October 2021 / U.S. EQUITIES
Sector Insights: The Three Drivers of Innovation in Biotech Stocks
- Advancements in research tools, increasing investment capital, and a maturing contract research and development field are driving biotech innovation.
- The net result of having better tools, more money, and more advanced capabilities has been the emergence of unique therapeutic modalities.
- Our sector analyst is leveraging his scientific background to identify investment opportunities that he believes will shape the future of medicine.
We are in an amazing period of innovation within the biotech industry. It is being driven by a deeper understanding of biology and better elucidation of the basis of human disease. Similar to the advantages of high-definition television, better resolution of human biology is enabling the design of more effective therapies, which are resulting in better outcomes for patients.
I am an immunologist who spent years in the lab studying autoimmune diseases. In 2014, I joined T. Rowe Price to become a biotech analyst. The role lets me leverage my deep scientific training while looking broadly across the therapeutic landscape to identify investment opportunities which will help shape the future of medicine.
I see three factors responsible for driving innovation in the sector. Generally speaking, these are technological advancements in research tools, which are facilitating discovery; an increasing supply of investment capital, which is funding the development of new therapeutic approaches; and a maturing contract research and development field, which is lowering the bar to company formation and helping to democratize drug development.
Collectively, these factors are enabling innovative approaches, resulting in new company formation and investment opportunities. For instance, modalities such as cell therapy and gene therapy are providing cures for patients who otherwise would not have had treatment options just 10 years ago, while emerging approaches such as targeted protein degradation and RNA-based therapies are just beginning to show their promise. The efficiency with which COVID vaccines were developed using mRNA stands as a testament to the promise within the sector. The wealth of new technologies and their potential application bodes well for the long-term prospects for investment in biotech, and over the next 10 years I expect that we’ll see many more transformative discoveries.
Let’s dive a bit deeper into why I think these developments are notable.
First, the effects of the advances in research cannot be overstated. New and better research tools are accelerating the pace of discovery and enhancing our ability to resolve complex biology. And as resolution of the underlying biology improves, drug developers can use that information to generate novel approaches to treat disease. For example, while it took nearly 13 years and $1Bn to sequence the first human genome, that process can now be completed in less than a day for only hundreds of dollars.
Since starting the Human Genome Project, we’ve learned that a person’s genetic code may only reflect a fraction of the risk of developing a disease. As such, newer techniques that measure how genes are regulated (called transcriptomics) and the levels of protein expression (called proteomics) are being deployed to increase the resolution of these factors in healthy and diseased states. Given that we can collect and analyze these data on thousands of individuals in parallel, we are making breakthroughs in the understanding disease biology.
We are also seeing new research tools emerge that are enhancing our ability to test scientific hypotheses. For instance, the discovery that CRISPR and Cas9, which are components of the immune system of bacteria, can be used to cut DNA in a directed way is being used by scientists to interrogate the role of specific genes in biological processes in ways that would have previously taken years to determine. Advances in microscopy techniques are enhancing the ability visualize proteins in their native state and enabling more precise measurement of protein structure. Since highly effective drugs interact with their protein targets with very specific geometry, a high-resolution view of the protein structure can facilitate more precise drug development.
Another big driver of innovation has been the capital markets, which have generously supported early-stage biotech for the last several years, enabling new technologies and approaches to advance. Successful biotech companies will take many years to develop their first product and begin generating revenues. Thus, in order to fund their development costs, they rely upon selling equity to investors. Early on, equity sales are done in the private markets where money is supplied primarily by venture capital investors. When those technologies are matured, usually by generating proof-of-concept data in animal studies or in humans, those companies attempt to access the public markets through an initial public offering. This process has been particularly robust for the last several years. We’ve also seen additional biotech companies founded by venture investors at a similar pace to what’s occurring in the public markets. The trend of new company formation has been increasing over the past several years but has been accelerated by the COVID-19 pandemic, which has shone a spotlight on some of the innovation within the sector and has drawn even more investment into early-stage biotech. Many companies which lack proof-of-concept data have received significant funding to develop their technologies as investors have looked for more innovative ideas to fund.
But ultimately this funding environment presents the biggest challenge within the sector, namely that there is a growing number of highly technical companies with largely idiosyncratic risk that are fighting for limited mindshare amongst investors and competing in overlapping domains. Having a scientific background helps me to understand some of the nuances of the programs and often helps me to access the complicated biology being addressed. There still is a significant amount which remains unknown as companies forge a new path, and therefore it is important to be humble about the limits of your knowledge.
The last big enabler of innovation is the democratization of drug development made possible by artificial intelligence and machine learning, as well as maturation of the contract research (CRO) and contract development (CDMO) sector. Artificial intelligence and machine learning are being leveraged to both expedite discovery and improve drug design with the potential to provide better selectivity and safety than has been achieved previously. CROs and CDMOs have made it easier for companies to outsource research and development activities. Early-stage science can be carried out by professional contract research organizations, allowing new ideas to be tested and validated in a capital-efficient manner, which lowers the risks behind early-stage science. Innovators with promising ideas don’t need to hire full teams and form companies to test promising ideas. Lastly, many early-stage companies leverage CDMOs to manufacture drugs early in development so that they don’t need to build out internal manufacturing, soaking up valuable capital.
The net result of having better tools, more money, and more advanced capabilities at an early stage in the company life cycle has been the emergence of unique therapeutic modalities.
Take gene therapy, for example, which has the potential to correct monogenic diseases. There are more than 5,000 distinct human diseases that are caused by a mutation in a single, specific gene. When the specific gene is mutated, it results in a nonfunctional protein, which can give rise to an incurable disease. In many cases, there are no treatment options because the protein which is mutated is essential for cell survival and cannot be replaced. Gene therapies leverage the natural ability of a virus to get inside of a human cell to deliver a healthy copy of the missing gene and restore functional protein expression. These early approaches have been cultivated in labs within academic centers, which don’t have the financial resources to turn these scientific discoveries into real therapies for patients. These discoveries need to be recognized by venture capitalists who provide initial funding to form companies around these ideas. With capital, these newly formed companies can begin leveraging contract research and development organizations to help run clinical trials and focus on building out FDA-quality drug manufacturing without the need for full teams of researchers, ensuring that these therapies can continue to progress.
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