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Life sciences industry outlook

Volume 8, Summer 2021

Key takeaways from the summer 2021 life sciences industry outlook

  • Public markets have recently favored medtech and life sciences services companies for near-term stability and established revenue streams; private capital continues to flow into biotechnologies and new drug development.
  • Continued investment in new technologies and therapies is an encouraging driver for the long-term health of the industry.
  • Clinical trial starts have rebounded and now exceed historic levels. The widespread adoption of decentralized trials is clear; however, the economic and efficiency trade-offs must be more thoroughly vetted.
  • Companies are choosing to commercialize their own drugs rather than license them or be acquired, but challenges must be considered too.
  • On a proportionate basis, branded drugs continue to increase in price, and it is these drugs that garner media attention and drive concern over drug prices, even when the latest reading of the consumer price index indicates a 2% decrease in prescription drug prices overall.
  • The adoption of robotic surgical techniques continues to grow as labor challenges in health care persist and advanced technology enables a wider range of robotic assisted procedures.

Markets

Contrasting market conditions appear in life sciences new economy

Considering the role life sciences companies have played throughout the pandemic, and their increased prominence in economic and political commentary, it may come as a surprise that the biotechnology and pharmaceutical sectors are being outperformed by the broader market, and that the consumer price index for prescription drugs (CPI-drugs) continues an 18-month decline.

Ever resilient, however, the life sciences ecosystem is emerging from the pandemic along with the rest of the global economy, and is facing its own unique set of opportunities and challenges involving capital markets, clinical trials and a complex development pipeline impacted by new business models and technologies.

Biotechnology continues to receive the lion’s share of public and private investment, but the high risk and long development cycle remain even post-pandemic.

Capital markets: Shifts and rebounds

As of June 30, 2021, all major indices are up 35% to 40% year over year, and all are outperforming the life sciences ecosystem, except for the life sciences tools and services sector, which has continued its upward trend, fueled by diagnostics, drug discovery and contract outsourcing efforts. The initial boost to biotech from its response to the COVID-19 pandemic has tapered as the sector regains focus on the core development of next-generation treatments of immuno-oncology, as well as cell and gene therapies. Biotechnology continues to receive the lion’s share of public and private investment, but the high risk and long development cycle remain even post-pandemic. Medtech and health care supply stocks have rebounded along with the resumption of non-COVID-19 medical treatments and surgeries, and we expect this trend to continue as the economy recovers and patients are increasingly comfortable pursuing elective surgeries and preventive care.

Public markets have recently favored medtech and life sciences services companies for near-term stability and established revenue streams; private capital continues to flow into biotechnologies and new drug development.

To be fair, the interconnection between drug developers and discovery companies continues to blur, and the important takeaway is that continued investment in new technologies and therapies is encouraging for the long-term health of the industry .

The first half of 2021 has seen as much private equity and venture capital investment as the preceding six months and 50% more capital raised than the first half of 2020. The total number of deals taking place has decreased by roughly 10% from the second half of 2020, but considering the broader economic recovery and the fact that investors have many other sectors to choose from, we see current-year performance as a positive indicator that investment will continue to flow into the life sciences ecosystem. The most significant change seen in 2021 so far is a waning preference for drug discovery companies, which likely peaked due to the pandemic. To be fair, the interconnection between drug developers and discovery companies continues to blur, and the important takeaway is that continued investment in new technologies and therapies is encouraging for the long-term health of the industry.

Mergers and acquisitions (M&A) in life sciences have not been robust through the first half of the year, but it does appear that deal flow will rebound to pre-pandemic averages. As discussed in our previous outlook, the Federal Trade Commission’s announcement of a working group focused on evaluating pharmaceutical company mergers, and the March lawsuit to stop the acquisition of Grail Inc. by Illumina Inc., is creating a chilling effect on life science’s M&A landscape. Our analysis excludes mega deals over $10 billion, of which there were only four completed in 2020, and none through June 2021. Several mega deals are pending or proposed, including deals between Thermo Fisher Scientific and PPD Inc., and AstraZeneca and Alexion Pharmaceuticals, which would serve as encouraging catalysts for further activity in the global life sciences ecosystem.

Going into 2021 there was concern that the life sciences initial public offering (IPO) market could face headwinds as the broader economy recovered and investors had a wider range of investment vehicles to choose from, including special purpose acquisition companies. But the life sciences industry has remained strong and is on pace to exceed 2019 and match 2020 in terms of completed IPOs, while 2020 may prove to be the high-water mark for total capital raised.

While the performance of public markets indicates that medtech and life sciences services companies are providing the greatest near-term value, we believe that private investment and IPOs provide a forward-looking view into the health and direction of the ecosystem. As shown in our analysis of life sciences IPOs, biotech continues to be the dominant sector for new market entrants; through June 2021 biotech has made up roughly 70% of all life sciences IPOs and capital raised.

High capital requirements, long development cycles and low probabilities for successful launches are key factors that make investment in life sciences a high-risk, high-reward proposition.

MIDDLE MARKET INSIGHT

Technology advancements, new business models and evolving patient populations highlight the importance for middle market life sciences companies and their stakeholders to understand their changing ecosystem.

Trials

Clinical trials: Emerging from the crucible and leading the pack

Eighteen months after the start of the pandemic, clinical trial starts have rebounded and now exceed historic levels, according to data analyzed from Scientist.com’s Trial Insights database. The data suggests an overall recovery across the majority of indications, but much like what we have seen in the broader economic recovery, some pockets of the therapeutic landscape are outperforming their peers. Oncology, for example, had maintained its long-term pace of new trial starts, with the total number increasing by 8% from 2019 to 2020. We expect another strong year in 2021 as the industry continues to shift focus to oncology and immunotherapies. This is compared to indications with lower mortality risk, such as infections, which saw a 17% decrease in total trial starts from 2019 to 2020.

New trial starts are a bellwether for industry focus in the long term, and late-stage trials provide insight into what will happen in the near term. According to the National Institutes of Health’s ClinicalTrials.gov database, COVID-19 trials made up 13% of industry-funded phase 3 trials in 2020. That number dropped to 8% for the first five months of 2021. Between September 2020 and June 2021, the indications with the greatest proportion of trials moving into phases 3 and 4 are oncology, pathological conditions, cardiovascular diseases, and infections, according to Trial Insights data.

Medical device trials set historic pace

During 2020, industry-funded medical device trial starts decreased 7% year over year, and fell below historical trends. However, 2021 looks to be the sector’s strongest year ever in terms of new trial starts, with a 114% year-over-year increase for the period January through May.

We acknowledge that the increase in the first five months of 2021 likely includes trials that were delayed because of the pandemic, but the breakout pace as well as the apparent public market interest in medical device and supplies companies indicate a positive outlook for the sector. Additionally, we’ve noted several portions of the medical device space, specifically surgical devices, are surging with new investor interest. These capital market indicators, as well as recent Supreme Court decisions to uphold the Affordable Care Act, indicate that growth in medical devices is far from transitory.

Decentralization – A lasting impact?

One of the greatest challenges the pandemic presented for the life sciences industry was the ability to conduct clinical trials, which were frequently forced to switch from an on-site to highly remote model. Fortunately, the industry had already been exploring decentralized trial models and was able to quickly adapt to the remote environment and absorb a surge of COVID-19-focused new trial starts. As businesses and individuals return to the physical economy, the life sciences industry plans to retain many of the decentralized activities it has adopted over the last 18 months. The long-term economic and public health impacts of this shift remain unclear, but recent investments and deal activity suggest this shift in business models will not be temporary.

In February 2021, ICON plc announced plans for the $12 billion acquisition of PRA Health Sciences, a merger predicated on synergies between the organizations, including PRA’s robust, decentralized trial platform. According to management meeting highlights published by Mizuho Securities LLC, ICON expects 80% to 90% of its future trials will require some form of remote monitoring.

The widespread adoption of decentralized trials is clear; however, the economic and efficiency trade-offs need to be more thoroughly vetted.

This sentiment toward investing heavily in decentralized trial models is consistent across the industry. In March 2021, Syneos Health announced its partnership with Science 37, a decentralized trial platform provider, and in April 2021, Syneos Health announced a separate partnership with Medable, another decentralized trial platform provider and direct competitor to Science 37. In its Q1 2021 earnings call, IQVIA stated that it is expanding therapeutic areas in decentralized trials and had recruited almost 170,000 patients using its decentralized trial solution. In its fiscal year 2020 earnings call, PPD took a more measured stance, stating that remote monitoring will be utilized more frequently than prior to the pandemic but wasn’t expected to fully replace on-site monitoring.

The widespread adoption of decentralized trials is clear; however, the economic and efficiency trade-offs need to be more thoroughly vetted. Fully virtual trials have a completely different cost structure, according to PPD in a Q1 2021 earnings call. While number of sites and travel to those sites are reduced, there is an increase in point-to-point solutions to serve patients in their homes as well as a much more decentralized supply chain. Though any increased costs may be offset by future savings, more promising is the potential to increase the efficiency and success rates of clinical trials, thus reducing the development timeline and overall cost of new drugs.

As a result of increased FDA regulation and complexity in clinical trials, we noted that the average years to completion for industry-funded phase 3 studies has been steadily trending upward. We specifically excluded COVID-19 trials given unique regulatory conditions that are unlikely to persist across all indications on a go-forward basis. We believe this trend highlights the opportunity and importance of driving efficiencies in the clinical trials, especially as new therapies become more targeted on smaller populations, and more middle market companies develop and launch drugs on their own.

Launches and Pricing

The changing face of who launches new drugs

The Goldilocks scenario for drug developers is that they find a successful drug candidate, shepherd it through clinical trials, and bring it to market to help patients. Along the way, they face countless challenges and must raise staggering amounts of capital. However, over time, the types of drugs being approved and the developers taking them to market is shifting from small molecule pharmaceuticals to biologics, and large pharma companies to middle market startups. While this shift is in the early stages, it is worth reexamining what it takes to bring a drug to market and how much capital executives, and investors, should plan on raising.

MIDDLE MARKET INSIGHT

The types of drugs being approved and the developers taking them to market is shifting from small molecule pharmaceuticals to biologics, and large pharma companies to middle market startups.

Looking at drug approvals over the past decade, we see that the number of novel drugs approved increased from 28 in 2010 to 61 in 2017. The number of annual approvals has since stabilized at 60 to 70. This held true even in 2020, when 64 new drugs were developed (excluding emergency use authorizations granted during the pandemic); 2021 is on track for a similar number, with 29 approved in the first half of the year.

The mix of drugs being approved is also changing as biologics gradually make up a larger proportion, and more drugs are targeting rare diseases. A rare disease is one affecting fewer than 200,000 people, and these “orphan drugs” often receive special considerations by the FDA. In 2010, only 28% of new drug approvals had an orphan designation. In 2020 that figure had grown to 48%. This may be an important consideration when determining whether a company should launch on its own, since drugs for rare diseases are sold in lower volumes and don't require sales and distribution networks as extensive as those of other drugs, but likely require a substantial price tag to be commercially viable.

This leads to the question of who is launching new drugs into the market. To determine this, we looked at all drug approvals from January 2020 through June 2021, and determined if the company responsible had any other drugs on the market or had licensed out any early stage drugs. In 2020, 22% of newly approved drugs were the first commercial product for their sponsor. That number has increased to 45% through the first half of 2021.

There are numerous reasons that companies are choosing to commercialize their own drugs rather than license them or be acquired. First, these companies have access to outsourcing partners to handle everything from manufacturing to distribution to sales. Add to this a growing pool of executives with extensive experience in large pharma who’ve left those organizations to run biotechs instead. These two trends mean that smaller companies now either have the expertise in-house or can outsource key processes involved in a drug launch.

Understanding the cost of developing a new drug

Worldwide, research and development spend by biopharma companies is expected to be $244 billion this year, according to Evaluate Ltd., with the vast majority of this spend going into the development of new drugs. The most commonly used metric for the launch of a new drug is $2.6 billion to get to approval, rising to $2.9 billion when accounting for post-market research and development. However, when we look at the total capital raised by life sciences companies from founding until their first drug is launched, on average they’ve raised only $330 million. What explains this enormous difference?

Smaller companies now either have the expertise in-house or can outsource key processes involved in a drug launch.

Before jumping to conclusions, it is important to understand how the $2.6 billion is calculated. A great deal of research has gone into that figure, and it represents a holistic way of thinking about the overall cost of developing one drug. First, we calculate the actual out-of-pocket R&D cost as $1.4 billion (2013 dollars). This includes the cost of successful as well as failed compounds. We then look at the opportunity cost of that R&D spend over the time it takes to actually develop a drug. This results in a cost adjustment from $1.4 billion to $2.6 billion, based on a discount rate of 10.5%.

This approach makes a great deal of sense from a developer’s perspective because it takes into account industry costs overall. It even makes sense for an investor who is considering an array of companies developing new drugs, because in reality most drug candidates will fail and never make it to market.

However, if you are a CEO or CFO of a new development stage biopharma deciding how much money to raise in your next round and how much equity to give up in exchange for financing, this isn't a very helpful metric. For you, the cost of your lead candidate failing is unlikely to just be rolled into the cost of the next candidate in the pipeline. Since a candidate failure could very well be a terminal event for the company, the only practical way forward is to assume future success.

In doing so, it is important to understand that the established cost structures for R&D programs at large biopharma companies don’t apply to smaller companies. Large companies are better able to survive a failed drug approval, so including those costs makes sense for them.

To understand the cost for a small to midsize biopharma company to develop a novel drug (either small molecule or biologic), we need to consider an alternative approach. Building off the analysis and giving specific consideration to companies taking their first drugs to market, we can estimate the cost for them to reach that commercialization milestone.

Between January 2020 and June 2021, 25 companies successfully launched their first commercial drug. For each we determined the amount of capital raised between founding and FDA approval, and calculated the average amount as $330 million. More remarkable is that six drugs reached approval having raised $100 million or less. The one company that has raised over $1 billion so far is BridgeBio Pharma, which in addition to launching its first two drugs in 2021, has 18 other candidates at some stage of preclinical or clinical development in the pipeline.

Based on the much lower average cost of development for an individual biopharma company and the increased likelihood that it will be able to launch its first drug itself, this is an ideal time for small to midsize biopharma companies to strategically plan for capital requirements—especially given the flow of private capital available, and the persistently high multiples seen in the life sciences ecosystem.

The capital requirements for new drug development admittedly do not consider failed drugs or the cost of commercialized operations and manufacturing. Factoring in those costs, as well as the size of the patient population and the health impact of a drug, are critical components of drug pricing—but these factors are often ignored or misconstrued in the public discourse on pricing.

Drug pricing and the consumer price index

The expiration of patents and introduction of generics and biosimilars have greatly expanded access to lower cost prescription drugs, and competition in the generics space has kept generic drug prices in a relative state of equilibrium for the last decade. Branded drugs have taken an opposite trajectory as they focus on smaller populations and more targeted indications. In 2007, branded drugs accounted for 37% of all prescribed units and 81% of sales, according to prescription drug data compiled by Bloomberg. In 2020, branded drugs made up only 15% of all prescriptions, but still accounted for 62% of sales.

On a proportionate basis, branded drugs continue to increase in price, and it is these drugs that garner media attention and drive public concern over drug prices, even when the latest reading of the CPI indicates a 2% decrease in prescription drug prices overall.

Since 2016 the total CPI has been growing at a faster rate than CPI-drugs, and the overall rate of out-of-pocket spending on prescription drugs has remained lower than CPI-drugs. Why is this happening, and what does it mean for the drug pricing conversation?

Common criticisms of CPI are that the overall basket of goods being measured is not representative of what consumers are actually buying, and that it does not react quickly enough to changes in new market entrants and substitutes. This concern extends to CPI-drugs as well, especially given the rapid advances in biotechnologies and cell and gene therapies.

For context, the methodology behind the CPI-drugs calculation involves a rotating group of retail pharmacies in roughly 100 urban areas, and a sample population of the most recent drugs prescribed in each of those pharmacies. The prices of those sample drugs are measured monthly for five years, and each year one-fifth of the sample pharmacies and their respective drugs is replaced with new pharmacies. As there is a regular refresh of the measurement basket, CPI-drugs likely reflects changing availability, prices and preferences for drugs. However, because the measurement is based on retail pharmacies, the product basket is by default full of lower-cost generics and drugs and therapies that do not need to be administered in a health care setting. Absent from the measurement are the specialty therapies and biologics that are administered in health care settings.

Herein lies the challenge for drug companies, regulators, payers and providers as they navigate the economic and political landscape around drug pricing. There are significantly more and higher quality generics and biosimilars available in the market every year, and because of this competition, prices and out-of-pocket spending have been increasing at a slower rate than overall CPI. At the same time, advancements in scientific technology are generating breakthrough therapies and personalized medicines that meet previously unmet needs. How are regulators going to manage the low cost of 85% of drugs prescribed that cover the majority of ailments, while also considering the high cost of orphan drugs that could cure a child’s blindness or treat Alzheimer’s disease?

There is no doubt that branded drug prices will continue to be a flashpoint for politicians and consumers—but given how closely divided Congress is, and the significant number of other priorities for the Biden administration, we do not expect any significant movement on drug pricing during 2021. As more developers bring their own drugs to market, and find more efficient ways to do so, perhaps pricing will reach a turning point.

Venture capital embraces the next phase in surgical devices

As technology becomes more advanced, nimble and physically smaller, and the demand for surgical procedures grows in aging and more affluent populations, the adoption of robotic surgical techniques continues to grow.

The benefits of robotic surgery often include enhanced precision, flexibility and control during operations. Additionally, emerging technology—including remote-operated systems, miniaturized devices and fully autonomous systems—continues to improve and offer additional benefits. As a result, venture capital investment continues to pour into the surgical device sector; and with $1.5 billion raised through June it is on track to eclipse 2020’s record year of $2.57 billion.

Competition to be first to market is heating up. Companies are spending large amounts of capital to expedite the final development and commercialization of their products in hopes of being first. Late-stage raises, including investments in eCential Robotics ($122 million) and Memic ($96 million), have pushed median deal size and post-money valuation for surgical devices to record highs in 2021. We expect this trend will continue as more and more of the benefits of robotically assisted surgeries are realized.

Low-cost, minimally invasive and personalized procedures are the goals many health care providers are currently seeking. Surgical devices, including robots that leverage artificial intelligence, will be the key to achieving these goals. The development and commercialization of these devices is costly and requires significant capital to fully realize the promise of these technologies.


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John Lanza
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John.Lanza@rsmus.com
800.274.3978


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