Investing in biotech – 4 things to consider
This is the second part of BioStock’s article series “Investing in biotech”. The first article in the series look at the structure and conditions for listed companies. In this article we take a closer look at parameters that are important for an investment case.
The preconditions for successful development are in general good for Swedish biotech companies, read more about this here (LINK). For those who are willing to invest in a company in the sector, there are a few aspects that are important to keep an eye on before buying shares:
- What does the portfolio look like and how far has it advanced?
- How does the company protect its assets?
- Do the company possess the right skill sets?
- What are the financial conditions?
What does the portfolio look like and how far has it advanced?
First of all, you need to assess the potential of the company’s project pipeline. Which diseases are targeted? Is the company developing completely new drugs or is it refining something that is already on the market? Does the portfolio consist of one drug candidate or several? How will the company position its candidates?
Another important aspect is how far the company has come in the development. Regardless of the potential you see, a drug candidate needs to get through the clinical trial process. It takes an average of 7.8 years from the creation of a Swedish development company to the start of its first clinical study, a development period that costs on average about 5.5 MUSD (Thornblad & Carlsson, 2021).
Once the project has reached the clinical stage, it takes an average of four years to go from phase I to phase III. Before phase III, a smaller biotech company usually wants to enter into an agreement with a larger partner who can advance the development further. The cost of getting a project through phases I and II costs in average approximately 16 MUSD.
One key question in assessing the potential of the project is how likely it is for the drug candidate to pass the different development stages, reach approval and market launch. Several industry analysts have studied these probabilities, and a compilation made by Thornblad and Carlsson in 2021 came up with the following:
- Phase I – 12.2 per cent
- Phase II – 21.1 per cent
- Phase III – 55.6 per cent
It is worth noting that the probability is affected by the type of substance developed and for what indication it is developed. For example, the probability of a project within infectious diseases reaching the market has historically been four times greater than that for oncology projects.
How does the company protect its assets?
Another important factor in every biotech investment is how the company protects its assets. Rights to ownership and patent protection are elementary assets in every pharmaceutical project and thus important components to have in place. The longer the protection lasts, the better.
So what patents are in place and how far does the protection extend? What does the company’s overall patent strategy look like? Are there opportunities to extend the patent and can the protection be strengthened in some way? This may involve further developing the candidate and, for example, directing it towards a new indication or developing a new formulation. The company can also protect manufacturing and other vital processes that protect the drug candidate from competition.
In addition to patent protection, a drug can also receive extra protection if it succeeds in achieving so-called Orphan Drug Designation. Orphan Drug Designation is a regulatory benefit that aims to stimulate drug development in less widespread diseases, where it has traditionally been difficult for pharmaceutical companies to find profitability. The designation grants an approved drug market exclusivity for up to seven years in the US and up to ten years in the EU. Similar protection can also be given to biological drugs, which can get a twelve-year exclusivity in the US and ten years in the EU.
Does the company have the right skills to succeed?
For a development project to be successful, it is not enough that research comes up with a promising treatment – the drug must be manufactured, approved by the authorities and it needs to be marketed. People who run the development of biotech projects should therefore have expertise in a number of areas.
An investor should look for answers to questions such as: What is the background of management and the board? Is there previous experience in taking drugs to market? What network of contacts does the company have?
What do the finances and the ownership base look like?
No matter how much expertise and experience there is in the company, and however promising the project may be, the development needs to be financed in some way – it is therefore important to look at the company’s financial situation. How far do the existing assets last? What does the long-term financing plan look like and what ability does the company have to raise new capital?
The ability to raise capital depends on what the ownership base looks like and how management and the board work to broaden this. In the biotech industry, a high level of institutional ownership often means that the company has owners who are knowledgeable and invested for the long-term. Does the company have enough long-term owners with the ability to support the development? Usually, you do not finance the entire pharmaceutical project at once, instead you inject capital as you progress in the development process. In this way, the risk is spread over time and the use of capital is optimised in the longer term. As a long-term investor, one should therefore also be aware that the need to raise additional capital along the way is very likely to arise.
In the next article in this series, we discuss some common methods of raising capital for biotech companies. In the fourth and final part, we look closer at how to value a company in the sector.
