Biotechnology: Industry Analysis, Key Players & Future Trends

Biotechnology: Industry Analysis, Key Players & Future Trends

Now may be the perfect time to invest in the biotech industry. Here’s why…

Due to the the R&D intensive nature of the product development process, the biotech industry has long struggled to achieve aggregate profitability. The lengthy road to product commercialization and weak recent IPO market means that M&A is the most viable exit strategy, and that time to exit has increased, from 6 years in 2006 to 9 years in 2012.

However, unprecedented levels of FDA approvals in recent years, plus a strong product pipeline and a resilient M&A market with established large biotech firms strengthening their capacity to acquire smaller firms makes this an attractive time for the biotech investor who is willing to be creative in how they structure their deals.

Defining Biotechnology

Biotechnology (biotech) describes any technological process that harnesses cellular and bio-molecular processes to develop technologies and products that help improve our lives and the health of our planet. Humans have been using the biological processes of microorganisms for thousands of years to make useful food products, such as bread and cheese, and to preserve dairy products.

Modern biotechnology provides breakthrough products and technologies to combat debilitating and rare diseases, reduce our environmental footprint, feed the hungry, use less and cleaner energy, and have safer, cleaner and more efficient industrial manufacturing processes.

Image: Shoeski, Wikimedia

Industry  & Key Players

Biotechnology companies mainly focus on three areas of application:

Healthcare: Biotech combines nature’s own toolbox with our improved understanding of the human genome to produce medicines and vaccines that help both the prevention and cure of diseases, many of them previously untreatable, as well as helping reduce the side effects of medications by tailoring treatments to individuals.

Energy & Industrial: Biotech uses biological processes such as fermentation and harnesses biocatalysts such as enzymes and yeast to become microscopic manufacturing plants.  These processes can be used to produce biofuels from biomass that can help reduce our reliance on fossil fuels and lower greenhouse gas emissions, lower the temperature that we clean clothes at in our washing machines, as well as improve efficiency in the manufacturing and water distribution industries, which all contributes to lower energy consumption.

Agriculture: Biotech is utilized in the agricultural sector to improve crop resistance to insects thereby increasing yield and reducing the need for chemical pesticides that cause environmental harm. Biotech can also improve the nutritional qualities of food by producing crops that are free from toxins and allergens and increasing vitamins content of crops to treat deficiencies.

More detail is available in this DataFox watchlist.

The 4 main areas of the world where biotech companies are concentrated at present are the US, Europe, Canada and Australia.  Due to the highly R&D intensive nature of the biotech industry, there are only a small number of revenue generating publicly listed firms, with a long tail of smaller development stage privately-owned companies.

The chart below shows that, by revenue and market capitalization, the publicly listed biotech firms are predominantly concentrated in the US, especially in California and New England.  Outside of the US, European countries including the UK, France and Denmark feature most prominently, with Sweden and Switzerland also falling just outside the top ten regions by market capitalization, with 25 and 8 companies respectively, and each country generating around $2bn of revenues.

Biotech Market Size

Healthcare: Biotechnology products represented 21% of the total $714bn global market for prescription drugs in 2012, equating to $150bn of sales.  The size of the prescription drugs market is expected to grow at a CAGR of 3.8% to reach $895bn in 2018, and the biotechnology industry’s share of this is expected to grow to 25%, equivalent to $224bn.  This represents a CAGR of 6.9% for the biotech market, higher than the growth of aggregate pharmaceutical industry because biotechnology products have a less aggressive rate of sales erosion from generic drugs (Evaluate Pharma ‘World Preview 2013, Outlook to 2018’).

Energy & Industrial: An increasing number of chemicals and materials, like base chemicals, polymers, industrial catalysts, enzymes and detergents are produced using biotechnology. In 2010, the sales of industrial chemicals created using biotechnology in at least one step of the production process equalled €92bn globally, and this is expected to increase to €228bn by 2015 (from Festel, G., Detzel, C. and Maas, R. 2012 ‘Industrial biotechnology – Markets and industry structure’, Journal of Commercial Biotechnology, Volume 18, No. 1).

Agriculture: The size of the agricultural biotechnology market is expected to grow to the value of $12bn by 2015 (Transparency Market Research ‘Agricultural Biotechnology Market, 2012-2018’).

Biotech Recent Trends

While biotechnology is not new per se, having been used by humans for thousands of years for agricultural and medicinal purposes, the maturation of the biotech industry into a material component of the global economy has been a relatively recent phenomenon.  As shown in the chart below, the combined market capitalization of the public companies in the 4 main global biotech centres of the US, Europe, Canada and Australia, did not reach the hundreds of billions of US dollars until the late 1990s and early 2000s (BIO Guide to Biotechnology 2008).

Because the process of developing biotech products is very capital intensive with long R&D and approval cycles, the industry has been largely unprofitable in aggregate historically.  The earnings of the small number of profitable publicly listed companies were vastly outweighed by the net losses of the much larger number of private, early-stage firms.

As the industry matured in the early to mid-2000’s, bringing about double digit growth in revenues, it moved closer to aggregate profitability and finally achieved this in 2008, albeit only as a result of a dramatic cost cutting (two thirds of US companies lowered their R&D budgets) following the recession, rather than organic growth.

However, brighter days may lay ahead for the biotech industry, as 2012 represented a banner year for FDA product approvals.  In the decade leading up to 2007, FDA approvals slowed dramatically due to a combination of concerns over patient safety and pressure from policy makers.  However, in the last couple of years, significant product breakthroughs have been made, resulting in a sharp increase in FDA approvals, with 39 products making it beyond Phase III trials.  This represents a level of approvals not seen since 1998-1999, a time when the human genome had yet to be fully sequenced.

However, it is not just the sheer number of approvals, but the nature of the drugs being approved that is a cause for optimism. The vast majority of the medicines approved were not me-too offerings but served genuine unmet needs, with 51% being first-in-class drugs, and 33% orphan drugs (designed to treat rare diseases).  This therefore represents an extremely exciting time for the biotech industry, as it demonstrates an ability to deliver results despite cost cutting measures, which should lead to improved aggregate profitability for the sector.

The recent improvement in approvals could be a catalyst for more M&A activity from big pharma companies looking to replace some of the blockbuster drugs in their portfolio whose patents may be expiring soon, which could translate into better exit opportunities and shorter return periods for investors in the coming years.

Despite the recent uptick in FDA approvals, the pipeline of pre-commercial products at US biotech companies remains strong, especially at companies based in New England, the Bay Area and San Diego, which explains why these three regions are attracting the lion’s share of inward investment (see fundraising section below).

Among Phase III drugs, cancer is the main area of focus, representing one third of all drugs in this stage of development in the US.  Outside of the US, the UK is the most promising region in terms of pipeline, with over 400 products in pre-clinical and clinical trials, with Germany, Switzerland and Israel following closely behind at around 300 products each. France however, has the largest number of products in Phase III trials closest to commercialisation.  Cancer is also the primary focus within Europe, representing 34% of all drugs in clinical trials, and 26% of those in Phase III.]

Biotech Fundraising

After a collapse in the funding environment following the global financial crisis of 2008, total investment flowing into biotech firms across various capital sources (venture, debt, IPO and secondary offerings) in the largest markets of the US and Europe have recovered to pre-crisis levels.  While the IPO market remains lukewarm, with only 11 deals in the US and 3 in Europe in 2012 raising just $805m in aggregate, follow-on equity offerings and debt issuances from public biotech firms have expanded while venture funding has remained robust through the economic cycle (Ernst & Young Biotechnology Industry Report 2013).

Venture capital investment into the biotech sector has been consistently strong over the past decade or more.  The graph below shows the total amount of venture capital investment annually in the US broken down by vertical since the dot com bubble of 2000-2001 (National Venture Capital Association MoneyTree report in conjunction with PricewaterhouseCoopers and Thomson Reuters).

This shows that the biotech industry (in light blue at the bottom of the chart) has been a consistently large recipient of funding, averaging over 17% of total investment in the last 12 years, equating to over $52bn in absolute terms over that period.  Most recently in 2013, biotech firms received over $4.5bn of VC investment, representing 15.4% of the total figure of $29.4bn.

In terms of the geographical regions attracting the most early-stage funding, within the US three areas stand out in particular – New England, the Bay Area and San Diego, unsurprisingly as companies headquartered here have the most promising product pipelines (see above). Within Europe, the UK, Germany and Switzerland lead the way for similar reasons.

The graphs below, which plot venture capital investment against innovation capital (defined as money raised by companies with less than $500m revenues, including private firms and therefore positively correlated to venture capital), illustrate the clear correlation between early stage investment and pipeline potential. Click graphs to zoom.

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Biotech Exits

The IPO market for biotech companies globally has not recovered since the financial crisis of 2008.  More encouragingly, the M&A deal-flow in the industry has remained reasonably robust, meaning thattakeovers are by far the most likely source of exit for biotech firms at present.  However, the median time to exit for a biotech company via an M&A transaction has increased significantly, from 6 years in 2005, to 9 years in 2010 through 2012.  This presents a serious challenge to VC funds that on average look to return capital to LPs within 10-12 years.

As a result, many funds have begun to adopt more creative strategies to generate a fast return on invested capital.  Approaches include only investing in later stage products with experienced managerial teams, entering joint-venture agreement with large pharmaceutical companies to co-found start-ups in which big pharma retains an option to acquire the company conditional on certain milestones being met, and investing in more asset-heavy companies that allow for quicker exit. Click graphs to zoom.

In terms of likely buyers in M&A transactions, historically big pharm companies have been the most common source of exit for biotech companies.  The total value of pharma-biotech acquisitions in the US and Europe in 2012 was $20.6bn, an increase of 32% on 2011.  While there is growing appetite from big pharm companies to acquire smaller biotech firms due to expiring patents and slower than expected organic growth in emerging markets, their capacity to spend has been diminishing.

Ernst & Young have developed a ‘firepower’ index for pharmaceutical and biotech companies, estimating their financial capacity to acquire as a function of cash reserves, market value and debt levels.  This index shows that the capacity of big pharma to spend on acquisition has been diminishing patent cliffs, lower margins and large debt issuances (see Fundraising section).  Conversely, big biotech companies (defined as those with more than $1bn in revenues) have seen their ‘firepower’ increase by over 60% since 2006 due to strong organic growth and low exposure to low margin generic drugs. This means that large biotech specialists could become an increasingly more likely source of exit through M&A for smaller biotech companies compared to large pharmaceutical companies going forwards. Click graphs to zoom.

Deep dive into the biotech industry in this DataFox watchlist.