United States

Conditions ripe for strategic investment among life sciences companies

Historically low interest rates provide a rare opportunity

INSIGHT ARTICLE  | 

Historically low interest rates are providing a rare opportunity for many businesses in the pandemic-depressed economy to access low-cost capital and make long-term strategic investments in technology and other improvements such as upgrades to their facilities, writes RSM US Chief Economist Joe Brusuelas.

Some companies in the life sciences space—such as contract manufacturing organizations (CMOs), contract research organizations (CROs), companies that need to build out additional lab space and those with well-established product pipelines—are no exception.

Opportunities for life sciences companies

The life sciences ecosystem has been accustomed to easy access to private and public capital for years, and 2020 was the industry’s best year ever for deal flow and capital raised. The current opportunity for companies to look past equity financing and take advantage of this low interest rate environment likely makes sense for some businesses more than others. Early-stage companies that are focused on research and development are not typically looking to make long-term fixed asset investments. But companies further along in the commercialization process, medical device companies, CMOs and CROs should carefully assess opportunities available right now that will help their business longer term.

Many life sciences companies face the same supply chain and manufacturing challenges as traditional consumer and industrial product companies, but with the added complexity of cutting-edge science, clinical trials, oversight from the Food and Drug Administration and other regulators, and the litigation and reputational risk that comes with creating products that could be the difference between life and death. The stakes are high and the tools, techniques and human capital necessary to remain competitive have become hyperspecialized and increasingly expensive. This has led to more outsourcing of critical functions to specialized service companies, or making significant investments in-house in order to be able to handle operations internally.

Capital and strategic investment

  • Facilities of the future: For years, life sciences research labs and manufacturing facilities have been shifting from using traditional tools and equipment to using highly advanced facilities that leverage powerful data analytics, artificial intelligence and machine learning systems, interconnected devices, and automation to reduce costs and streamline drug development and other operations. Some of the most advanced systems and tools have been out of financial reach for much of the middle market, but as technology costs come down and skilled labor becomes more scarce and expensive, this may be a moment to assess which investments could help enable an increasingly digitized future.
  • Onshoring, nearshoring and outsourcing: Global supply chain disruptions and a growing move toward nationalization were spurred, in part, by the United States’ trade dispute with China, and were exacerbated by the COVID-19 pandemic. Specifically for life sciences companies, fears of drug and medical device shortages and increased public awareness of how much the United States relies on China and Asia-Pacific nations for its life sciences manufacturing has increased calls for repatriation—or at least nearshoring—of drug and medical device manufacturing. While pressure is currently limited to political rhetoric for the most part, recent executive orders (from both the previous Trump and current Biden administrations) are signaling that legislation may be on the horizon. Companies looking to increase local manufacturing capacities as part of a long-term strategy should evaluate what options low interest rates might afford them when it comes to geographic changes to their operations.
  • Innovation through acquisition: With the rapid pace of advancement in biopharma technologies, many companies have found that innovation and expansion of product pipelines are better achieved through acquisitions than R&D. The number of such acquisitions continues to increase, and the average deal value between 2016 and 2020 has been about 55% of the peak average the industry saw in 2014 and 2015. With targets looking to exit faster, and acquirers able to access low-rate capital, management teams should consider the opportunity for their next expansive or defensive acquisition.

Refinancing and bridge financing

  • Companies across the economy are determining whether to take advantage of refinancing opportunities now while interest rates are low, and that applies to many in the life sciences ecosystem as well; companies should refinance their existing debt and look at ways to strengthen their balance sheets as they prepare for the eventual post-pandemic environment.
  • Over the last year, there has been an increase in the number of late-stage private equity and venture capital investments in the life sciences space and a relative decrease in the median value of those investments, according to our analysis of PitchBook data. 2020 was also the most active year ever in terms of life sciences initial public offerings and mergers and acquisitions activity. Our evaluation is that many life sciences companies felt a capital crunch resulting from pandemic-induced lockdowns, delays in development and pressure on labor, which caused many to raise bridge financing to get them to the next business phase. If such conditions continue, companies should evaluate a line of credit or other nondilutive debt financing that could help preserve investor valuations.
  • A similar approach may be appropriate for startup companies and early-stage investments. Taking out a line of credit or note as part of an early stage round could provide short-term capital support between development milestones and planned financing rounds, as a means to avoid dilutive capital calls. 

Why invest now?

In recent years, middle market firms have lagged their larger industry counterparts in capital outlays, a trend that has been documented in the RSM US Middle Market Business Index. In an encouraging sign, the December 2020 MMBI survey showed that more than half of respondents (52%) said they expect to boost investment in productivity-enhancing capital expenditures such as software, equipment and intellectual property over the next six months.

“Due to the unique confluence of events that is upon us,” writes Brusuelas, “firms will actually make money by borrowing, because we are operating at near-zero nominal interest rates that become negative when adjusted for inflation.”

Contact RSM Partner and Life Sciences Senior Analyst Adam Lohr or RSM Director and Life Sciences Senior Analyst Steve Kemler for more information.

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