The Impact Of The Surging Biotech Market On New Startups And CMO Outsourcing
By Ed Miseta, Chief Editor, Clinical Leader
By Jim Hamby, VP, Business Development, Ash Stevens
The biotechnology market sector has experienced stellar performance in recent years, outperforming the S&P 500 and most other market segments. In just under three years, the NASDAQ Biotechnology Index (BMI) has risen over 180 percent, climbing 32 percent, 65 percent, and 34 percent (as of Dec 1, 2014) in 2012, 2013, and 2014 respectively. First quarter 2014 kicked off with 23 Biotech IPOs, the strongest first quarter performance since 2000. With such strong market demand for new biotech companies with innovative assets, most analysts believe the outlook for the sector remains quite promising. This would potentially seem like good news for contract manufacturing organizations (CMOs) as market enthusiasm and gains would be expected to stimulate investment in new biotechnology startup companies.
There is, however, a distinct disconnect between the demand for new assets in the Biotech sector and lack of early-stage funding for biotech startups. Early-stage funding has remained at low levels while the biotechnology sector on Wall Street thrives. It remains to be determined if the biotech industry will continue on a path of tight risk capital to support a low and steady pipeline of new biotech startups, or whether market demands for innovative assets and investor gains will fuel an expansion in new biotech startups.
Big Pharma and Big Biotech have become increasingly reliant upon a steady pipeline of innovative products originating from the biotech community. Nearly half of all pharma approvals in 2013 were sourced from the biotech community. Greater R&D cost efficiencies have also been attributed to the biotech sector. A recent study of high-priority therapeutic products approved by the FDA from 1998 through 2012 estimated that the biotech sector’s R&D allocates per-approval is about a quarter (26 percent) of that spent by the pharmaceutical industry (Nature Biotechnology, Vol. 32, No. 7, July 2014). Many in the industry believe the number of therapeutic products originating from biotech companies is likely to increase as Pharma companies continue to consolidate R&D efforts while market demands for innovative assets continue to rise.
Innovative assets in Phase 2 and Phase 3 are becoming scarcer and more expensive as they are acquired by buyers and the demand on the buy side continues to grow. The depletion of these assets is triggering buyers to look at higher risk earlier stage companies to fill their pipelines. In 2012, only 4 percent of acquired products were in Phase 1. In 2013, Phase 1-acquired products rose to12 percent while Phase 2-acquired products declined from 42 percent to 19 percent. If this trend towards earlier stage funding persists, it could eventually lead to an increase in the number of early-stage biotech companies coming online as later stage opportunities become depleted. If market demand does lead to an increase in new biotech companies coming online, the increase will likely be modest considering the current selective and tight funding environment in today’s pharmaceutical industry. In addition, it will take several years in lag time for fresh startups to transition to the point where they would engage a CMO service provider or launch an IPO.
Economic Factors Drive Sector Growth
On Wall Street, strong earnings, an improved regulatory environment, access to capital through IPOs, and a maturing industry with seasoned management and entrepreneurs are some of the key drivers underpinning the robust activity of the biotech markets. Currently, the biotech pipeline, which contains a low number of companies, reflects a dearth of funding received during the 2008 recession and the decline of early-stage VC funding. In today’s healthcare environment, many early-stage companies have to rely upon funding from government, foundation, and/or private sources to advance their therapeutic products and stimulate investor interest.
As a consequence, there exists today a significant disconnect between market demand for new innovative assets and the early-stage funding of innovative biotech start-up companies. It has been particularly difficult for young companies in this current environment to secure the necessary funds required to go from the declaration of clinical candidate to “proof-of -concept” in the clinic. This funding gap has been termed the “valley of death,” and many start-up companies fail at this juncture, leaving their science untested in the clinic. Some investors, however, argue that the reduction in the number of early-stage investors and biotech companies has helped fuel the current boom by weeding out weak companies and providing better returns. This may have some validity in the short term, but the serial financing of the same community of managers, scientists, and entrepreneurs that have been successful in the past is likely to diminish innovation over the long haul and discourage young entrepreneurs.
It remains to be determined if strong demand for innovative assets will lead to an increase in the number of promising young biotech companies with good science, or if judicious financing by a small community of investors will maintain a low-level pipeline of select biotech companies. On the other hand, a robust public biotech market may also serve to entice a glut of new investors looking to capitalize on the boom in the short term. This would likely be bad for the industry, potentially fueling a sector bubble or giving rise to a surplus of less than stellar early-stage companies whose failures would discourage investment. Overall, the biotech sector still looks strong moving into 2015. Consequently, the outlook for innovator CMO service providers appears to be somewhat brighter as the industry continues to recover from the 2008 recession and the biotech IPO markets remain robust.
Large One-stop-shop or Small Boutique?
The CMO service industry, like the pharmaceutical industry, is undergoing an active period of consolidation as the market struggles to support the current level of excess capacity. There has been a resurgence of CRO/CMO service providers pursuing a one-stop-shop strategy via merger and acquisition (M&A) as these companies try to assert themselves as dominate players in the industry. Private equity and capital investment firms are also active in the area as they look to bundle assets and grow their sales. The jury is still out on whether or not the pharmaceutical industry will embrace the one-stop-shop approach, particularly for those organizations offering a diverse menu of services spanning multiple disciplines. Consumers of innovator CMO services are likely to be concerned about the ability of a one-stop-shop to provide quality services across the broad spectrum of tasks to meet all or most of a sponsor company’s development needs, as well as ensure smooth transitions between the various services. Offering limited related services, such as drug substance and drug product manufacturing, may prove to be a more attractive approach where there is a greater potential for quality continuity.
The biotech industry is in its fourth decade of existence, and many drug development professionals and industry consultants are very experienced and comfortable working with multiple, high-quality outsourcing providers to optimize their programs for success. Whether a service provider is a large one-stop-shop or a single niche (boutique) CMO, experienced drug developers seek out CMO service providers that can distinguish themselves from the pack, particularly in the areas of quality and reliability. Sponsor companies are more likely to use an a la carte approach with one-stop-shop vendors, picking and choosing services that meet their quality standards.
M&As Create Apprehension
In addition, consolidation in the CRO/CMO industry makes some Sponsor companies apprehensive about staying with or engaging CMO partners whose organizations are undergoing reorganization. M&As can change a sponsor company’s perception of an organization--even one they have successfully worked with in the past. Sponsor companies are paying closer attention today to the financial and corporate stability of potential CMO partners as the industry continues to consolidate. CMOs involved in M&A are giving Sponsor companies extra pause as sponsors become increasingly concerned about the impact change might have on their programs.
While consolidation will lead to larger companies with diverse services and locations that can take advantage of economies of scale, this also opens up new opportunities for smaller niche CMOs in the innovator space. Presently, about half of all new innovative therapeutics originate from biotech companies, and that number is expected to increase. Smaller, more nimble niche CMOs may be better suited to meet the needs and flexibility of some biotech companies as they seek interactive strategic partnerships whose expertise they can leverage. Whether a large one-stop-shop or a small boutique CMO service provider, quality and reliability will remain crucial drivers for CMOs trying to persevere in today’s innovator pharmaceutical environment. All indications are that the biotech markets will continue to be strong moving into 2015. Consolidation in the CMO industry is also likely to continue at a healthy pace going forward into next year. As the dust settles in the industry, it remains to be determined which business strategies and CMOs will emerge as preferred suppliers to take advantage of an upturn in the market or to compete for the best business opportunities in a tight market.