The systemic importance of the life sciences sector is undeniable. In the US, four out of ten IPOs have been healthcare companies over the last five years and, as Dr James Burt, CEO of Pharmanovia, argues: it is simply too big a sector for generalist investors to ignore
The past few years have shone an unprecedented spotlight on the pharmaceutical industry. The Covid-19 pandemic represented the largest public health crisis in a generation, and it was the pharmaceutical industry, among others, which rose to the challenge. It even managed to enhance its reputation in the immediate aftermath of the pandemic, according to indicators such as the Edelman Trust Barometer.
On pandemic effects
Despite perceptions that the healthcare sector as a whole gained from the global pandemic, in reality it was a case of winners and losers.
Key challenges, which are sometimes surprising for those outside of the sector to acknowledge, included the near universal delay to pivotal clinical trials, resulting in a slowdown of many companies’ pipelines. It was something exacerbated by the regulator’s understandable focus on prioritising solutions for Covid-19.
During this time, we also saw a reduced number of patients seeking treatment for non-Covid related illnesses.
While the pandemic’s impact appears to be receding, some of these effects will continue to play out for several years and we are already seeing the impact on public health of the delay in treatments during Covid.
The unprecedented pandemic response accelerated relatively new biopharmaceutical approaches, such as mRNA vaccines, boosting prospects for these new therapies. However, an over-supply of capital in 2020/21 led to significant valuation accretion of early-stage biopharmaceutical assets and increasing numbers of higher risk pre-clinical biopharma companies listing – more than 50 in those two years, almost the same number as the previous five years combined.
From 2020, investment dollars rotated from Covid-impacted sectors into healthcare, stimulating valuations, but by 2022 much of this ‘tourist capital’ had begun to rotate back out, and at pace. There has been a marked increase in the number of EU/US healthcare companies trading at or near cash and parts of the healthcare sector now look cheap in comparison to many other economic areas.
Current investing environment
It is worth considering the current macro-economic environment and how that affects pharma’s position in an investment strategy. Healthcare is traditionally considered a defensive stock ‒ during a period of economic downturn, populations tend to reduce discretionary spending and defray big ticket purchases ‒ particularly if the cost of living and interest rates increase. This can heavily affect industries such as gambling, automotive, retail and real estate.
The pharmaceutical industry, however, benefits from relatively inelastic demand, which is why it is often described as ‘recession proof’. Healthcare will always be prioritised by consumers, and the need for medical treatments does not diminish, regardless of how the economy is performing.
In addition to the stability of the sector in times of trouble, it is also worth considering the demographic backdrop resulting from the general improvement in life expectancy ‒ in no small part due to better healthcare.
The proportion of the population aged over 65-years-old, the largest consumers of medical care, is set to double in the next generation. Innovations in digital healthcare promise to improve patient compliance and increase access to prescribed medicines, thereby delivering better health outcomes through higher medicine consumption and further compounding the demographic trends.
Large scale vs innovative and agile
All this said, the pharmaceutical industry should not be viewed as a single entity, but instead as a mosaic of many different opportunities and sub-segments.
There is a strong case to be made that investment should be weighted towards innovative and agile firms developing new solutions to pre-existing problems, but especially those with a lower risk profile than blue-sky or pre-clinical biopharmaceutical companies.
While a few well-known large cap pharma companies have done exceptionally well in recent years because of the pandemic, the industry is approaching the next significant patent cliff. In the early-2000s, genericisation of key molecule classes, such as statins, was in large part plugged by the so-called second wave biotherapeutics: monoclonal antibodies and other recombinant proteins.
It is these products that are now under threat of IP (Intellectual Property) expiry and biosimilar competition; patent expiry affected revenues totalled an average US$16.5bn in 2020/21 but are predicted by Evaluate Pharma to average nearly US$43bn per year from 2022-26. Third wave biotherapeutics such as RNA therapeutics, CAR-T, cell and gene-therapies, are emerging, but as a segment it is not clear which approaches will lead to long-term success in a crowded and rapidly evolving field.
Big pharma largely abandoned earlier stage development for reasons of risk, low productivity and an inability to centralise innovation, and is now more reliant on acquiring, or partnering with, emerging biopharma development companies to defend against the upcoming revenue risk. As some of these approaches could be considered curative, rather than therapeutic, they potentially require changes to pharma business models and the approach of payors – those who typically finance or refund the cost of medicinal products.
The more secure investment opportunities lie in smaller firms with non-cyclical stable positive cash-flows. For example, Pharmanovia’s business model focuses on re-engineering and reinvigorating legacy well known medicines – it’s analogous to putting an electric engine in a vintage car – the car is still desired, but it can be improved upon.
Many older medicines were formulated decades ago. In the intervening period there have been huge advances in pharmaceutical formulation technology. It is now possible to adapt pharmacokinetics to produce long-acting versions and so improve compliance. New routes of administration such as patches, nasal sprays or films can circumvent the need for invasive injections. Newer formulation approaches can improve bioavailability, allowing lower dosing and, hence, lowering side effects.
Evidence has also come to light about other conditions that benefit from these well-known medicines. As older molecules are better understood, they come with significant safety data and the reformulations often do not require full phase III clinical trials, which lowers execution risk, reduces cost and increases speed to patient.
It is also telling that there are moves afoot from policy makers and regulators to encourage such incremental innovation and support for under-considered subgroups, such as paediatrics or orphan pathologies. In the US, the well-established 505B2 regulatory pathway represents a halfway house between generic and full regulatory submissions, inherently conferring abridged exclusivity on well evidenced value-added medicines, and without necessarily requiring the full suite of clinical trials. The European parliament is debating the creation of a similar pathway as part of the current review of EU pharmaceutical strategy.
ESG considerations
With ESG an increasing focus for investment funds and investors, pharma needs to catch up.
Pharmanovia launched its first ESG report in 2022 where it laid out a clear ambition and commitment to sustainability and good governance. Furthermore, Pharmanovia’s strategy itself philosophically chimes with the reuse, reduce, recycle mantra of the environmental movement.
There is clearly a huge social impact in reconditioning well-known and efficacious legacy medicines to ensure improvement for patients, prescribers and payers, while not costing the earth. In short, it’s an investment we can all feel good about.
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