The biotechnology and pharmaceutical industries have been the most fashionable sectors of the past couple of years. The market has this idea that, much like technology companies in the late 1990s, any biotech or pharma company could be the next one to skyrocket. If it discovered a cure for cancer or Aids, for example, the stock price of one of these companies would soar. The problem, however, is that retail investors’ lack of knowledge of the nuances of these complicated industries is keeping many of them from investing.
While portfolio managers and hedge fund traders generally understand the issues specific to the bio-pharm industry, this isn’t true of less sophisticated investors. Many of them are unaware of most of the factors that are ideologically and financially central in determining the long-term success of these companies.
This poses an interesting challenge for IROs working for bio-pharma companies because they have to explain the very involved microscopic facets of the industry in a way that is both efficient for them and comprehensible to the investor. Understandably, the research these companies are involved in is often too complicated to explain to every investor in much detail. But there are some important ideas that need to be communicated that I feel often get overlooked.
Firstly, even quite advanced investors don’t understand the difference between a biotech company and a pharmaceutical firm; in an age of increased partnering between the industries, their differences have blurred. But it’s important to explain the added value each type of company brings to a partnership. Biotech companies have the precious pipelines and pharmaceuticals have the marketing capability to advertise and promote the drugs and technology that issue from those pipelines. While each firm has its own pipelines and marketing ability, partnering allows each to take advantage of the other’s strengths – as seen in Amgen’s acquisition of Immunex in 2002, for example.
Determining value
Another aspect that is important for an IRO to explain is the complexities of revenue-splitting that results from partnerships, and how this can drastically affect a firm’s bottom line. It’s difficult to assess the value of biotech or pharmaceutical companies on their own but once you combine the two in a partnership, it gets even more complicated.
A biotech company is inherently valued on its technology pipeline and its future revenue stream. Future revenue is predicated on assumptions about which pieces of technology will become mainstays in the industry. Similarly, pharmaceutical companies are valued on the basis of which drugs in the pipeline will make it through pre-trial clinics and finally receive New Drug Application approval. While this is all standard in the industry and easily explained, it is not commonly known and understood by investors. What’s more, investors are unaware of the cost of insuring against litigation for patent infringements and merger-related expenses, in addition to the basic cost of building a pipeline.
Because the level of experience and understanding – both in general investing and investing in the bio-pharm industry – varies a lot from person to person, IROs have a large responsibility to gauge each investor separately. However, as the sector gets hotter and hotter, more and more people will be blindly plunging in with the hope of striking gold. They will need extra guidance not only because of their limited knowledge but also because of the complexity and uniqueness of the industry. The facts above are simple but central enough to biotech and pharmaceutical companies that knowing them will allow investors to decide whether the companies they are exploring fit their risk tolerance.
Investors must understand that the industry is in a period of consolidation and change, and there are many who doubt the near-term tangibility of the fully integrated pharmaceutical company model. That said, optimism in the industry will undoubtedly prove correct in some biotech and pharmaceutical companies. Picking the right firm is always important when exploring a sector, but it’s especially important here. By explaining the basics and guiding investors toward sources where they can do their own research, IROs will lend clarity to a very complex industry.
