Fortunes made in biotech

The costs and risks are high, but the little understood biotech sector can provide impressive returns if all the hard work pays off

Biotech is an exotic asset class, evoking images of vials and white lab coats. This image parallels the complexity of the subject matter, which lies far beyond the comprehension of the lay investor. For most of us, investing in biotech betrays the tenets of legendary investor Warren Buffett, who preaches the importance of understanding what you’re investing in. “Buy a stock the way you would buy a house,” he says. “Understand and like it such that you’d be content to own it in the absence of any market.”

But there is another side to this coin. Avoiding biotech altogether means missing out on attractive returns. CSL is a case in point. Had you invested $10,000 in CSL at its initial public offering in 1994, you’d be sitting on more than $1.2 million pre-tax.

Investors face a conundrum: invest in something that’s hard to understand and fraught with risk, or miss out on potentially stratospheric performance.

Biotech is particularly obscure – just read the reports detailing the results of drug research phase trials. For this reason, biotech investment professionals – few and far between in Australia – typically hail from scientific rather than finance backgrounds.

Scientific jargon can be a turn-off

Bianca Ogden is a case in point. She manages the Platinum International Health Care Fund, equipped with a doctorate in virology and experience at Johnson & Johnson developing drugs targeting colon cancer and at Novartis looking into HIV drugs.

“In my office, people look at me and think I’m from

a different planet,” says Ogden. It’s by necessity. The companies she’s investing in are run by people from that planet.

“The people in charge of biotech companies often have a scientific background and the jargon that comes with it, and that’s foreign to regular investors,” she says.

Perhaps this is why investment in Aussie biotech is comparatively low. But that’s not to say the sector doesn’t have potential. Rather, it’s underused.

A 2019 survey by financial advisory firm Grant Thornton found that support for Aussie biotech drains away as product development moves from public institutions to commercialisation.

“Extracting [biotech] technology from universities into the start-up environment was seen as hampered by a lack of experience and knowledge available. This is compounded by the lack of awareness of the process itself. This support gap directly impacts the early investment required for biotech SMEs to flourish,” says Ogden.

“Australia has biotech potential, but the correct funding environment isn’t really there.”

Getting a drug to market takes money and rigorous science, and you can’t have one without the other. Without funding, the science can’t progress, but without the science the funding doesn’t come, she says.

“The Australian financial sector does not have the patience or understanding of the industry that we see in other countries,” says the Grant Thornton report.

Battle to raise finance

Biotech investment in Australia was given a leg-up in 2011 with the introduction of the research and development (R&D) tax incentive, which provides companies with a tax offset for eligible research and development costs. Yet its scale remains small.

According to a submission to the Senate by the accountancy body CPA Australia, in 2016-17, one million companies paid a total of $74 billion in corporate income tax. However, there were only $2.7 billion in non-refundable R&D tax offsets and 10,638 companies claimed, suggesting that R&D is undertaken by relatively few Australian businesses (see graph).

While this incentive has provided a small sugar hit to biotech, the industry still faces a challenge gaining government support.

According to a 2017 report by the McKell Institute, “there’s a perception amongst the industry that politicians do not understand the realities of biotechnology research and development”. One respondent lamented “biotechnology is only a narrow and very misunderstood sector of the medical industry. I suspect the policymakers have little or no idea what the biotechnology industry is.”

Still, Australia’s lack of funding is largely a function of the risk inherent in drug development, which is in turn a reflection of how difficult it is to get the science right.

‘ “In my office, people look at me and think I’m from a different planet”

‘ An easier option is to invest through a managed fund or ETF

“For every 1000 drugs that begin clinical trials, only one will actually make it to market,” says Iain Wilkie, from stockbroker and wealth management firm Morgans.

It’s a war of attrition – to progress to market, drugs need to win multiple battles of both science and finance. Add to this the sheer length of time it takes to bring a drug to market. Product pipelines can stretch as long as 15 or 20 years. “Investors want a six-month time horizon before seeing returns and that’s unrealistic in the biotech sector,” says Ogden.

There’s drug discovery, clinical stage design, three phases of trials, approval by the pharmaceutical regulator, manufacture and finally distribution.

Costs are staggering

“Today delivering authentic healthcare innovation worldwide is more challenging and complex than ever. It demands a sharp focus on what customers need,” says Clive Meanwell, chief executive of The Medicines Company. “It requires the development and delivery of data, knowledge and products that make a difference.”

Each stage requires finance. US research group PhRMA estimates that the research and development of a successful drug costs a staggering $US2.6 billion ($3.6 billion). And it doesn’t come in one hit.

“Say a company raises money to do one trial; they’ll have to raise again for subsequent trials,” says Ogden.

In addition, drug companies need to have the ecosystem in place not just to fund and develop a drug, but also sell and distribute it.

“If you’re going into an established market, you need a strong market entry plan to displace some of the incumbents, or at least show the benefits over an existing product, which is quite hard to do,” says Wilkie. “If you’re going for a new product, you need to be across the supply chain – do you have a sales force?” And drugs can look promising and still fall flat. “Pfizer had a breast cancer drug everyone thought would work, but it didn’t, and the stock dropped,” says Ogden.

Avoid the flavour of the day

But it’s more than just science and funding. The role of people in biotech companies can’t be discounted.

“You can’t predict whether a drug will fall over; it comes down to understanding the science, the technology, but also the people,” she says.

“The first thing is to look at the board and their record of success,” adds Wilkie.

If there’s internal belief in a drug, more resources will be poured into it. In this way too, biotech managers are similar to fund managers in the sense that they pick and choose where to invest the company’s resources.

It’s also worth steering clear of the flavour of the day. A few years ago it was marijuana; today it’s Covid-19.

“You saw it with marijuana, cryptocurrency and now Covid,” says Wilkie. “I tend to steer clear when I see a company pivot to the thematic of the day.”

Ogden agrees. “It can be good if you’re already invested in the thematic when it heats up, but you don’t want to go chasing it,” she says. “In the end it’s better to go against the crowd, because you’ll always find something much more interesting and cheaper. It’s better to do your own work, find something new, and go on a journey with it.”

For the investor who doesn’t have all day, every day to find something new or novel, an alternative way to gain exposure to biotech may be to seek out other areas of the supply chain.

“If you look at how this coronavirus vaccine will be made – that takes glass vials, syringes, etc. Manufacturing has also become modular and digital,” says Ogden. “Those areas are a lot less risky and more easily understood.”

According to Grand View Research, the global pharmaceutical glass packaging market size was estimated at $US14.27 billion in 2018 and is anticipated to expand at a compound annual growth rate of 6.4% over the forecast period. That’s before Covid-19 hit. Supplying a vaccine, when and if it comes, to the global population will take a lot of glass vials.

An easier option may be to invest in a managed fund, such as the Platinum International Health Care Fund, or an exchange traded fund. ETF options listed on the Australian stock exchange include the iShares Global Healthcare ETF (IXJ), the BetaShares Global Healthcare ETF (ASX: DRUG), and ETF Securities’ ETFS S&P Biotech ETF (CURE).