Profits up as R&D slows in biotech sector

June 2013 | FEATURE | SECTOR ANALYSIS

Financier Worldwide Magazine

While the biotech industry’s major players are performing admirably in 2013, the remainder of the sector must up its game in order to demonstrate value in a persistently challenging environment, says Ernst and Young’s (E&Y) 27th annual biotechnology industry report, released in April.

The survey ‘Beyond Borders: Matters of Evidence’ suggests that in 2012 the global biotechnology industry continued along the path to recovery as many public companies in the sector achieved both top and bottom line growth for the third straight year. However, research and development (R&D) funding, was cut by many companies. Profits in 2012 were boosted by 37 percent or $1.4bn to a record $5.2bn in 2012, though this figure is heavily augmented by the reduced growth experienced in R&D funding.

Implementation gap

E&Y’s report, launched at the Biotechnology Industry Organization’s 2013 International Convention in Chicago, states that an “implementation gap” has materialised at a large number of small to mid-sized companies when it comes to gathering evidence, which demonstrates the value of the products they have under development. This emerging gap in how biotech executives judge drug value versus corporate efficiency has repercussions for the future ability of these companies to raise capital and attain attractive deal valuations, to ensure they are reimbursed for the cost of developing their products once they have been granted regulatory approval.

According to E&Y, in order to bridge this implementation gap, small to mid-sized firms must re-imagine their R&D strategies, placing as much emphasis and attention as possible on how private and government insurers or ‘payers’ will value their new products as they produce workable medicines.

E&Y carried out a survey of biotech executives at 62 US and European companies with revenues below $500m. Ninety-four percent of respondents said that it was “important” or “very important” that firms keep a strategic focus on the value and efficiency of the drugs they produce. Most companies, however, acknowledged that they had held off implementing drug value programs or specific evidenced focused initiatives over the last 12 months. E&Y suggest that the results of their survey “indicate that companies focus on efficiency initiatives with far greater frequency than on measures to collect evidence and demonstrate product value”.

Equally, of those 94 percent of respondents, only 11 percent have added payer or reimbursement expertise to their management teams, while just 13 percent have supplemented their clinical development teams with similar expertise. Only 4 percent have added payer or reimbursement expertise to their boards of directors. Glen Giovannetti, E&Y’s global life sciences leader, noted that “In today’s increasingly outcomes-focused, evidence-driven health care systems, biotech companies cannot afford to pursue an R&D strategy that only focuses on whether or not their drug works. They need to also understand whether it will be valued and reimbursed by payers.”

Profits up, R&D growth down

For the majority of the 27 years this survey has been carried out, the biotech industry has been unprofitable by aggregate. In most years the profitable firms were eclipsed by the net losses of the larger group of companies still in the unprofitable R&D phase, although this trend was reversed somewhat in the mid 2000s when high digit revenue growth across the sector began to move the industry towards profitability. However, as E&Y points out “Biotech had become profitable almost overnight not because of a huge uptick in product sales or the rapid maturation of scores of new leaders, but because large numbers of companies had been forced to slash costs simply in order to survive. Rather than being a sign of the industry’s strength and stability, biotech’s overall profitability had become a by-product of uncertainty and weakness.”

Despite a dip in R&D spending in 2009, since the financial crisis hit companies have consistently increased spending in this area. According to E&Y, two-thirds of biotech companies increase R&D spending every year. 2012, however, saw a downward trend. Although US commercial leaders (firms with revenues above $500m) increased R&D expenditure by 18 percent, the rest of the sector cut spending by 5 percent.

The data suggests that R&D spending by public companies in the four conventional biotech centres (the US, Europe, Canada and Australia) grew by only 5 percent in 2012, down significantly from 9 percent in the previous year. Across the major markets, commercial leaders’ R&D spend remained strong; it was smaller, pre-commercial entities which held back the overall pace of growth. According to Mr Giovannetti “If you take away the 16 commercial leaders, the rest of the industry actually declined in its R&D spending.”

Drug approvals

Despite the persistently difficult conditions, the biotech industry has continued to refresh itself. A number of up-and-coming companies in both the US and Europe grew their product revenues sufficiently in 2012 to become market leaders. Furthermore, the number of FDA approvals, which had been on a seven year lull until 2011, increased for the second consecutive year. 2012 saw 39 new products approved, which represents the highest number of new approvals for any one year since 1997. The majority of the approved drugs, according to E&Y, “were not me-too offerings but first-in-class treatments that seek to address genuine unmet needs”

In order to sustain these impressive levels of approvals it will be crucial for the companies introducing these new drugs to remain focused on collecting the right kinds of evidence about the value of their products.

Regional review

Revenue in the industry grew 8 percent in 2012, down from 10 percent in 2011. In the US, revenue growth slowed as a result of the rapid growth experienced by US firms during 2011. Sales at those companies declined due to new competitors entering the market with simpler treatments and lower price points.

Revenue growth of publicly traded companies in the US matched the wider industry’s 8 percent, reaching $63.7bn. This is down from 12 percent recorded in 2011. This drop-off is a result of a progressively more competitive marketplace and increased scrutiny from payers and providers.

US R&D expenditure increased by 7.8 percent in 2012, slightly below the top line growth, and down from the 9 percent growth rate experienced in 2011. R&D remains under pressure at medium and small biotech firms particularly, with 41 percent reducing R&D spending in 2012.

R&D revenues at larger, commercial leaders (companies with revenues in excess of $500m) grew by double digits in 2012. Revenue at the commercial leaders also increased significantly in the last year compared to smaller firms. It is anticipated that larger firms will continue to outperform the small to midsized firms in both R&D and revenue. In 2012 the gap widened as commercial leaders increased R&D expenditure by 18 percent while other companies cut spending in this area by 5 percent.

Revenues of European publically traded companies also grew by 8 percent in 2012, falling below 2011’s European performance when the sector’s top line increased by 10 percent. Data suggests that five years after the onset of the global financial crisis, many European companies are still in cost-cutting mode. To that end, R&D spending among European firms failed to keep up with the top line as expenditure decreased by 1 percent. This decrease, E&Y suggests, is a reflection of “European market realities” as access to capital is significantly more challenging in Europe than it is in the US. European waters are being muddied further still by the economic challenges the continent faces and the ever present risk of sovereign debt crises in the eurozone. The biotech industry, which had been on the brink of aggregate profitability in recent years, finally achieved its goal in 2012. However, this development can be seen primarily as a result of the widespread cost cutting regimes put in place by many companies.

The travails of the Canadian biotech industry also persisted in 2012. Revenues were flat compared to 2011, showing a 1 percent change. R&D expenses, which have been falling for a number of years, declined 12 percent in 2012, and the bottom line depreciated by 18 percent. The Canadian sector has been heavily impacted by M&A; many leading Canadian firms have been subject to acquisitions by foreign firms. Consequently, Canada’s aggregate financial results are extremely sensitive to the kind of year by year swings which often transpire at smaller firms.

In Australia, revenues of publicly traded companies grew by 7 percent, crossing the $5bn threshold. This is an improvement on the 6 percent growth achieved in 2011. However, in line with other established biotech hubs, R&D expenses failed to stay in line. The Australian market is dominated by CSL Limited; the company drives the entire sector’s performance. CSL reported a strong year with net income over $1bn for the first time. The firm recorded growth in both revenues and R&D throughout the year, yet despite this impressive performance revenue and R&D expenditure for the entire sector fell 13 percent and 8 percent respectively.

Funding, IPOs and M&A

Biotech firms headquartered in the US and Europe raised $28.2bn in funding throughout 2013, down from the $33.3bn raised the previous year. This is the first annual drop since the financial crisis kicked in. The fall was caused by a reduction in debt funding which declined by nearly a third, from $20.3bn to $14.1bn.

The IPO market also remained lukewarm in the US in 2012, where only 11 dealswere completed, and was practically nonexistent in Europe, with only three completed deals, two of which raised negligible sums. In the US, aggregate proceeds of only $805m were raised from the IPO market, down from $857m in 2011. Funds raised in follow-on and other offerings increased by close to $1.5bn, reaching $7.9bn.

Venture capital funding in both the US and Europe declined 5 percent to $5.4bn, which represents a slower decline than expected in light of the fundraising challenges faced by firms recently, particularly in Europe. This slower rate of decline suggests that VC firms have begun investing in the sector again following the financial crisis. Pharmaceutical venture funds and others have begun to fill the gap left when VC firms retrenched their investments. The cumulative value of M&A involving US and European companies reached $27.4bn, up 9 percent from 2011.

Based up on the data presented by E&Y it is clear that the industry-leading commercial biotech companies are still performing admirably, despite persistently tough economic conditions. Meanwhile, it is of paramount importance for smaller and midsized firms to retool themselves and their R&D strategies to ensure they are adequately compensated for their product development lifecycles. In the long term, the prospects of the biotech sector depend on bridging the “implementation gap”.

Richard Summerfield