Week 14: Investment Opportunities in Biotech and Pharma

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Week 14

Investment Opportunities in Biotech and Pharma

The biotechnology and pharmaceuticals sector is a complex one for investors to navigate but can provide immense rewards for knowledgeable based investors with a longer-term view. Biotechnology and pharmaceuticals are probably the most seductive and exciting sectors of the market to invest in.

Not only can investors have the warm feeling that they are helping humanity (an emotion not readily generated by buying shares in Apple or BHP), but when drugs or devices are developed and successfully adopted, it can be very profitable. Furthermore, healthcare as a sector exhibits little correlation with Chinese growth, the health of the domestic economy or US interest rates and has some powerful demographic tailwinds.

For reference the difference between biotech and pharmaceutical companies is that biotech’s like CSL use microorganisms or biologicals to perform a process, whereas pharmaceutical companies such as Pfizer employ a chemical-based synthetic process to develop small-molecule drugs.

Biotechnology and pharmaceutical companies can enjoy both high growth and high profit margins when a treatment they own and develop is successful and is adopted. Demand for new and potentially life-saving treatments is relatively price inelastic. Furthermore, patents and the time and effort required to obtain regulatory approvals for new drugs provide strong barriers to entry for other companies looking to produce competing products.

The sector can be a challenging place for retail and professional investors alike. Aside from determining whether a company’s drugs will be successful, investors also require that the product be adopted by physicians and often that it be included on a government’s list of approved and subsidised treatments such as Australia’s Pharmaceutical Benefits Scheme (PBS). In 2014, Australian taxpayers spent $9.1 billion on the PBS and listing every medicine on the PBS would quickly make the scheme unsustainable. For example, there is a good chance that an expensive new drug might not be listed on the PBS if it is deemed to only provide a marginal benefit over existing alternatives.

Governments globally are looking to curtail healthcare spending that has been consistently growing at a multiple of tax revenue growth. So, what to look out for before investing into biotech and pharma industry. For one consider what is the life of the new and existing patents? After Lipitor’s cholesterol patent rolled off, the cost of the treatment dropped from US$500 per month to US$50.
The impact of this was an 81% reduction in sales in the US for Pfizer. Investors should be aware whether competitors have similar treatments undergoing approval or if another entity is disputing a company’s patents.

What is the approval Status? Where is a company’s treatments in being registered for clinical use with the US FDA (Food and Drug Administration)? FDA approval is a requirement for sale in the most profitable healthcare market in the world. Companies with at least one product in end-stage trials are safer investments than those just beginning the investigative phases of development. We have seen many companies issue exciting prospectuses and raise capital based on the results of their treatment on mice, with minimal further developments many years later. On average, it takes 12 years and over US$350 million to get a new drug from the laboratory onto the pharmacy shelf.

Does the target company have diversity within its pipeline of products? The number of investors that have made huge gains in one tiny biotech are dramatically outweighed by those that have seen share prices crater after a company’s only drug failed to win FDA approval. CSL shrugged off the failure of a competitor’s parallel trial of a plasma-derived product used to treat Alzheimer’s, as it had a range of other treatments both in the market and in clinical trials.

And ultimately what is the size of the addressable market? Whilst investing in companies treating niche ailments can be profitable, the addressable market is far greater in areas such as HIV/ AIDS, cancer, heart disease, diabetes, neurological disorders and immunological diseases.

Furthermore, companies operating in these areas are more likely to attract a takeover bid from the big pharma companies looking to restock their pipelines.

Remember it is a complex sector to navigate and many promising companies are not yet profitable, yet alone able to pay dividends. Furthermore, the biotechnology and pharmaceuticals sector encompasses a wide range of companies with many specialising in very niche areas.

Even where an investor possesses a strong understanding of a particular area of medicine, this knowledge may be of little use in evaluating other similar treatments.

Conversely interesting opportunities can be discovered by analysing the prospects of particular companies and looking for related opportunities amongst similar companies in complementary or competing positions.