Biotech stocks are always risky, but much to the chagrin of biotech investors, 2023 heralds a new set of potential pitfalls beyond the usual clique of bugbears.
There are (at least) three fresh risks. Let's learn about them so that you can improve your investing process.
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1. Competition is coming to previously unperturbed niche markets
One major risk on the radar is that competing in rare disease markets or other niche therapy markets is no longer going to be the safeguard of a company's market share that it once was, especially within a few specific areas.
For example, Editas Medicine, CRISPR Therapeutics, and Bluebird Bio are all either developing gene therapies for both beta thalassemia and sickle cell disease, or, in Bluebird's case, already have a therapy for one of the conditions on the market. CRISPR's candidate for the two conditions will be submitted for regulatory scrutiny before the end of the first quarter, per its collaborator, Vertex Pharmaceuticals.
That doesn't mean you shouldn't invest in those companies, as there might be room for more than one competitor in their soon-to-be-shared target market. But, it does mean that there is a risk of those businesses foundering in the event that a competitor's product simply performs better or costs less to accomplish the same therapeutic outcome for patients. Likewise, there is a risk that the looming fights over market share could make positive regulatory or clinical catalysts have a dampened effect compared to what one might usually expect.
So be sure to look at the competition's status when you're judging whether to invest in a biotech, even if the target market might seem small, because the industry is now entering an era of fierce fights in relatively small spaces.
2. Penalties from regulators may be inbound for some players
On March 15, the Centers for Medicare and Medicaid Services (CMS) announced that it aims to penalize the manufacturers of certain drugs covered by Medicare, whose prices had been increased faster than the pace of inflation would warrant. Businesses you've heard of, like AbbVie and Pfizer, will need to send a rebate to Medicare before the end of 2025.
Analysts on Wall Street have already indicated that the rebates will be a downward pressure on the share prices of the affected companies. It remains to be seen how much they'll be on the hook for, so it's hard to say how big an effect there will be. Still, the takeaway for investors is very clear: Biopharmas that tout price hikes as a strategy for juicing their earnings are now at risk of being penalized if they plan to have their medicines covered by Medicare. And it probably makes sense to think of the companies that already need to pay out as being slightly riskier than they were before, at least in the short term.
3. It's really hard to raise capital on attractive terms right now
The last risk to beware off in 2023 with biopharma stocks is that it's not very favorable for businesses to refresh their cash reserves with stock offerings or by taking out new debt right now. That makes companies without existing earnings power or significant cash and equivalents on hand comparatively riskier than before.
There are a couple of reasons for this emerging risk, starting with the bear market. Many biotechs are experiencing significant collapses in their share prices. That means there's a psychological barrier when it comes to issuing new stock to raise cash, as the amount of money companies could raise today is likely a lot less than what they could have raised with a stock offering 12 months ago.
Another reason is that interest rates are rising thanks to the Federal Reserve's campaign against inflation. The cost of borrowing money is rising, which means that borrowing money today will require putting it to use for a higher return than before. And because pre-revenue biotechs specifically live or die based on how much cash they have to try to get their medicines out the door, lenders are even less likely to give favorable rates to under-capitalized companies. They know that future borrowing conditions may be grim, and they might not get their money back.
The way to mitigate this risk is to limit your investments to reasonably well-moneyed players with a clear statement regarding how long their cash runway is expected to last. One year's worth of cash isn't enough anymore, so look for stocks with two or even three years of dosh if you don't want to take excessive risks.
