Long-Term Opportunity in Biotech

Matt Johnson, Vice President, Healthcare Investments at Bailard

March 31, 2020

While the coronavirus outbreak has propelled biotech to the forefront, this is a sector Bailard has been watching for years. Here we discuss opportunities and considerations in the sector, and how they might promote long-term good for investors and hopefully the world at-large.

Principles of Biotechnology Investing Social distancing has altered our daily lives in dramatic fashion. Familiar routines revolving around family, friends, work, and leisure are now nearly unrecognizable from just a month ago. While we certainly wish we didn’t find ourselves in the midst of a pandemic wreaking havoc on our health and economy—as seasoned small and microcap-focused biotech investors—we are familiar with boom-bust investing environments and their associated volatility.(1) From the early days of the biotechnology industry, we’ve seen tech bubbles, wars, hepatitis C cures, multiple bouts of financial crises and drug pricing tweets, just to name a few!

We have also seen dramatic legislation move markets. A few months ahead of the implementation of the Affordable Care Act, the $17 billion Health Information Technology for Economic and Clinical Health (HITECH) Act of 2009 was passed to jumpstart the adoption of Electronic Medical Records. As a byproduct, the HITECH Act fostered the genesis of numerous companies working to connect consumers with their own healthcare.

Regardless of underlying currents, in our opinion, several key investment theories persist. These important principles include:

• Cash is King

• Cash is Queen

• Cash is… everything

• Seasoned management teams that understand the three principles above are highly valued

• Science and technologies that are patient-driven rule the day

• Pay a premium for clinically-meaningful data

• Follow the legislation

Cash, or rather ‘access to cash,’ is the lifeblood of research and development focused healthcare companies that are often years away from realizing revenue of an approved product. Management teams of these earlier-stage companies face a near-constant challenge to raise adequate funding from prospective investors in order to reach value-creating milestones.

Cost estimates to develop a single drug from inception through to FDA approval are topping out at nearly $3 billion.

It is worth noting that a great drug can be ruined by a poor management team and the stakes these days are high. Cost estimates to develop a single drug from inception through to FDA approval are topping out at nearly $3 billion. And a ten-year study just published this March found a median cost of $985 million in research and development for bringing a single drug to market. (2) This analysis accounted for the expenditures of failed clinical trials as well. In our opinion, investing in management teams that have successfully navigated these ebbs and flows of capital market cycles is an important driver for future success. In today’s environment, we believe well-capitalized companies, platform-based technologies that can be financed via non-dilutive partnerships, or companies with late stage assets that are approaching near-term profitability, will be sought after.

In addition to the cash component, in our view, attractive companies exploit a new type of technology that results in outsized treatment effects. Whether it be a specialized drug targeting a driver mutation in a highly-defined population or perhaps using genetic editing tools to correct a devastating disease, meaningful changes in outcomes that will have a dramatic impact on patients’ lives should bring value from an investment point of view. And it is impossible to diminish the importance of the value from the patients’ perspective. At the end of the day, the scientists, caregivers, family members… all of us… are seeking a better way of life. We believe novel medicines will play a role in keeping people healthy to enjoy their families and friends, even if those current moments are now occurring over video chat!

A savvy management team doesn’t just raise enough cash at the right time and have a knack for identifying unique technologies; it must also implement a robust operation from research bench to bedside. When trials are run with clear endpoints and expectations in mind, operations are honed and timelines are optimized. When shortcuts are taken or important questions are left unanswered in the early stages of development, risks increase and muddied answers often result as the data envelopes are opened. Investing in clear, rationally-designed trials may cost more, but, if the data succeed, there are greater odds of commercialization success. The clear signal the data have shown allows for achieving the ultimate value from a product.

Incentives Creating Opportunity

Finally, the healthcare sector is a highly-regulated space and, like any market where there are incentives, over time you may see those incentives create opportunity for investment. In our universe of companies, the purview of the Food and Drug Administration (FDA) rests on drugs, devices, and certain diagnostic tests that require the Agency’s approval prior to marketing the product. The FDA has become highly capable of utilizing incentives such as the Breakthrough Therapy Designation and Priority Review Vouchers for expediting review times for certain products. These types of tools, along with leaps in scientific breakthroughs, have been effective at increasing product approval rates and reducing drug development time in some instances.

In response to the COVID-19 pandemic, we have seen Congress pass the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law. Among many other incentives, the CARES Act outlines $11 billion to support research and development of vaccines, therapeutics, and diagnostics to prevent or treat the effects of coronavirus.

Over the longer term, we should expect renewed interest and creative payment systems to incentivize companies and investors to develop antibiotics, antivirals, and vaccines for little known threats that could come along as swiftly as COVID-19. Let’s hope the CARES Act incentives not only alleviate our current debacle but help improve our response to future threats as well.

1 See repeatedly-relevant 2012 Bailard whitepaper, The Third Wave of Biotech: An investment rational for the timely investing in small cap healthcare

2 Wouters OJ, McKee M, Luyten J. Estimated Research and Development Investment Needed to Bring a New Medicine to Market, 2009-2018. JAMA. 2020;323(9):844–853. https://jamanetwork.com/journals/jama/article-abstract/2762311

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A quick primer on FDA definitions:

A Breakthrough Therapy Designation is for a drug that treats a serious or life-threatening condition and preliminary clinical evidence indicates that the drug may demonstrate substantial improvement on a clinically significant endpoint(s) over available therapies.

The FDA awards Priority Review Vouchers (PRV) to drug sponsors that develop drugs for tropical diseases or rare pediatric diseases or to use as medical countermeasures. The PRV—which can be sold to another drug sponsor—may be redeemed later to receive priority review from FDA with a targeted review time of six months, rather than the ten-month standard review, for a drug application of the PRV holder’s choice.