Biotech investors love to take on oodles of risk in hopes of getting an outsized reward when one of their bets finally pays off. As though the odds of success weren't long enough, the industry is now shifting as a result of a trio of new headwinds.
The good news is that these issues will likely abate in the long term. But if you're interested in investing in the space anytime soon, you need to be aware of what's going on and what you can do to mitigate your exposure to these new risks. Let's take a look.
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1. Interest in recently trendy drug development areas is plummeting
As Moderna (MRNA 3.28%) shareholders know, the market's obsession with coronavirus vaccines and therapies is a thing of the past. Now, revenue from such products is in free fall too, and companies with a bunch of anti-coronavirus medicines in the pipeline are looking like they're caught out of position.
According to Moderna's first-quarter earnings report, it might make as little as $5 billion from sales of its vaccine in 2023, down from $19.2 billion in 2022.
The drop in coronavirus vaccine sales was probably inevitable, but it's a major headwind for any players competing in the space. Unfortunately, that's true regardless of whether they're marketing a vaccine, like Novavax, or they're just now starting the development process.
Investors should take note to avoid such biotechs for the near future -- unless they're willing to hold on to their shares for the several years that it'll take for other pipeline projects to hit the market.
2. Pre-clinical research costs are rising, and may not fall anytime soon
Most of the time, investors don't think much about the constituents of a biotech's research and development (R&D) costs. The majority of the industry's research costs and earnings performance isn't driven very strongly by the price of commodity goods, and critical raw materials like test tubes tend not to fluctuate very much in price. And typically, nor do more advanced research materials like antibodies, cell lines, and nucleic acids. Even common animal models like mice are available consistently and inexpensively.
Higher animal models like non-human primates (NHPs) are the exception to the rule. NHPs are commonly used for vaccine development efforts, among other niches where test tube models and lower animal models won't do the trick. While NHPs account for only 0.5% of the animal models used in biomedicine, biotechs and other researchers in the U.S. have faced a shortage of NHPs since at least 2019.
The culprits are China's choice to stop exporting monkeys during the pandemic, and a U.S.-led crackdown on illegal NHP smuggling operations. Before the pandemic, a certain type of NHP species that's popular with private biopharma researchers, cynomolgus macaques, cost researchers around $2,000 per individual to procure. Now, each individual can cost upwards of $19,000, and lead times have increased up to a year and a half.
If you consider that to conduct one pre-clinical study it might be necessary to procure and maintain around 20 of the creatures, it's easy to see how the expenses can add up quickly. And that's not even considering the costs of paying for the monkey's retirement to a primate sanctuary after its stint as a test subject.
Until biopharma companies can create their own monkey breeding programs, there isn't much hope from anyone in the industry that the shortage will resolve anytime soon. In other words, if you're thinking about investing in a biotech that does a lot of pre-clinical development in non-human primate models -- which is something that a biotech will almost certainly disclose in any kind of detailed discussion of its pre-clinical data -- you should understand that it is exposed to sharply rising costs that might keep on rising.
3. Funding is drying up, and collaborations are getting more competitive
2022 and 2023 have been hard years for biotech businesses that are looking to raise funding or go public. There were only 47 initial public offerings (IPOs) in 2022, while there were 152 in 2021. Likewise, last year's companies raised only $4 billion with their IPOs in contrast to the $25 billion of 2021.
The headwind could continue, and it means that the biotechs that are likely to IPO soon will probably have significantly smaller cash holdings than their slightly older peers. At the same time, funds raised from secondary stock offerings, which happen when an already-public business issues more shares, also fell sharply lower since 2022.
Furthermore, larger biopharmas are demanding more favorable terms from the biotechs that they fund. While it's possible that this will change if the Federal Reserve stops hiking the interest rate that determines the cost of borrowing money, so long as inflation remains elevated, it's better not to count on it.
The takeaway for investors is that with biotech stocks, cash is king, much as it ever was. The difference now is that the importance of having "enough" cash to make it to the next drug development milestone is even higher than before, because it'll be harder to find more if there isn't enough.
