Two Reasons Why Small to Mid-Sized Biotechs Can't Get Financing in a Biotech Boom

Following the Ernst & Young report Beyond borders Matters of Evidence 2013  that biotechnology companies worldwide have boosted profits by 37 percent to a record $5.2 billion in 2012, party by tempering growth in R&D spending, Pharma IQ spoke to Ana Nicholls, Healthcare Analyst at The Economist Intelligence Unit, about the key findings of the report and the challenges that small to mid-sized biotechs face with respect to financing.

Pharma IQ:
Please could you give a brief overview of the key findings of the report?

A Nicholls: The report is in many ways encouraging, because it suggests that biotech companies are continuing to recover from 2008's downturn. Net income, revenues and even R&D expenditure for 2012 were all up on 2011, as are new drug approvals. But the growth rates are slowing after 2010-11's rebound, and having cut costs drastically over the past few years, the industry still faces a number of challenges. One of these is financing: despite a rise in the number of M&A deals, companies are still finding it hard to raise capital through IPOs or venture capital. R&D spending growth is also slowing, which could stem the flow of products in the long term.

Pharma IQ:
In your opinion, what has been driving recent profits in biotech?

A Nicholls: For the past few years one of the main drivers of profit growth has been cost-cutting, so even where revenues have been dampened (as in much of Europe) margins are continuing to rise. This seems less clear-cut in the past year, though, because staff numbers are starting to rise again, particularly in the US, where profit growth was strongest. So I think the recent rise in profits is more down to new products coming through and the prices that companies can charge for these breakthrough treatments. That is why performance has been so uneven, with some companies seeing a sharp rise in profits and other continuing to report losses.

Pharma IQ: Has there been a jump in the perceived value of biotech companies by investors?

A Nicholls: Though investor interest in biotech companies has risen, they are still surprisingly out of favour in many markets, despite their strong growth prospects. That's mainly because they are risky - and in a specialised IP-driven way that many investors are uncomfortable with - and because they tend to have poor cashflow. They are, in essence, a bit too all-or-nothing for investors to do more than take a marginal bet on them. Recent efforts to support innovation, such as the patent extension in the US or the patent box in the UK, should help, though. Biotech funds (covering several companies) do help to spread the risks, too, but there aren't very many to choose from.

Pharma IQ: What are the challenges that small to mid-sized biotechs face with respect to financing?

A Nicholls: There are two challenges. One is the general collapse in bank lending, particularly in Europe, which has obviously affected small companies most and small risky companies like biotechs even more. E&Y's report masks this a bit, because larger companies did quite a lot of debt financing in 2011 (though less in 2012), encouraged by low interest rates. The other is that venture capital is still scarce for small companies, largely because VC investors lack a clear exit route now that biotech IPOs have dried up. Again this is particularly true in Europe but even in the US IPOs have been largely restricted to larger companies or those with products that are nearly prodution-ready. That leaves VC investors reliant on the M&A market for a quick exit, unless they are prepared to invest with a long-term horizon.

Pharma IQ: What trends are we seeing with regards to M&A?

A Nicholls: Biotech M&A has been less strong in the past year or so than many had expected, given that (mostly) cash-rich pharma companies are keen to find new products to replace those going off-patent. But like other investors, pharma companies are trying to reduce the riskiness of their investments. This means they are either making acquisitions gradually, subject to the biotech companies reaching certain milestones, or they are looking solely at companies with late-stage products and evidence of commercially-minded management. 

Pharma IQ: What strategies are small to mid-sized biotechs employing to survive?

A Nicholls: Cost-cutting remains one of the main strategies for survival, but after 4-5 years of downturn there is not much less to slash. Companies are therefore focusing their remaining resources, especially research spending, on a smaller number of projects, particularly focusing on disease areas for which there are fewer existing treatments. Alliances with pharma companies - or indeed with universities or other bodies - help too if they come with a schedule of payments. The number of these, though not the value, seems to be rising, albeit fairly slowly. 

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Interview conducted by Andrea Charles.