Outlook 2024 - Biotech 360°: Historic trends and revolutionary advances

A distressed market despite a massive unaddressed TAM

As 2023 nears its end, the biotech industry faces its third year of negative returns in a row. This has only happened once before in the 43-years history of publicly listed biotech companies. After a similar three-year downturn from 1992 to 1994, the industry saw a huge 63% rally in 1995. Even the steepest and most memorable 2001-2003 bear market for biotech lasted 869 days total. Since the last top in february 2021, we are already at >1'000 days and counting.

After an exceptional year with triple-digit gains in 1991, the biotech industry experienced a harsh correction from 1992 to 1994, driven by some high-profile drug failures, uncertainties over healthcare legislation, and rising interest rates. Shorts were betting on the downfall of the industry, while the few specialist funds at the time were bleeding assets under management (AuM) in large amounts, and some were closing down as no one wanted to invest in Biotech anymore.

While we are not in the same environment today, many of those reasons still resonate. As the saying goes, "buy when there's blood in the street," which not everyone truly applies. We believe the risks of experiencing another lousy year in 2024 are low, and wise investors might want to consider this investment opportunity.

As the ultimate long-duration asset (given its heavy capital requirements for risky investments and distant future cash flows), the biotech industry continues to be hypersensitive to changes in interest rates. A change in the perceived (or real) interest rates trajectory to the downside, might very well catalyze a re-rating of the industry. 

Has the need for biotech disappeared? Quite the opposite, as, according to the WHO, 10 of the top 10 causes of death and accounting for 55% of worldwide deaths, are still health-related. As much as concerns about WW3, terrorism, and sentient AI worry us, none come close to the actual yearly death toll of diabetes, stroke, sepsis, or cancer. The secret to longevity is "don't age fast and don't get sick"; and it's all about biology and biotech.

Consider the value we place on life and health: $1'200 for a new iPhone, $12'000 a year for 15% weight loss, or $150'000 for a few more months with cancer. What would one pay for an extra healthy year of life?  The math is too mind-boggling to be written.

What’s next? Is there a sign of life in this market?

Big Pharma derive ~50% of their revenue from biotech products (66% of which they acquired through M&A or licensing...), yet the valuation of the whole biotech sector stands just at 6% of the pharma sector. 

About one-third of all biotech stocks are trading at a negative enterprise value today. Prior to 2021, it was rare for a biotech company to trade below its cash value. On the rare occasions when it happened, the subsequent returns often rewarded the risk taken.

With M&A deals crossing the $100bn mark in 2023 so far (and half of the premia above 75%), it is clear that Big Pharma sees value in Biotech, and so should investors.

Another sign of a strong biotech market is a surge in IPOs. In 2020, 2021, biotech IPOs were diluted in the deluge of IPOs. The picture was clearer in 2022, when out of a paltry 181 total IPOs, 104 were biotech companies. To provide further context, the >20 years standing record for the Biotech industry was 63 IPOs in 2000. The IPO rush grinded to a halt, with only 7 new listings in 1H2023. However, over 200 private biotech companies have delayed their IPOs due to funding challenges. This represents the highest number of delayed IPOs ever recorded in the industry, and could lead to a rush of IPOs within the next few years. As a hint, it is worth noting that some of the best returns can be achieved by investing a year or two before the IPO rush.

Innovation is not slowing down; in fact, it's gaining momentum. In December, we anticipate the first CRISPR gene editing therapy to receive approval in the U.S. Additionally, the FDA has received over 2'000 new drug applications for cell and gene therapies, which is three times the number from four years ago.

In a concise equation: The combination of the worst bear market in biotech's 43-year history, a record number of Phase 2-Phase 3 assets trading near or below their cash value, high short interest, M&A potential, falling interest rates, and the impending approval of the first gene editing therapy, all point to a compelling opportunity for buying big in the biotech sector.

On the verge of tackling the biggest threats to humans

Biotech companies can be categorized according to the kind of threats they tackle into three main groups:

1. Maintaining Body Balance: this includes tackling metabolic diseases and obesity.

2. Restoring Body Function: advancements in organ function enhancement and gene correction.

3. Eliminating Threats: finding ways to eliminate pervasive threats (such as cancer) to human health.

Maintaining the body balance

• Obesity: A Pervasive Issue Defining Our Civilization

With 1.9bn people classified as overweight and 650mn as obese, obesity has become a defining issue of our civilization. It stands as the leading healthcare burden worldwide, estimated to cost a staggering $2tn annually. The implications of this problem are grim; for individuals with a Body Mass Index (BMI) over 35, the chance of reaching the age of 70 years drops to a mere 60%.

However, there is a bright side to this challenge. Obesity is among the rare class of medical conditions where patients exhibit a firm willingness to pay for effective treatments. A remarkable 16% of Americans are willing to spend more than $500 per month out of pocket for obesity drugs. To put this in perspective, this translates to 48mn Americans willing to invest $6,000 per year, amounting to a staggering $288bn in potential revenue. Even in a 50/50 split Novo Nordisk/Eli Lilly, it is three times the most conservative worldwide estimate of the obesity market.  

To illustrate the scale of this opportunity, it's worth noting that this revenue would exceed the total sales of iPhones in 2022 by nearly 50%, and it would be ten times larger than the highest annual peak sales ever recorded for any drug.

No wonder among the 2 IPOs with a solid positive return this year in biotech, one is an obesity-focused one: Structure Therapeutics.

With a flurry of results expected for protection against the consequences of obesity and from the oral form of the injectable drug, 2024 will be focused on metabolic diseases.

• NASH: The fatty liver disease GLP-1s cannot defeat

GLP-1 therapies, while celebrated for their numerous health benefits, have fallen short in treating one of the most severe diabetes and obesity-related conditions: Non-Alcoholic Steatohepatitis (NASH). NASH, a deadly liver disease, occurs when excess fat accumulates in liver cells, gradually impairing and eventually halting liver function. It's a widespread affliction, with about 6% of adults globally affected, a number projected to rise to approximately 9% by 2030. Despite the burgeoning $35bn market, effective drug treatments for NASH remain elusive.

Recent developments highlight this gap. Novo Nordisk's Phase 2 trial with GLP-1 for advanced patients failed, joining a list of unsuccessful attempts, including Intercept's Ocaliva and, more recently, Akero’s efruxifermin, which led to an 80% plunge in their stock (though in this case, the setback was more about overly ambitious goals than outright failure). Currently, only Madrigal Pharmaceuticals seems promising, with a market approval expected around mid-March. This anticipation is bolstered by a significant secondary offering of $500mn, a sum five times the average market capitalization of a U.S. biotech company. However, Eli Lilly's early 2024 Phase 2 trial with Mounjaro looms as a potential competitor to Madrigal.

The confidence in GLP-1s to address liver fibrosis remains tentative. Moreover, Madrigal's drug not only exhibits a more favorable safety profile but also comes in an oral formulation. Significantly, 14% of the patients in Madrigal's Phase 3 trials were already on GLP-1 therapies, underscoring the persistent need for effective treatments, whether GLP-1 based or not.

Restoring organ functions

• Alzheimer's Disease: The Challenge of Aging and Brain Health

Alzheimer's disease and various forms of dementia stand as the collective nightmare of brain aging that affects everyone.

Up until July 2023, not a single treatment available on the market could modify the course of the disease. Only in July 2023, did Eisai make a breakthrough and became the first to market with a disease-modifying therapy. Looking forward to 2024, another promising asset is expected to come into the market: Donanemab, developed by Eli Lilly, with its anticipated approval in the first half of the year.

Initial sales for these disease-modifying therapies may be slow, as people will understandably exercise caution concerning their safety and effectiveness. However, approving these groundbreaking treatments will likely rekindle interest in the field and encourage more investment in addressing Central Nervous System diseases. With the exception of major depressive disorder, the realm of "brain" disorders has seen limited innovation over the past two decades.

• Gene modification: Correcting "God's work" 

This December, a historic moment is on the horizon with the anticipated approval of the first CRISPR therapy in the United States, a decade after the groundbreaking research that earned its creators a Nobel Prize.

All life forms on earth use DNA to store information. It is the single and most remarkable shared trait of all living creatures. Mastering the tools to modify the genetic code opens up the most significant breach in evolution: directing it rather than being subject to it.

The initial wave of CRISPR applications in healthcare primarily focuses on correcting genetic diseases. CRISPR Therapeutics is concentrating its efforts on hematologic diseases and ex-vivo modifications, while Intellia, the second most advanced clinical company in this field, is targeting liver diseases through in vivo modifications. Both companies are well-funded, boasting a combined cash reserve of $3bn.

CRISPR's anticipated green light on 9 December 2023, marks a historic moment. In parallel, Intellia is expected to release phase 2 data in 2024. Notably, Eli Lilly has acquired Beam Therapeutics' opt-in rights for Verve Therapeutics' gene therapy programs, with a focus on cardiovascular disease.

The pricing of CRISPR's exa-cel therapy is likely to be around $2mn. Although it may seem costly, it is comparable to the $2.8mn price tag for the competing Bluebird Bio's gene therapy. Bluebird Bio's therapy has set a high bar for CRISPR therapeutics regarding efficacy, with 89% of 41 patients remaining free from needing blood transfusions after a median follow-up of 42 months.

A drug pricing watchdog committee estimated that the cost of blood transfusions for these patients in the U.S. amounts to $6.4mn over a lifetime. Therefore, both therapies, if maintained over a lifetime, have the potential to be cost-saving.

Considering there are approximately 20'000 eligible patients in the U.S. alone, even if only a fraction of them opt for treatment, CRISPR could generate significant revenue, potentially reaching $4bn for a single indication.

Eliminating threats

• Cancer: The threat of disfunction

Cancer remains a formidable threat, responsible for nearly 10mn deaths annually, accounting for almost one in six deaths globally. It represents a significant health challenge and is the largest drug market, characterized by remarkable growth. The estimated worldwide sales of oncology treatments are around $375bn, with a 5Y Compound Annual Growth Rate (CAGR) of 14% by 2027, constituting nearly a quarter of all drug sales.

An intriguing development in the fight against cancer is the emergence of a therapeutic approach known as Antibody-Drug-Conjugates (ADC), which has garnered substantial attention since 2019, particularly in 2023, when Seagen, which was acquired by Pfizer for $43bn in early 2023 at a premium of 53%.

We have historically invested in the space via Seagen until it was acquired and thereafter through Daiichi Sanyo, which secured the largest upfront deal in biotech history this year, receiving $4.4bn from Merck. All signs indicate that ADCs will continue to be a significant focus in 2024.

Cell therapy is another area to watch closely. Among the few biotech stocks that have shown positive performances since 2021, Legend Biotech is particularly noteworthy. Specializing in treatments for patients with no other options in a subset of blood cancers, the company has defied expectations with remarkable results and has overcome the substantial challenges associated with manufacturing processes. Legend Biotech has already gained a competitive edge, even in a relatively new modality, and is challenging its main competitor, Abecma.

In 2024, two significant catalysts are anticipated: 1) the commercial ramp-up of what may be the most successful drug in multiple myeloma and 2) the discussion with the FDA in April 2024 to address patients earlier in their treatment, vastly expanding the addressable market.

Cherry on the cake for therapeutic developers: Big Pharma needs them

Big Pharma is currently facing a precarious situation marked by three significant challenges, each of which implies a net positive for SMID (Small & Mid Cap) biotech:

1) Abysmal R&D Returns: One of the major concerns in Big Pharma is the dismal performance of research and development (R&D) efforts, with an average Internal Rate of Return (IRR) of a mere 0.6% among the top 20 pharmaceutical companies. This figure represents a sharp decline from the 6.5% IRR observed a decade ago. Despite doubling R&D budgets, the proportion of drugs invented internally has remained low, at just 28%. As a result, innovation appears to be shifting away from Big Pharma and accelerating into the hands of smaller biotech companies.

2) Loss of Exclusivity for Blockbusters: Big Pharma is facing a looming threat from the loss of exclusivity for many of its top-selling drugs. Over $200bn in revenue is at risk from now until 2028, affecting blockbuster drugs such as AbbVie's Humira ($21bn), Merck's Keytruda ($30bn), Johnson & Johnson's Stelara ($10bn), and Pfizer's Eliquis ($15bn). These drugs have been significant drivers of share price performances for their respective companies, with Humira and Keytruda accounting for approximately 50% of their company revenue. However, newer assets with strong intellectual property (IP) protection are primarily found within smaller biotech companies.

3) Impact of IRA Drug Pricing: The Center for Medicare and Medicaid Services (CMS) has initiated efforts to control drug pricing. This adds another layer of pressure on Big Pharma as they grapple with the loss of exclusivity and drug pricing regulations. The CMS program targets high-cost drugs, with the first selected drugs accounting for approximately $50.5bn, or about 20% of CMS gross covered prescription drug costs. Eligibility for negotiation is based on specific timeframes, with small molecules becoming eligible after nine years on the market and biologics after 13 years. Here again, SMID biotech with brand new IPs are immune to the negotiation.

In light of these challenges, Big Pharma is left pondering where it can find its next avenue for growth besides SMID biotech.

The Biotech supply chain is not out of the woods yet.

Outsourcing Services: facing challenges

It's essential to exercise caution when considering the state of the supply chain in the biotech industry. A noteworthy concern is the reliance on outsourcing services, particularly by SMID biotech firms, which often depend on effective cash management for survival. Many firms have adopted cost-cutting measures, such as staff layoffs and restructuring their pipelines, to navigate challenging financial circumstances. This shift in approach is reflected in the decline in the number of clinical trials initiated.

In 2021, ~12'000 trials were initiated, but by 2023, this number had dropped to ~7'800, falling below the average in the previous decade (2010-2020).

The impact of these cost-saving measures has also been felt by Clinical Research Organizations (CROs) and Contract Development and Manufacturing Organizations (CDMOs) that serve the biotech sector. Companies like Charles River Laboratories (a CRO) and CDMOs such as Catalent, Lonza, and Wuxi Biologics have seen their stock prices decline by 50% to 70% since 2021.

Veeva, a specialized Customer Relationship Management (CRM) software provider catering to over 1'000 biopharmaceutical companies, has issued warnings to investors about the challenges of securing new contracts with SMID biotech firms.

Even if there is a turnaround in the biotech market, it will likely take time before this translates into noticeable growth in the top-line revenue for outsourcing services providers. We have limited exposure to this sector.

Artificial Intelligence (AI): a transformative force in healthcare

AI is a hot topic across various industries, but its potential impact on healthcare is particularly noteworthy, with the potential to generate trillions of dollars in value.

Since 2019, no sector has seen such a rise in publication count in scientific journals other than Medical AI. Including the Alphabet Inc Deepmind initiative Alpha Fold is probably the single most significant achievement in biology since the Human Genome Project. It can predict protein structure, and 90% of all drugs are based on how well they bind to a given protein.

In the words of Nvidia CEO himself: “The greatest impact of generative AI is to revolutionize the life science and healthcare industry." When Nvidia, which had already partnered with Schrodinger in the past, announced an equity stake in Recursion Pharmaceuticals, it further confirmed the firm commitment in this field. Today, Recursion Pharmaceutical is in the top 10 of private cloud powered by Nvidia A100.

AI will not increase the probability of clinical success to 100%, but the pharma industry is already generating $1.4tn yearly with an average of 9% chance of success. Imagine the value that could eventually be generated with a 15% to 25% success rate.

The Life Science sector's reliance on China

Most Life science tools' underwhelming performance has a common cause: China.

Why that? Because Chinese purchases now account for an average of 10% to 20% of the revenues of leading life science companies. This market segment has demonstrated the strongest Compound Annual Growth Rate (CAGR) since 2016 and is poised to overtake Europe in terms of market share.

Furthermore, China often undertakes substantial projects, such as the recently launched 30-year proteomics initiative. While mapping approximately 90% of the human genome was a significant achievement in 2003, our understanding of the proteome, which encompasses the complete set of proteins produced by human cells, remains limited. Proteomics holds immense potential for drug development, making this project a boon for companies in the life science tools sector.

However, despite these promising factors, 2023 has not been without challenges, and orders from China have stalled. China's growth has not met the expectations set for it. As we move into 2024, the situation in China will be closely monitored, as vendors hold significant expectations for this market.

A broader view on biotech exposure

Biotech has consistently demonstrated a robust track record of outperforming other sectors after a crisis. The oldest Biotech index, the NBI, returned solid gains within each decade after a crisis, 94 to 2001: tripled - 2002 to 2008: doubled - 2009 to 2015: quadrupled - 2016  to 2020: doubled. Many points support that we are nearing the end of the current bear market.

Besides short-term market considerations, Biotech remains the single most civilization-changing industry we have ever known. Lately, antibiotics and vaccines have doubled our life expectancy in less than a century, the birth control pill shaped a new society for women in less than 50 years, and obesity drugs could reshape the landscape of chronic disease in 15 years or less while genetic medicine opens up an entirely new path to life.  Investing in biotechnology represents a unique opportunity that not only offers the potential for financial returns but also allows investors to be part of transformative advancements that will shape the future of human civilization, hence why Atonra did launch one of its first products in this sector.

Catalysts

• "Fair" drug pricing by the CMS. Price comparable to existing pharmacy benefit manager discounts, will alleviate pressure.

• CRISPR and Alzheimer sales better than expected. Exciting new blockbusters could trigger interest from generalist funds.

• IPO windows reopens. A staple of a Biotech bull run is a flurry of IPOs.

Risks

• Pharma M&A disappointing. If the M&A value is lower than 2023 it may spark concern about why Pharmas do not see value in biotech.

• Unexpected healthcare policy arising after the U.S. election. The republican candidates have not formulated clear plans for healthcare which adds uncertainty.

• Cell and Gene therapies fail to deliver. According to the FDA head for biologics: "If the FDA only approves two or three [cell or gene therapies] per year over the next few years that’s a failure.” Disappointing on such expectations would result in a negative rerating of the biotech's long-term revenue generation capacity.