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Early-stage biopharma: An opportunity for strategic investment

The biotech public market has dramatically outperformed the S&P500 index over the past two decades. Biotech returns have continued to increase for both public and private companies over the years. A growing majority of the approved drugs commercialized by large pharma companies are externally sourced through licensing and M&A deals with smaller biotech companies and start-ups.

The rapid reactivity of the industry to address the Covid-19 pandemic has further enhanced investor confidence in this industry. As a result, historic amounts of capital have been deployed into the sector over the last few years. The privately held biotech sector saw double-digit annual growth in fundraising from venture capital groups and a triple-digit increase in initial public offerings.

Despite this boom, early-stage biotech companies have received a disproportionately smaller investment. Even among specialized venture capitalist and private equity groups, investment has shifted to later stages of drug development, which are often large-scale clinical trials. 

Early-stage biotech companies translate discoveries regarding disease biology, chemistries, and pathways into preclinical drug assets that go into clinical development. Shrinking investments in early drug research have led to the ‘valley of death’ dilemma, where lack of funding kills more promising programs than scientific failures. Without overcoming this limitation, smaller companies cannot pursue new therapies and medical breakthroughs.

The specialized and regulated nature of the industry, select failures in late-stage clinical trials, and perceived costs and time involved in bringing them to market are partially to blame for this stigma. Most biotech companies remain pre-revenue before successful financial exits, and traditional metrics of profit & loss are not relevant to predict success, further contributing to investor aversion. As the public pursues less risky yet underperforming asset classes, investors have followed suit migrating towards funding clinical-stage drug assets and companies.

However, investing in late-stage drug assets have not protected investors any better. If anything, failing in the late stages of clinical development is more costly. Often, clinical trial results are binary and limit course correction. The flip side is that the returns are also less spectacular at the end of the valuation curve for investors that enter late into the drug development cycle.

Biotech companies can be highly profitable for investors who get in early. These companies possess the most innovative products on which the industry and patients depend for next-generation medicines and treatments. Such companies often have attractive valuations with enormous upside for returns.

The drug development cycle provides multiple entries and exit options for investors. The valuations can be particularly lucrative once a drug molecule reaches preclinical proof-of-concept, filing an investigational new drug application, or enrolment of patients for clinical studies. The definition, time, and cost of obtaining pivotal proof-of-concept can vary based on the disease area and class of drug. However, the typical time to achieve this milestone averages five to six years which is palatable for many investors. 

Short-term investors may perceive the biopharma sector as cyclical , but this can be an advantage in times of economic uncertainty. The industry has historically been resilient, weathering recessions much better than the overall economy or other knowledge-based industries. While traditional asset classes are susceptible to fluctuations in market dynamics, investments in early-stage biotech ventures are uncorrelated to the performance of different industries and assets (such as real estate, commodities, and bonds). Such investments, therefore, balance and diversify the overall investment portfolio.

Several tailwinds offer additional security to investors concerned about the constricting public markets, and that pre-revenue stage companies will lose prospects of raising downstream capital to sustain development. Firs, demand from large Pharma for innovative new products to fill their pipelines is at unprecedented levels providing opportunities for co-development, licensing, and M&A. Moreover, follow-on capital is available from VC, PE, and hedge fund groups with mandates to allocate funding for late-stage development than at any time in the past.

Due to the enduring need for new treatments, a small number of promising drug candidates in development, and increasing population pressures, the overall growth potential of this industry is excellent. Aging populations, epidemics, and chronic diseases are driving the need for new therapies that are effective and affordable for patients. By 2030, two-thirds of the world’s population will become part of the middle class from emerging economies, increasing the demand for innovative new medicines.

These trends, coupled with massive technological advances, access to vast sums of clinical and patient data, and the fact that over 90% of the drugs have not yet been discovered, provide strategic opportunities for investors seeking diversification and high yield returns. 

Ali H. Munawar is the CEO of Pledge Therapeutics

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