Biotech’s Comeback: AI, M&A, and Innovation Drive New Growth

The biotech industry has been on a rollercoaster ride over the past few years. The success of Covid-19 vaccines demonstrated its ability to innovate, leading to record investment and driving stock prices to all-time highs. But then the industry was hit by rising inflation and high interest rates, causing it to fall out of sight for most investors.

However, the biotech sector is poised for a comeback. With the Federal Reserve cutting interest rates and a market ready to expand beyond Big Tech into previously neglected industries, new opportunities are emerging for investors.

Valuations for biotechnology are very attractive. The Russell 2000 Biotechnology Index, a good indicator of small to mid-sized biotech companies, is still 50 percent below 2021 highs despite healthy long-term fundamentals for the industry.

AI leads to golden age of medical innovation

The healthcare industry will experience a boom in the coming decade. And a significant part of this will be driven by innovations in biotechnology. As people as a whole become older and wealthier, the demand for new therapies will increase – not least to treat diseases associated with ageing (e.g. cancer) and affluent society (e.g. diabetes).

In recent years, promising drugs have been developed and groundbreaking therapies approved for many disease areas. 2024 saw significant progress in the treatment of obesity with the introduction of GLP-1 drugs. The next generation of innovative therapies is on the verge of breakthrough, such as GLP-1 combinations, oral GLP-1 drugs or amylin-based therapies. The initial data are promising and could further improve efficacy and tolerability in weight loss, and the field remains one of the hottest areas for clinical trials and investor interest.

Another exciting area is cancer drug development, driven by new technologies and better scientific understanding. Promising advances include antibody-drug conjugates (ADCs), which combine a drug with an antibody that specifically targets tumor cells without harming healthy cells.

Bispecific antibodies can bind to not just one but two different cell types (for example, a cancer cell on one side and a T cell on the other) to trigger an anti-tumor response. In addition, improved technologies for cancer diagnosis, such as liquid biopsy, can identify tumor DNA circulating in the blood, improving early detection and prognosis of cancer.

At the same time, the advent of advanced AI and other cutting-edge technologies is increasingly enabling the development of tailored therapies. We expect the biotech industry to be by far the best placed to benefit from AI, not least because it is an early adopter – there are already around 1,500 providers of AI in healthcare – and because the industry has generated vast amounts of data and models on which to train AI systems.

AI has already made progress in discovering potential cures for chronic diseases and accelerating drug development. In the last few years alone, Meta’s AlphaFold and competitors have predicted 600 million protein structures critical to drug development. In contrast, in the 50 years before AI, only around 200,000 were discovered.

This dynamic, driven by AI, could usher in a golden age of medical innovation in which biotechnology takes a leading role.

Biotech M&A as a response to expiring patents

Such innovations are an important way for the pharmaceutical sector to circumvent the problem of patent expiration, which will result in around 150 billion US dollars in lost sales in the coming years. This is a strong incentive for large companies to invest more in research and development – but also in the acquisition of small, innovative companies. This brings us to another key growth driver for the sector.

M&A activity in Europe and the US has reached record highs in 2023, and we expect activity to remain strong over the medium term. Large-cap pharmaceutical companies have a lot of cash on their balance sheets to deploy, and the patent cliff provides a strong incentive for them to leverage the capital. With markets tending to price in the prospect of declining revenues well before actual patent expiration, it is critical for companies to act now to identify new pipelines to support future revenues.

The acquisitions are particularly attractive now given the cheap valuations. For us as asset managers, the M&A boom offers an opportunity to generate alpha as some of our investments are bought up by larger companies at significant premiums. Thanks to its focus on small and medium-sized companies, Pictet AM’s biotech strategy is optimally aligned with this theme. Since the beginning of 2023, eight of the companies in our portfolio have been acquired at premiums between 30 and 100 percent.

Biotech sector makes comeback with high-quality IPOs

We are also seeing renewed interest in biotech investments, both in the public and private markets, which should further strengthen the sector. In the first half of 2024, the biotech sector secured $29 billion in public funding – a 72 percent increase year-on-year, driven by high follow-on issuance.

The number of IPOs also continues to show signs of recovery from the lows of 2022 – albeit at a much slower pace. This indicates renewed investor interest. Crucially, the newly listed companies are of significantly higher quality compared to the IPO boom of 2020/2021. Despite potential turbulence from short-term macroeconomic developments and the presidency of Donald Trump, biotechnology remains one of the most attractive sectors for investors. Driven by groundbreaking innovations and attractive valuations, the sector continues to offer significant growth potential.

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(Featured image by Louis Reed via Unsplash)

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