- Conditions favor biotech outperformance of broader markets for at least a few more quarters.
- Outsourcing offers biotech firms varied advantages, from cost reduction to enhancing credibility.
- The sector’s success and the outsourcing trend is fueling ancillary businesses, notably specialty REITs, CROs and research tools companies.
As biotech indices continue to surpass all-time highs, one must contemplate if there is additional room to run. We continue to believe the sector will outperform the broader markets for at least a few more quarters. In our opinion, this is warranted given the current success of high-profile drug launches backed by a pipeline of highly innovative medicines that address large markets. In addition, the industry continues to benefit from a favorable regulatory, reimbursement and pricing environment, as well as a consolidation theme.
These solid fundamentals have created a strong financing environment over the past few years, with flows of capital to the sector accelerating recently. This offers unique stability for beneficiaries of a robust biotech balance sheet, creating derivative investment alternatives. Companies supporting the industry will benefit from the capital raised by drug developers. Specifically, we see opportunities in dedicated specialty labs, healthcare systems, contract research organizations (CROs) and select tool providers such as those offering clinical trial management software.
Although the majority of capital raised is dedicated to trial funding, specialty real estate investment trusts (REITs) enjoy a high barrier to entry given the unique requirements of the highly technical and heavily regulated biotech sector. As an example, lab space requires state-of-the-art air control, waste and wastewater handling; all of which are regulated and scrutinized by the FDA and EMEA under strict facility guidelines if the space is used in the drug development process. The expertise required to meet the needs of drug developers creates a high barrier to entry into this market. Further, prime geographical locations adjacent to leading academic centers are finite. Drug developers require locations adjacent to centers of excellence for cross pollination of ideas and to better manage interaction with clinical trial sites. This leads to long occupancy times, as facility moves for drug developers are not trivial due to the coordination of an amalgam of preclinical assay cycle timelines with the physical move.
CROs have enjoyed strong growth in the past few years following a retrenchment by their larger clients due to large mergers, patent expirations and economic uncertainty. As the regulatory demands on clinical trials have increased, so has trial complexity, and the stakes to design and execute trials effectively have only gotten higher. In addition, big pharma is seeking to reduce costs and is inclined to shed under-utilized internal resources, let alone make the necessary technological investments (following years of neglect) required to be world class. For all these reasons, more research is being outsourced to CROs who can do a better job, faster and at lower cost. Smaller biotechs do not have the resources to begin with so they outsource from the start, and they want the credibility of a leading CRO standing behind their trial in the event a larger player wants to acquire them. Hence it is likely CROs can continue to grow faster than research spending given an outsourcing tailwind, with reputable scale providers taking increasing share.
The increasing sophistication of research and clinical trials is also aiding the tools market. If overall spending on research is not growing dramatically, the capabilities of research tools is increasing dramatically. Be it for safety or efficacy, an increasing amount of data is being collected during trials. Most noteworthy, genetic data can enable biotech companies to target drugs for specific sub-populations and ensure high efficacy for the drug when used with a companion diagnostic. As the number of trials is increasing, the complexity of each rising, and the value of manufacturing the drugs going up, tools companies are also providing more services to the industry. Tools companies are helping biotechs manufacture the drugs for both trials and commercialization at lower cost while achieving higher quality. Tools companies and CROs are also helping manage the logistics of trials by handling the distribution of candidates / placebos to patients. They are also distributing lab kits, collecting samples, running lab tests in efficient central labs and providing results using software developed for managing clinical trials.