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How to navigate the biotech investment downturn: Get back to basics

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The bubble has burst, but the party is not over. In fact, some would say it just took a break. The leading index fund of biotechnology stocks (XBI) has lost more than 60% of its value from its peak in February of 2021. This has negatively impacted investor returns and stalled investment into the capital-hungry companies in the sector. With hindsight being 20/20, this, perhaps, should be of no surprise.

But what about looking forward? Is the future bright for biotech investment dollars—as bright and promising as the science, innovation, and talent would indicate? The answer is decidedly yes and despite the fact that life sciences and biotech companies face increasing competition for investor attention and dollars, there is much to be optimistic about.

Biotech gold

Biotech’s multi-year success in attracting investment dollars was supercharged by the pandemic and the sector’s development of the Covid vaccines and therapies. The speed of development and success of these solutions showed the world the importance and strength of biotech. The face of biotech and pharma got more than a makeover. This not only attracted the capital of traditional biotech investors, but it also attracted an influx of capital from generalist and retail investors, which contributed greatly to this boom.

Over the last year, this new investor base started to realize that biotech is not a day trader’s dream—but instead, it’s a long-term investment that is accompanied by ups and downs, often more extreme than in other sectors. Additionally, navigating the emerging biotech landscape requires more than the ability to follow the herd—namely, an astute understanding and appreciation of the high science behind the investment. In other words, picking a “winner” isn’t easy without deep technical expertise. As they say, all that glitters is not gold, and this is true in biotech as well.

In time, as other industry sectors came back to life, investors started looking elsewhere. This, coupled with end-of-2022-tax-loss selling—and more recently, the constant cadence of interest rate increases—resulted in investors moving away from high-growth stocks into bonds and other “favorable” instruments. The result? Plunging biotech valuations and emerging biotech’s access to new capital becoming increasingly more difficult.

Market correction

Licking their wounds, stalwart (and wise) investors began to divest themselves from the all-in/all-out herd mentality that partly fueled the early boom and quasi-bust and started to ground themselves in the science behind these companies and their work. The flush of earlier momentum matured into a more tempered and diligent investing process.

In addition, gun-shy investors became increasingly interested in de-risked, late-stage biotech assets, which created a vicious cycle where emerging biotech companies found themselves scrambling to find the capital necessary to fund the clinical trials needed to produce the safety and efficacy data that was now in demand.

There is hope—in fact, a lot of hope.

Survival of the Fittest (aka innovative)

Emerging biotech companies that weather the current drought of investment dollars will survive by first and foremost having “the goods”—excellent science that will withstand the tests of the development process to benefit those in need. Thereafter, teams build great companies, and hallmark features will include thinking outside of the box, getting rid of waste, and focusing on the basics.

The basics

Management teams will need to become razor sharp on how they communicate the science and potential behind their early stage assets and then package that information in an effective and compelling way. Successful companies will be made up of leaders who work deeply on their communication skills and actively leverage their relationship networks instead of passively relying upon an IR firm to do the work. This sharpness must also be used to define the critical path to the value-creating milestones and doggedly sticking to it. For example, questions such as, “What is the mechanism of action?” in this day and age should be met with, “The compound works and it is safe, and we may backfill that understanding later.”

Thinking outside the box

Today’s landscape requires attracting alternative sources of funding. Patients are our customers, not investors. Thus, one such place to look would be disease foundations. The Cystic Fibrosis Foundation pioneered this model, with other foundations following suit. It is a natural fit for both company and foundation not only from a market alignment perspective, but also from a subject matter expertise perspective, and it also offers the foundation a potential wellspring of ongoing sustainability.

Another alternative source of funding is from an economic development perspective. Many countries, for example, want to include biotech as an economic pillar. Emerging biotech companies that embrace non-traditional stakeholders will be better positioned to weather the downturn and cultivate a new and clear mindset about who ultimately—in addition to investors—gains value from their efforts.

Getting rid of the fluff

Biotech often outsources a number of functions—due by necessity to lack of resources to integrate vertically—to contract manufacturing and research organizations that charge a premium for their services, modeled after their big pharma contracts. Reevaluating those providers and the associated contracts can save millions of dollars.

The takeaway

There is no arguing that the last year has been a rocky one for biotech companies, but trends suggest that the sector is ready for an upswing. The revenue model works, innovation continues to bear fruit, and the need is ever-present. The harsh winter will result in a hearty harvest.

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