Published March 15, 2023 | 3 min read
Key Points
- Sweeping changes in drug pricing policy introduced through the Inflation Reduction Act could hit drug development strategies in the long term.
- Further interest rate rises may reduce risk appetite, restricting early stage and smaller cap biotechs.
- Reforms to the process for accelerated drug approvals may increase development risk.
- Breakthroughs in treating rare diseases, cancers or psychiatric disorders all have potential to transform the shape of the sector.
A new pricing landscape
The passing of the Inflation Reduction Act (IRA) in 2022 will have far-reaching consequences for the biotech sector. In our view, its long-term impact on earnings per share, strategy and business development remain underappreciated.
The IRA introduces sweeping changes to the way pharmaceutical drugs can be priced. It caps out-year revenues by requiring mandatory discounts of 25%, 35% and 60% after 9, 12 and 16 years on the market respectively. Small molecules are eligible for negotiation after 9 years and biologics after 12 years.
Meanwhile, Medicare price increases are capped to the rate of inflation, while companies will be responsible for a 20% rebate for patients in the catastrophic coverage phase.
Besides the impact on biopharma revenue, the changes may influence drug development strategies and possibly mergers and acquisitions. However, the IRA is likely to remove the prospect of more dramatic pricing policy measures in the near to medium term.
During 2023, we will be monitoring for further clarity on how the US Department of Health and Human Services will implement the IRA, including new executive rulemaking. In September we will see the initial list of drugs selected for negotiation.
“A lower risk appetite among investors and higher borrowing costs for prospective acquirers could hit smaller cap biotechs.”
Rate hikes could hit small players
Biopharmas are typically less susceptible than most to inflationary pressures or recession concerns, due to the inelastic nature of prescription drug demand, the industry’s ability to set prices and its relative lack of reliance on raw materials and better margins than other sectors. However, the wider economic picture will still affect the industry.
In particular, the potential for further rate increases to 5% or beyond in 2023 could increase the cost of capital, a key consideration for early stage biotechs and a disincentive to investing in higher-risk biotech stocks.
A lower risk appetite among investors and higher borrowing costs for prospective acquirers could hit smaller cap biotechs. However, we expect less impact on quality names with convincing clinical data.
Approvals: Limited reforms
Changes to the process for accelerated drug approval – including pathways for revocation, pricing restrictions, or mandatory timeframes for confirmatory trials – could increase development and revenue tail risk. However, the reforms are not as wide-ranging as they might have been.
The Prescription Drug User Fee Acts (PDUFAs) were reauthorized in September 2022, with few modifications. Notably, greater powers sought by the US Food and Drug Administration (FDA) – such as extended ability to withdraw drugs from the market, or to require studies to be running before accelerated approval is granted – were largely ignored by lawmakers. However, we see potential for these topics to be revisited in the near term.
PDUFA reauthorization ensures agency funding for key programs through 2027. This adds an element of stability that can keep the regulatory path well-oiled.
“In vivo gene editing has the promise to target and correct mutations that drive rare and genetic diseases, cancers and some infectious diseases, with high durability and efficiency.”
Advances with disruptive power
A host of potential breakthroughs have the potential to transform the sector in 2023 and beyond.
In vivo gene editing has the promise to target and correct mutations that drive rare and genetic diseases, cancers and some infectious diseases, with high durability and efficiency. Successful gene editing could supplant gene therapy and antisense knockdown approaches, and possibly small molecule approaches for larger indications.
However, current technologies have focused on liver delivery, and additional work will likely be required for other tissues. Safety risks might also lead patients to favor more established technologies, such as gene therapy, or emerging RNA-editing programs.
In psychiatry, single administration or short course therapies have the potential to reshape the market by replacing chronic treatments, but the entrenched nature of chronic treatment may make change difficult.
Finally, success in cancer vaccines promises a personalized method of treating tumors, if these can overcome previous challenges that saw them fail in later stage trials. Cancer vaccines may be used in combination, which will likely expand the market rather than overtake current immune-oncology treatments.
Potential scenarios that could unfold as a result of these and other disruptive forces are explored in more detail in the latest edition of our innovative Game Changers report, part of the RBC Imagine research brand that assesses the long-term impact of change drivers.
Brian Abrahams, Luca Issi, Gregory Renza, Leonid Timashev and Yinglu Zhang authored “Game Changers: Disruptive Forces in Biotech – 1H23 Edition,” published on December 19, 2022. For more information about the full report, please contact your RBC representative.
