The Financial Squeeze on Emerging Pharma and Early-Stage Innovation

Access to public or private funding remains an existential challenge to fuel early-stage innovation as the biotech industry seeks to recover from a constrained financial & deal-making environment.

Emerging Pharma companies are an important customer base for CDMOs/CMOs and as drug-development partners for larger bio/pharma companies, and the financing flow is an important barometer of the health of this sector. A recent analysis by the management-consulting firm, EY, on the state of the biotechnology industry, shows that access to public or private funding remains an existential challenge to fuel early-stage innovation. What do the numbers show?

By Patricia Van Arnum, Editorial Director, DCAT, pvanarnum@dcat.org 

Looking for a rebound in 2024
After experiencing a constrained financing and deal-making environment over the last two years, US and European biotech companies are looking for a rebound in 2024 with some early signs of a potentially improving situation, according to  a recent analysis by Ernst & Young LLP’s (EY US) in its Beyond Borders report, the firm’s annual analysis of the state of the biotech industry. For the last two years, the industry has experienced significant challenges around a constrained financing environment, which has lead many emerging and early-stage biotechs having to restructure their operations by cutting staff, merging with other companies, or narrowing R&D focus by reducing some of their pipeline assets. Key to an improved environment would be a change in monetary policy through lowering interest rates in the months ahead. Also, the continual need by large bio/pharma companies to advance product innovation lays the foundation for increased deal-making, particularly as they seek to counteract the loss of exclusivity of products totaling more than $300 billion.

“Despite the Federal Reserve delaying action on interest rates, biotechs still have grounds for continued cautious optimism,” said Arda Ural, Ph.D., EY Americas Life Sciences Sector Leader, in commenting on the firm’s recent report. “The combination of record-level deal-making capacity seen throughout 2023, firepower of Big Pharma, and the healthy innovation capacity of the sector, including possibilities from artificial intelligence, will ultimately help the biotech sector to not only survive but thrive in the mid- to late-term.”

The biotech industry is still seeking to recover from a post-pandemic downfall, which created an outlier in comparison to recent industry norms. While the aggregate sector revenue was down for a second consecutive year in 2023, historically, it trended upward at 4.8% per year for the last decade, according to the EY analysis. Between 2015-2021, it grew at 9.2% per year, due to the spike from COVID-19 vaccines and therapeutics launched in 2021. Breaking away from this long-term secular trend, revenue decreased in 2023, along with the decline in pandemic medication sales. In its analysis, EY projects that revenue levels will return to its historical trend, once free of pandemic-related disruptions.

Grounds for optimism is the level of product innovation in the bio/pharma industry. In 2023, the US Food and Drug Administration (FDA) approved 80 novel bio/pharma products across the Center for Drug Evaluation and Research and the Center for Biologics Evaluation and Research, representing one of the highest total approvals, matched only by 2018.  With that, there is continued cautious optimism for more deal-making. Healthy deal activity early in 2024 was an indication of a pent-up demand, and if the macro conditions normalize with potentially lower interest rates, further activity is expected, according to the EY analysis. The shift in deal-making will be supported by underlying secular demand from the large bio/pharma companies for technologically de-risked assets to replenish and fuel topline growth, and the record-level firepower, currently estimated more than $1 trillion at the end of the first quarter of 2024, will be further deployed through the back half of 2024. The EY analysis points out that when the deals do get done, the deal premiums (difference between the share price one day prior to announcement and the offer price) are at an all-time high of 83%, suggesting that the late-stage, good quality assets can garner significant investor interest.

Challenges remain
However, the EY analysis points out that access to public or private funding remains an “existential challenge” to fuel early-stage innovation. Initial public offerings (IPOs) will continue to be selective and below the historical annual average. Following a drastic fall of 93% in IPOs from 2021 to 2022, IPO investment in biotechs nearly doubled to $2.9 billion in 2023, according to the EY analysis. Although still very modest, 2024 is showing signs of further IPO recovery continuing into the year.

In addition, the EY analysis points out that public markets kept the Biotech Index flat when baselined to January 2020 while overall, the Standard and Poor’s (S&P) stock market index recorded major gains of 57% in the same period, fueled by technology companies, in particular by the generative artificial intelligence (GenAI) tailwind.

Another challenge for the biotech sector is that venture funding is anemic, and that although follow-on financings appear to have improved over the 2022-2023 period, they remain suppressed valuations. As a result, the EY analysis suggests that almost a third of biotechs do not have sufficient cash to sustain their operations over a year.

Venture financing stayed flat at $18.9 billion in 2023, below the five-year historical pre-pandemic average of $47.5 billion. Early-stage venture investment in 2023 was down 8.7% from 2022, with early-stage assets bringing in only $12.48 billion for the full year, according to the EY analysis. However, companies that have strong scientific rationale and an experienced management team have still been able to bring in venture investments in a challenging financing environment. The first quarter of 2024 saw biotechs bringing in $5.8 billion in venture financing.

“With the patent cliff for Big Pharma and uncertainty around the IRA [Inflation Reduction Act], faith in innovation will be one of the key pillars in biotechs’ strategies for continuing recovery from the tough times experienced in 2022 and 2023,” said Rich Ramko, EY US Biotech Leader, in commenting on the firm’s recent analysis. “For now, financing is still catching up, and capital access remains an issue for many companies in the sector. However, biotechnology remains an innovation-driven industry, and innovation is thriving.”

With that, alliance spending by the large bio/pharma companies into smaller bio/pharmaceutical companies shows signs of improving although alliance spending is below pre-pandemic levels. As Big Pharma compensated for decreased M&A spending from 2020 to 2022, alliance spending became the leading alternative as it offered bio/pharma companies a lower-cost, lower-risk approach to accessing innovation. However, the total potential value for 2023 alliances was $125.3 billion, which is still more than the totals committed to these partnership deals prior to the pandemic but falls below the level seen in 2020, 2021, and 2022, according to the EY analysis.

Oncology remains the dominant commercial focus for pharma: As both the largest and fastest growing sector among the major therapeutic areas, oncology will account for 33% of bio/pharma’s overall growth in the next five years, according to the EY analysis. Its central importance is reflected in the number of new products reaching the market, the number of clinical trials targeting cancer, and the higher M&A investment in oncology products than any other bio/pharma assets.

Although 2023 revenues for European and US public companies dropped 10.7% from 2022 after a profitable spell throughout COVID-19 for vaccine makers, debt and follow-on financings in 2023 surpassed that of 2022, jumping nearly $9 billion to $29.4 billion, but financial pressures remain. In 2023, the number of biotechs publicly traded across the US and European Union dropped by 5.3%, according to the EY analysis. Companies have looked to strategically adapt their business models to become more optimized, which drove deal activity and an 86% increase in M&A compared to the previous year, and a 38% increase on the previous five-year average, according to the EY analysis.

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