to in­crease their hold­ings.

Drug pol­i­cy un­cer­tain­ty

In­vestors still seem po­ten­tial­ly in­trigued in the mar­ket, even if their sen­ti­ment has be­come more pes­simistic. The biggest fac­tors dri­ving this pes­simism are drug pric­ing and pol­i­cy, even as grid­lock in Con­gress con­tin­ues to stymie any leg­isla­tive ac­tion. How­ev­er, key mem­bers of the De­mo­c­ra­t­ic Par­ty re­main crit­i­cal to­wards the in­dus­try in terms of drug pric­ing and tax re­form. Mean­while, the ap­proval and sub­se­quent con­tro­ver­sy around the Alzheimer’s drug ad­u­canum­ab could dri­ve more bi­par­ti­san mo­ti­va­tion for ac­tion.

As it stands, both pric­ing and pol­i­cy are very much in lim­bo. There’s no per­ma­nent head at the US Food and Drug Ad­min­is­tra­tion (FDA) yet, which is con­tribut­ing to reg­u­la­to­ry un­cer­tain­ty, and the agency’s Pre­scrip­tion Drug User Fee Act (PDU­FA) is due for reau­tho­riza­tion by Sep­tem­ber 2022. The ne­go­ti­a­tions for the PDU­FA are in the ear­ly stages, but it’s an ob­vi­ous op­por­tu­ni­ty for re­forms.

The pan­dem­ic is still im­pact­ing eco­nom­ic re­cov­ery

The COVID-19 cri­sis con­tin­ues to have a sig­nif­i­cant im­pact on the sec­tor. It’s a pos­i­tive dri­ver for those com­pa­nies in­volved in vac­cines and treat­ments and, more wide­ly, as a mile­stone in the his­to­ry of pub­lic health, lead­ing to a more pos­i­tive pub­lic per­cep­tion of the in­dus­try. As the pan­dem­ic re­cedes, gen­er­al­ist in­ter­est in biotech may re­turn, open­ing up new sources of cap­i­tal for in­no­va­tion.

But it’s al­so a neg­a­tive in­flu­ence, di­rect­ly im­pact­ing clin­i­cal tri­als and drugs launch­es, and cre­at­ing un­fa­vor­able eco­nom­ic con­di­tions. There’s now a large pool of un­em­ployed and un- or un­der­in­sured in­di­vid­u­als, which may yet in­crease, and could put pres­sure on pric­ing and ac­cess reg­u­la­tion. The US is al­so in the midst of a Delta spike, sim­i­lar to those un­der­way in the UK and Is­rael, which may de­lay full re­open­ing. If vari­ants con­tin­ue to cir­cu­late, it could fur­ther im­pact the eco­nom­ic re­cov­ery.

Patents and in­no­va­tion

One of the key de­bates around COVID-19 vac­cines has cen­tered on waiv­ing IP rights to help bol­ster pro­duc­tion of ex­ist­ing vac­cines. De­trac­tors ar­gue that even with­out IP rights, many na­tions lack the skills, ex­per­tise and fa­cil­i­ties to pro­duce vac­cines. Ad­vo­cates, how­ev­er, say a suc­cess­ful­ly ne­go­ti­at­ed waiv­er would stop man­u­fac­tur­ers from block­ing pro­duc­tion or ac­cess to raw ma­te­ri­als and al­so pre­vent com­pa­nies from charg­ing un­af­ford­able prices while in­su­lat­ed from com­pe­ti­tion.

This de­bate, along with a num­ber of loom­ing near to mid-term mega patent cliffs in the in­dus­try, could keep patent pro­tec­tion at the fore­front of in­vestors’ and reg­u­la­tors’ minds. With more an­titrust scruti­ny to en­able faster path­ways for biosim­i­lars, com­plex gener­ics, Cit­i­zen Pe­ti­tion re­view, REMS test­ing and back­logged AN­DAs, the po­ten­tial longevi­ty of biotech fran­chis­es could be capped. How­ev­er, large-cap com­pa­nies have nav­i­gat­ed some re­cent ex­piries through bolt-on prod­ucts, set­tle­ments, lit­i­ga­tion wins and pipeline pro­gres­sion or ex­pan­sion.

Biotech in­no­va­tion, how­ev­er, re­mains a key dri­ver of val­ue in the sec­tor and is ex­pect­ed to con­tin­ue at a rapid pace – pos­si­bly ben­e­fit­ing from R&D ad­vances and fund­ing fol­low­ing the pan­dem­ic. We ex­pect in­no­va­tion around new drug tar­gets, de­sign, man­u­fac­tur­ing, and de­liv­ery of ad­vanced cell and gene ther­a­pies, and ex­pan­sion in­to new dis­eases, par­tic­u­lar­ly in the can­cer, neu­rol­o­gy, and rare dis­ease spaces, to dri­ve en­thu­si­asm for the in­dus­try.

M&A, earn­ings and growth

It’s been a tough year for biotech so far, with the XBI down 10% on the year de­spite a ris­ing broad­er mar­ket. Af­ter a record run, FDA strin­gency on cut­ting-edge modal­i­ties and a se­ries of neg­a­tive da­ta cat­a­lysts have high­light­ed that in­her­ent drug de­vel­op­ment risks had not been ap­pro­pri­ate­ly rec­og­nized in ris­ing com­pa­ny val­u­a­tions. But there are some sig­nals that we’re near the bot­tom. In­no­va­tion is one im­por­tant dri­ver for a bounce back, but M&A ac­tiv­i­ty and earn­ings re­ports could al­so have their part to play.

Any sharp downticks in ma­jor M&A deals, such as we’ve seen in re­cent months, have al­most al­ways been fol­lowed by a sharp uptick. Bio­phar­ma firms are flush with cash and with loom­ing patent cliffs and de­pressed val­u­a­tions among some small­er firms, we could see more deal ac­tiv­i­ty through year-end. The pos­si­bil­i­ty is fur­ther bol­stered by man­age­ment com­men­tary, which con­tin­ues to sug­gest open­ness to M&A deals. What’s changed is that large bio­phar­ma seems to be pre­fer­ring small­er, ear­li­er stage deals, pri­vate com­pa­nies, or dis­count­ed late-stage as­sets, rather than the large $15 bil­lion ac­qui­si­tions we’ve seen in the past.

With the econ­o­my re­open­ing to a de­gree al­ready in the first half of 2021 and COVID vac­cines con­tin­u­ing to roll out world­wide, it’s like­ly that biotechs will al­so show im­prove­ments in re­port­ed earn­ings in the sec­ond half of the year. As the sec­tor demon­strates con­tin­ued re­cov­ery and ac­cel­er­ates com­mer­cial ex­e­cu­tion in the re­opened econ­o­my, while show­ing in­ter­est in M&A and busi­ness de­vel­op­ment, this could re­vi­tal­ize in­ter­est in small, mid and large-cap names. Many of these names are at cur­rent lows and those val­u­a­tions could look at­trac­tive as the com­pa­nies con­tin­ue to di­ver­si­fy and in­vestors rec­og­nize that their pipelines are un­der­ap­pre­ci­at­ed.

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