Mark Odendahl
Welcome back to the Industries in Motion podcast from RBC Capital Markets. Reminder, this is where we'll be exploring what's new and what's next in today's fast moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers. Again, my name is Mark Odendahl, and I'm head of US Capital Markets Research here at RBC. And we're really excited to bring our biotech team on today's podcast. Today we'll have Brian Abrams and Greg Renza, who are a very important part of our large biotech effort here at RBC Capital Markets.
Mark Odendahl
Brian leads our biotech team and has close to 20 years’ experience on the sell side. Greg has nearly a decade of experience on the sell side and is an important part of the overall health care effort here at RBC. The biotech team recently published a very in depth report, taking a look and they called it the halftime report. So it looks into trends, thematic trends in the biotech sector as we work through the back half of 2023. And as we go into 2024.
We'll talk about M&A trends. We'll talk about pharmaceutical pricing trends, we'll talk about how the IRA impacts the biotech sector. So let's get into it.
Brian Abrahams
Thanks, Mark. It's great to be here.
Mark Odendahl
So let's kick it off with you, Brian. what's ahead for the biotech space as we move through the second half of the year.
Brian Abrahams
There's a mix of tailwinds and headwinds that we see for the group into the coming year. Innovation remains high, a marquee attribute that should continue to attract investment into the biotech sector. We've seen the FDA continuing to be reasonably permissive for new drug approvals, albeit with some exceptions. And the macro environment is improving with inflation easing and interest rate hikes slowing, but that may be somewhat counterbalanced by increased competitive crowding across a lot of therapeutic areas that biotech companies play in. And we've also seen risks around both drug manufacturing and safety become increasingly prominent as of late. We have been encouraged to see signs of investor sentiment improving in our checks. And as we get into 2024, we could see legal and regulatory developments that ease concerns about FTC and Ira overhangs the capital window is starting to open and potential data approvals and broader launches across larger market spaces like Alzheimer's, muscular dystrophy and oncology, could help contribute to a broader sector recovery. In the meantime, as we go through the rest of this year, we are seeing an opportune time to step into the many undervalued higher quality names out there as the tide potentially begins to turn more favorably next year.
Mark Odendahl
So let's talk about innovation more, the biotech sector could be the most innovative sector in the US economy. What's what are the key parts of biotech success over the last few decades?
Brian Abrahams
Well, innovation is really the lifeblood of the biopharma group, and it's been coming from a lot of different places lately, there's been a continued push into metabolics and diabesity excitement over new weight loss drugs, there's finally a sense of more medical prospects and Alzheimer's disease. We've seen we've seen a renewed focus on immuno oncology that's using the immune system to fight cancer. Next Generation therapies including cell therapies that retrain the body's immune system. A lot of interest of late as well in neuro psychiatry, novel drugs for depression, safer drugs for bipolar disorder, many of which harness new mechanisms and approaches including psychedelics. And this is all been helped by new modalities from next generation antibody constructs to protein degraders, to genetic therapies, different ways that drugs can be made to better hit the target on a cell in the body. And these are things that we couldn't have done before. We're excited about the launches of some innovative drugs in areas like Alzheimer's and psychiatry, and we've started to see really promising In clinical data in areas like Nash and TTR.
Mark Odendahl
So the regulatory side is important here to discuss and consider when we're talking about this innovation. Talk to us about the FDA and how they're handling the growth of the biotech industry.
Brian Abrahams
That's an aspect that's been really important. And I think the FDA has really been along for the ride here. And in terms of innovation, they've definitely shown increasing flexibility for earlier approvals and high unmet need diseases. The FDA is Commissioner Robert Califf continues to seem open to new innovation, especially in regards to areas like gene therapies and new modalities. There's a lot more communication between drug makers and the FDA, with increasing flexibility and permissiveness, for earlier approvals and high unmet need diseases. Even before the traditional phase threes are completed. We saw that recently in areas like ALS, Alzheimer's, and muscular dystrophy. CBRE had Peter Marx's operation warp speed for orphan diseases is a great example of a regulatory body working collaboratively with industry to help advance the development of new drugs while maintaining high standards. All of this is likely to perpetuate faster, smoother drug development paths for biopharma. And we see a number of key catalysts in the back half of this year that could further perpetuate these advances.
Mark Odendahl
Now, let's bring Greg into the conversation. Greg, why don't you talk to us a little bit and dig deeper into some of the specific trends like diabetes, and obesity and the arms race that we've seen in those sub sectors of biotech.
Greg Renza
It's great to be here. Thanks for having me.
Greg Renza
So obesity is a widely pursued and headline indication at the moment, new competition is raising the bar for weight loss, it's giving the market new optionality, it's giving patients new expectations on what can be expected from weight loss therapy. Now, the adoption of these approved therapies for diabetes serves as a foundation, but the impact and the new science is really changing the way we think about the condition. There's the shift from contemporary single receptor agonism. To now by specifics and multifunctional roles, these approaches represent this recognition that there's an opportunity for weight loss that goes beyond just glycemic control. Now, several players are waiting in and out of the space, they're navigating what's called this heterogeneity of obesity. But they're also looking at some of these concerns around unintended effects on safety and tolerability. So although on the surface, obesity does appear to be a relatively simple disease, there is this great degree of variability out there. And this can add some challenge to both developing drugs and also managing patients clinically. And in a similar way, just looking at longer term safety, adverse events tolerability, such as nausea and vomiting, that could impact quality of life for patients and real world tolerance.
Mark Odendahl
So with any kind of source of innovation in the economy, there's ups and downs. And a lot of times in this biotech sector, there can really be binary outcomes. Greg, have there been setbacks accompanying this wave of innovation? And can you talk through that a little bit?
Greg Renza
Now, one of the flip sides of innovation is competition. That's a lot of companies pursuing similar targets and therapeutic areas. So of course, successful high potential areas do create buzz, and companies and innovators want to move into those spaces. Now, there's often room for multiple drugs in a space. But we know things are kind of getting crowded. More competitors on the market can slow launch, or even affect how we are investors view peak opportunities. That does just mean less share for everyone. And now a number of our companies have been affected by growing competition across many different spaces. Some that come to mind are lung cancer, Alzheimer's disease, schizophrenia. And in fact, we know that there are at least nine companies just focused on sickle cell disease alone. And there's going to be several competitive situations to watch over the next 12 months or so. A number of these situations do reflect this battleground between more nimble biotech and Big Pharma. So it will be interesting to see how well those less resourced Companies in biotech can hold their own against Big Pharma, both developmentally and also commercially, without really significant without really compromising their leveraging or yielding probabilities of success. In addition, we all know that looming threat of generics and increasing biosimilars. That continues to weigh on long term revenue opportunities for the space.
Greg Renza
Competition is also being felt far earlier than before, with companies now fighting for clinical trial enrollment, and also for the attention of the clinical community, even before drugs reach market. We know today the number of patients that studies are seeking to recruit has more than doubled to nearly three and a half million, which is up from about one and a half million years ago. Also, the use of some of these unique modalities means that drugs are getting more expensive to make, more challenging to give, more complexity and administration, it really means greater time, risk and cost. And we also know manufacturing is getting far more complicated today and this has been a hot topic of late since there have been some high profile regulatory setbacks due simply to manufacturing.
Mark Odendahl
What are what are some of the benefits of all this competition you're seeing in biopharma?
Greg Renza
Now, there are several benefits to competition in biopharma. Data from competitors can also serve as an additional catalytic event. Whether it's positive or negative, these read throughs can be informative and even stock moving. This is especially the case in places where mechanisms may be less validated. This competition drives new learnings, better productivity, it just leads to a greater rate of innovation. Highly competitive environments could also foster greater strategic activity, and M&A that we do note a more stringent antitrust outlook could balance this tale and innovative and highly differentiated drugs have still seen successful launches in competitive or even genericized environments. And we do note that many drugs, especially in those rare disease areas, they have actually continued to hold their market share even post generic entry. The other bottom line here is that by increasing the number of available therapies, we have more options for patients and more benefit, even on a more personalized and precise basis.
Mark Odendahl
So let's go back to Brian. And I want to go back to referencing the report that you guys just put out the halftime report and diving into the IRA, the inflation Reduction Act. What kind of impact will the IRA have on drug development?
Brian Abrahams
The IRA contains very explicit provisions about price cuts once drugs are on the market for nine to 13 years for patients who are on Medicare. While towards the end of these drugs lifecycle, drugs can typically drive revenue for 15 or more years. So it is potentially material and can in theory have a chilling effect on revenue tails for drug makers, especially in disease areas focused on older people and start to more significantly weigh on the initiation of new projects and continued development of early stage assets, particularly in the small molecule space. The administration recently formalized their efforts to expand the IRA scope, with recent details on the laws mechanism, suggesting CMS has more leeway to discount drugs more substantially. And this is not just going on in the US. Europe has also recently announced regulatory protocols that could shorten prescription medication exclusivity periods, also adding uncertainty.
Mark Odendahl
So what's been the response of large pharma? You know, the large pharma players or industry groups as it relates to the IRA and some of these regulations.
Brian Abrahams
So biopharma is and lobbying groups are taking legal action against CMS drug pricing negotiations, citing implications for innovation and long term value. There are three main avenues for legal challenge, citing the first fifth and eighth constitutional amendments. Longer term, we do see this as an uphill battle. That being said, though, we think any preliminary injunctions we might see at the end of this year or the first half of next that could delay its implementation, even temporarily, could have an outsized, positive effect on perceived revenue tails, and stocks for the biopharma group.
Mark Odendahl
M&A is obviously played a very important role in the biotech sector, as smaller companies with successful drugs get taken out. Could you give us your view of M&A and as we head into the back half of the year and into 2024?
Greg Renza
A number of large market biopharma drugs are expected to lose exclusivity. In 2023, we've estimated about $44 billion in revenue losses today, and that should grow to about 150 billion in losses by 2028. We believe the need to plug these gaps should provide greater impetus for M&A activity. And on the same token balance sheets, they've never been stronger, lots of revenue, especially post COVID therapeutics and vaccines and that cash is ready to be deployed. And with large biopharma is looking to end 2022 with record cash levels in excess of $200 billion. The firepower necessary for such deals is pretty extensive. And we believe an uptick in M&A activity. And that strategic potential could provide a much needed source of catalysts for biotech stocks that focus on growth and diversification among large caps who face these typical headwinds in the market? That reminds us of the upside that's within a potential biotech target that's ripe for an exit. And despite deal volumes, overall, they've been down versus prior years, we have seen some signs of life, and this activity is certainly picking up.
Mark Odendahl
The FTC will have something to say about that, right? So well, how do you factor in, you know, some of the recent activity that we've seen from a regulatory front and M&A into that outlook?
Greg Renza
How the FTC is unexpected actions play out will weigh on the sector. We do believe it will continue to incur some pressure on deal activity just given this inherent uncertainty. The increasing scrutiny on M&A from regulators is real, and is likely to reduce near term urgency for deals, especially for those larger ones. This is also coupled with that limited visibility this sector typically has on broader macro trends, market volatility, and the cost of capital over the year, which also could be a deterrent. Now that said, the tone and sentiment on M&A that's coming from biopharma management teams has been consistently positive throughout the year. They note their strong capital position and their desire to fuel out your innovation. And this is a major positive influence. There are high interest in those smaller call at $1 billion plus deals is meaningful. And we know that companies are willing to pay a premium. Now on those deals that are still pending, expert feedback that we've received, and even hearing from investors that we've polled and surveyed, they do see these larger deals currently under review, as likely to close which could provide a relief point to the sector. Now net-net even if there's this chilling effect on Mega mergers due to the FTC, we do see a shift in focus to earlier stage assets and companies. And this is a potential positive for the group overall, especially those small and mid-cap innovators.
Mark Odendahl
Brian, how is biotech performing relative to the broader market?
Brian Abrahams
Biotech has continued to underperform the broader market in 2023. It's now down year to date. The sector had been a big beneficiary during the pandemic 2020 and 2021. The biotech SBI index hit all-time highs, biopharmas were really benefiting from revenue from COVID vaccines and therapeutics. And they were defensive at a time where other sectors were getting crushed. During that time, a staggering two 185 biotech companies went public, but many which were early stage high risk stories are now reaching inflection points and experiencing setbacks in the past year. That's something we believe has pulled down major biotech indices, weighed on sentiment and triggered some bankruptcies and reverse mergers. And this is likely contributed also to the tighter capital window, as has a rising interest rate environment which has disincentivized investment in higher risk stories. Additionally, many larger companies have faced maturing franchises and patent cliffs that have slowed earnings growth.
Mark Odendahl
So let's put all this in the blender, everything that you've talked about. Where do we go from here? Where do you see the space going? And how would you position into 2024?
Brian Abrahams
So when it comes down to it, biotech is still a sector driven by catalysts and by innovation. Drugs that work and solve an unmet medical need tend to get adopted and paid for and tend to drive stock upside when they produce clinical results. And so we look for opportunities where people may be harping too much on the negatives for a particular name, be it competition, reimbursement, unknowns, or clinical risk, and not appreciating what the cashflow opportunity could be, especially if there's a catalyst or an event that can help level settings. We think a number of stocks, particularly in the small and mid-cap space, which has been held back of late particularly because of M&A slowing, have novel exciting pipelines and look to be trading below fair value. So opportune time to step in, especially ahead of clinical data readouts. And if we start to see an uptick in M&A again. On the flip side, we'd stay away from companies where the science isn't sound, or they're just making me toos. Among the mid and larger cap companies, we would remain owners of the quality stories given limited major downside risks that we acknowledge less enticing valuations versus last year could cap upside. But if diversification initiatives, which we should learn more about in the coming quarters, can restore confidence that these bigger companies may have second or third acts. Those are going to be the companies that are going to be the bigger winners who can actually invest their cash flows effectively into R&D and business development successfully. And that could start to broaden enthusiasm about the group overall.
Mark Odendahl
I think that's a great point to end it. You know, we could, we could talk all day on the numerous trends within the biotech sector. This is a big research team for RBC. And we're delighted to have Brian and Greg on the podcast today to talk about their halftime report.
Greg Renza
Thank you.
Mark Odendahl
And a reminder, we'll be keeping track on topics like the biotech industry right here on Industries in Motion. Until next time, thank you for joining us on this episode, recorded August 14, 2023. Be sure to subscribe are the industries in motion wherever you listen to your podcasts. If you'd like to continue this conversation, or you're interested in more information about the halftime report, please contact your RBC representative directly or visit our website www.rbccm.com/industries in motion for further insights. Thanks again and look forward to hosting you next time on Industries in Motion.