Investing in biotechnology has become trickier

Due to the pace of innovation, a company might have only a year without competition. Firms can no longer launch a drug and enjoy ten years of competition-free growth. 

A decade ago investing in the biotechnology sector was relatively straightforward in that the lower risk, larger companies were growing well and stock selection took a back seat.

But today it’s much harder to be successful. Smaller, rather than larger, firms are generating decent returns as they grow their top lines. And greater competition means the periods of high profitability may be shorter.

Ten years ago those large firms created a first-generation of biological drugs which had multi-billion dollar sales potential and often a monopoly on the particular disease category. This was followed up by another wave of equally successful drugs.

But now these bellwether large cap companies have matured and are now too large and not nimble enough to grow to the same extent. In other words, the large biotechnology sector looks a lot like the pharmaceutical sector did at the start of the millennium. History has repeated itself as these companies become a victim of their own success.

While the large companies have stagnated, that’s not the case for other small- and medium-sized biotechnology companies. But selecting the right investment is far from straightforward.

Not only does a biotechnology investor need to know which companies will produce growth but they also need to know what other drugs competitors are developing. A company can no longer launch a drug and enjoy ten years of growth, free from competition.

Due to the expansion of innovation and an increase in the number of biotech companies, a company might have only a year without competition. For example, Vertex launched a very effective compound which treated Hepatitis-C virus. The launch was the strongest drug launch ever but it was short-lived. Sales plummeted 12 months later when Gilead launched a combination of drugs which was even more effective and had a better safety profile.

This contraction in the time of market exclusivity reflects the acceleration in the speed of innovation making it easier for firms to develop new products more rapidly. While this is a tremendous benefit for patients as their treatment options continue to increase, it makes it much harder to be a successful biotechnology investor.

For example, it was thought that Bristol-Myers Squibb would corner the immune oncology market with Opdivo but Merck then launched Keytruda, which has been shown to be more effective. Now Roche has launched a new drug and there are a large number of other drugs within the same ‘class’ in development with new compounds being constantly launched.

Keeping tabs on all the potential competitors in a particular class of drug is a labour intensive process which requires the ability to absorb large amounts of information. This can be mitigated by continuous interaction with management teams to keep on top of data releases and market developments.

But it’s not possible to talk to every single biotechnology company so investors have to be selective and prioritise certain disease areas. That requires knowing the competitor landscape in each drug class. It’s best to avoid those areas where there will be multitude of competitors, such as diabetes, and instead pick those where there are a small number of highly innovative drugs.

There are a vast number of different indications within oncology: for example, treatment for kidney cancer is not the same as for lung cancer. And within each disease category, there’s a variety of types of tumours. To add to the complexity, different drugs are used at different stages of the disease.

Drugs which target a specific indication, particular tumour or a stage of disease treatment are often well protected from competition. That’s because is hard to receive approval for these specific categories which generates barriers to entry. Considerable investment is needed to overcome these hurdles.

Focusing on companies which are developing treatments for rare diseases can also be profitable. The US regulator encourages companies to find drugs for diseases like cystic fibrosis, which only affects a small number of people, by giving them ‘orphan drug status’.

This is when the FDA gives the company a seven-year period of exclusivity unless another drug, which has a greater efficacy and a better safety profile is developed during that time. The European Medical Agency is even more generous, offering firms developing drugs with orphan drug status 12 years without competition.

While the long-term growth prospects for the biotechnology sector are appealing, taking advantage of that potential is less straightforward than previously Investors need to have in-depth knowledge of a large number of disease categories, in constant contact with companies and able to think strategically.

Carl Harald Janson is lead investment manager at the International Biotech Trust.

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