What does Biotech Cost?
Investing in biotech can be very rewarding, and very frustrating. No need to communicate that much further. But our view of it is typically that of the public investor, not the venture funding that likely drove the creation in the first place. Their view is often riskier, but also with an earlier reward model (going public, acquisition, etc.).
This was part (only part) of a recent PWC industry commentary I recently read titled 'Biotech Reinvented: Where do you go from here?', available free with registration. The white paper looks at a number of factors effecting the biotech industry, which is mostly (not entirely though I think) being defined as originating with the biopharmaceutical startup industry (which is ~ 30 years old now). Once promoted as a driver of pharmas future productivity, that promise hasn't fully been realized. While a number of exceptional biopharmaceuticals do exist, the industry overall hasn't seen productivity increase in terms of the number of new drug approvals for some years now (peaked mid 90's).
The report notes that the model is threatened by a number of factors, including a reverse brain drain, costlier programs, and importantly capital constraints. The proposal / suggestion is that the industry will need to get more collaborative and share both risk and reward to continue to thrive, and look more to managing outcomes than selling products. These latter points are ones that I have been reading for some time, and while some attempts at models for such interatctions exist, the sucessful commercial examples aren't plentiful. For a bit more, I would suggest reading the PWC paper.
Of the 49 references listed in the paper, I find I was overly focused on just one, which talked to capital contraints. The reference was one of a report from Iain Cockburn and Josh Lerner from the Bioscience Business Roundtable (just subscribed to their newsletter, no opinion yet). The report was titled 'The Cost of Capital for Early-Stage Biotechnology Ventures'. It is worth a read. Here is how it was summarized in the PWC paper.
" .. the business model on which Biotech has relied for the past 30 years is now breaking down. This model is based on external investment – typically, venture capital – in an innovative idea arising from an entrepreneurial source, often a group of academics. It assumes that investors can realise value through one of two routes: flotation on the public markets or, more frequently, a trade sale to an established pharma company. And it carries a very high risk of failure. In one recent study of 1,606 biotech investments that were realised between 1986 and 2008, 704 investments resulted in a full or partial loss, while 16 only covered their costs. The same study shows that the gross rate of return on these 1,606 biotech investments was 25.7%, compared with a pooled average return of 17% on all venture capital invested over the same period. But costs and the ‘overhang’ from unrealised investments reduced the net rate of return to about 15.7%, and there were huge variations in the cash multiples earned by the 886 investments that made a profit."
That was one message (set of messages) from the report, but the focus was on determining the cost of capital for the industry. Please do look to the report* (which is ppt formated) to see that they determined via a couple of methods (historical return, CAPM). They found the cost of capital for venture financing of biotech to be over 20% (it is lower for publicly traded companies). Imprtantly, the venture industry hasn't been meeting this hurdle over the past 5-10 years. That isn't good for future investment, and the strategies that PWC discusses for 'reinventing biotech' are not likely to have a near term effect on this important phase of investment.
Quite bothersome. Biotech costs too much, and hasn't adequately delivered of late to justify the cost, at least not at the origination funding level. That can't continue for the industry to stay healthy. Perhaps smaller more discriminatiing investment will help (we're getting it in any case).
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* Note: I linked the cost of capital report twice from different web sources. From the main one (first link), I couldn't see the red lines in the graphs for whatever reason. If you have this issue, check the second link.