Exploring the Biotechnology Sector with RA Capital Management

Posted by bedrock on 31st May 2024

Despite an enormous amount of innovation, the biotech sector has widely lagged broader equity markets in recent years. However, an M&A surge – driven by big pharma seizing on depressed valuations in the small biotech space – is starting to catalyse a recovery. With no signs of M&A activity slowing and with rates peaking, the case for investing in biotech now looks compelling.

To delve deeper into the dynamic and evolving world of biotech investing, Ben Hancock from Bedrock’s Research team recently hosted a live Q&A with Tess Cameron and Laura Stoppel, Principals at RA Capital Management.

RA is a leading investment manager focused on companies developing drugs, medical devices, diagnostics, healthcare services, and research tools. With a deep pool of in-house scientific expertise, RA’s brand of evidence-based investing spans private and public markets and targets companies at different stages of treatment development – from pre-clinical to established commercialisation.

In this article, Ben shares important insights from his conversation with Laura and Tess and sheds light on the current dynamics in biotechnology investing.

What is Biotechnology investing?

Biotechnology investments fund companies harnessing biological processes to develop innovative products that improve healthcare outcomes. Given its development of novel technologies such as cell and gene therapies, the sector has substantial research and development requirements – but also high growth potential, though volatility can also be high.

From Start to Finish – Becoming a Leading Biotech Investor

Q: [Ben] Could you give some background on RA Capital and how it has grown to become what it is today?

A: [Tess] Our journey began in 2002 when Rich Aldrich, a founder of Vertex Pharmaceuticals, recruited Peter Kolchinsky straight from a Harvard PhD to invest in listed, early-stage life-science companies. Rich’s idea was that someone with a deep scientific understanding of companies in this area would be better placed to generate strong returns than a more traditional financial analyst. Peter was then joined by Raj Shah and after a strong two years of investing for Rich, Peter and Raj launched our flagship RA Capital Healthcare Fund in 2004. We are now one of the leading life science platforms, investing across both public and private and in everything from new-company formations through to later stage commercialised assets.

An evidence-based approach to investing remains at the heart of everything we do. Our team of 25 investment professionals is backed by our dedicated healthcare research platform, TechAtlas. TechAtlas has about 45 professionals, most of whom hold PhDs, so there are >70 people looking in depth at every investment that goes into our portfolio.

A: [Laura] Running a unified strategy that spans the entire spectrum of biotech opportunities allows us to pinpoint and seize the best-priced opportunities, regardless of their stage or status.

The Excitement of Development-Stage Biotech Companies

Q: [Ben] While you invest across all stages of the biotechnology life-cycle, you remain focused on companies in the development stage – what is interesting about this area?

A [Laura] By the time a drug is approved by the FDA, it has already had multiple rounds of validation and faced stringent regulatory scrutiny. Drugs at this stage can be great investment opportunities but the potential upside is generally lower. In contrast, pre-commercial opportunities – anything from an untested idea fresh out of academia to clinical-stage assets generating clinical data in real time – carry higher risk but potentially also higher rewards. In the pre-commercial space, we can use our specialist knowledge to dig into the deep biology of a particular mechanism or the early clinical data and try to predict how that will translate to phase two and phase three trials. If we get this right, the upside can be enormous.

In addition to financial capital, we provide strategic and operational support to our companies – be it helping with regulatory strategies, clinical trial design or identifying potential partnerships. The combination of capital, expertise, and resources can maximise early stage companies’ potential for success. Beyond this, early-stage investing is simply really exciting: there are drugs in our portfolio now being brought to market that we first started investing in when they were just a concept!

“Pre-commercial opportunities – anything from an untested idea fresh out of academia to clinical stage assets generating clinical data in real time –carry higher risk but potentially also higher rewards.”

Building Success Through Science and Strong Relationships

Q: [Ben] How do you go about sourcing early-stage opportunities?

A: [Laura] Over two decades, we have prioritised strong relationships with academia and peer investors. We also maintain strong relationships with management teams, even if we don’t invest in their current projects. When they start new companies, they reach out to us. Our reputation in the field is highly respected, which opens lots of doors.

Our landscaping approach is also key. You need a holistic view of disease areas and to understand not only where the field is today but also where it will be in 5-10 years. TechAtlas leverages 1000s of meetings each year to build landscape maps for over 100 different diseases. These maps organise all drugs in development (and those that are already commercialised) by mechanism and impact, and allow us to see what candidate is likely to be most successful, as well as where there might be gaps in the market. (You can explore some of the publicly available atlases on immune-oncology, Parkinson’s disease, and COVID-19, here)

This can really help us in, for example, new company formations. A good example is our company Aerovate, which is now listed. A number of years ago, Ben Dake, the TechAtlas associate working on PAH (pulmonary arterial hypertension), was speaking to physicians in that area and heard that there was a drug called imatinib – originally approved for treating a form of cancer – that was highly effective, but had severe negative side effects when taken orally. So he thought that if the same drug could be inhaled and delivered straight to the lungs, the standard of care could really be improved. Aerovate was born out of this idea.

Improving Prospects for Early-Stage Biotech Companies

Q: [Ben] The biotech sector has had a rocky few years, particularly smaller cap, development stage companies. However, it looks like there has been a turnaround in the past year. What are the market dynamics and how do you see things shaping up from here?

A: [Tess] There was a lot of excitement around biotech in 2020, given covid-19, and valuations rose sharply. Many generalist investors with little understanding of the underlying science have since started to withdraw their money, pushed also by rising interest rates. Valuations collapsed across the board. The sell-off was frustrating but it also created a lot of opportunities for specialists like us to buy into companies that had reached significant milestones or had unambiguously positive data at cheap valuations.

A: [Laura] The value in the sector is starting to be recognised by the broader market, but also by large strategic acquirers (i.e., big pharma). A key dynamic is the need for strategics to replace revenues they will lose from loss of exclusivity on their blockbuster drugs in the coming years (estimates are for c.$200bn of revenues to be lost from 2024 to 2028 as a result). They are shopping around for companies with compelling programmes to replace these revenues, resulting in record M&A activity. Right now, valuations and fundamentals are such that big pharma could acquire the entire development-stage universe with just four years of free cash flow, which highlights the value disconnect in the market. We expect M&A to be an important driver of returns.

‘The value present in the sector is now starting to be recognised by the broader market, but also by large strategic acquirers’

The Impact of Drug Pricing Control Policies

Q: [Ben] Drug pricing controls are always a key risk in this space and the US Inflation Reduction Act (IRA) included several provisions to lower prescription drug costs. How has the IRA impacted the biotechnology sector?

A: [Tess] The 2022 IRA permitted Medicare to negotiate drug prices directly with pharmaceuticals after a certain period post-FDA approval, instead of simply paying the average market price. For biologics (complex molecules typically derived from natural sources), the period is 13 years; for small molecules (simpler molecules, typically synthetic), the clock was set at 9 years. This compares to the c.14 years of exclusivity that we currently underwrite drugs to before they go generic. This makes it very difficult for us to invest in early stage small molecule companies that we know would be subject to these price controls e.g., those that have high Medicare utilisation (though there is less impact on biologics).

You may be asking “what is stopping further price controls from being implemented?”. We take some comfort in the fact that bills with harsher price controls have failed in the past because vocal detractors across both parties recognised the chilling effect that they can have on R&D. Unfortunately, these concerns seem to have been ignored this time but we continue to illustrate the ramifications to policymakers and hope that that the policy will ultimately be changed. However, in the meantime, we continue to focus our efforts on areas that will be less affected. It is also worth highlighting that this policy could accelerate revenue losses for big pharma, acting as a further tailwind for M&A activity.

‘It [the Inflation Reduction Act] has made it very difficult for us to invest in early stage small molecule companies with Medicare utilisation.’

How to Tackle Healthcare Affordability

Q: [Ben] What do you think is the best way of tackling healthcare affordability concerns if not through drug price controls?

A: [Tess] We believe that affordability is really a function of insurance. Insurers can make a cheap drug expensive or an expensive drug cheap, and we see this all the time in the US, with patients sometimes being charged $10+ for a generic pill that costs 50c. One of the positive elements of the IRA is that it actually offers a roadmap for insurance reform that could tackle this. Notably, it caps Medicare patients’ out-of-pocket expenses at $2000 annually, spread evenly throughout the year. As for drug pricing, there are already market mechanisms to ensure that drugs are priced appropriately and in line with the value they bring to society. But reducing the price of an expensive drug will only reduce the out-of-pocket expense for the patient if the insurer passes on this saving. So we believe that insurance reform, supported by the market mechanisms already in place to control drug pricing, is the best way to tackle healthcare affordability.

‘We believe that insurance reform, supported by the market mechanisms already in place to control drug pricing, is the best way to tackle healthcare affordability’

The Future of Biotech: AI & Innovation

Q: [Ben] Why should investors be excited about the future of biotech?

A: [Laura] There is lots to be excited about! Artificial intelligence and machine learning have always been an important part of the drug development process but there are now new ways that the industry is looking to leverage it. For example, there are companies that are analysing previous clinical data and trying to assess why a particular drug may have failed; was it because the drug itself wasn’t optimal, or was there some unseen issue with the patients selected for the trial? If AI could be used to improve patient selection in trials, this could increase the probability of a drug being approved.

There is always a lot of innovation happening but two particular areas that we have been following very closely are metabolism and auto-immune disease. In the obesity space, GLP-1s have been completely transformative for patients suffering from obesity, but there are still issues with the drugs themselves and a large unmet need. So we have been looking at orthogonal approaches that tackle obesity by increasing the metabolic rate instead of suppressing appetite. This approach actually led us to investing in a company called Rivus. On autoimmune diseases, there has been a constant evolution of treatment methods over the years but the issue that remains is that these diseases require long-term treatment. However, there was an interesting paper published recently that said that if you could take a cell therapy approved for oncology and give it to a patient with lupus nephritis, there could potentially be a cure. These developments showcase the broad applicability and transformative potential of biotech innovations, making it an exciting field for us all to participate in.

Conclusion

From the discussion with Laura and Tess, there are 4 key takeaways for those considering actively investing in the biotechnology space:

Importance of Expertise: An understanding of the science underpinning biotech companies is key to investing successfully in the sector.
Volatility Creates Opportunity: Indiscriminate sell-offs driven by external factors can provide opportunities for expert investors to pick up innovative biotech companies at a discount. Having a flexible and multi-stage strategy can allow you to capitalise on the best opportunities, wherever they may lie.
M&A Activity Should Remain Strong: Long-term dynamics – namely the need for large pharma to refresh aging drug pipelines – alongside attractive valuations should continue to support elevated M&A activity and a recovery in biotech equities.
Insurance Reform is Key to Tackling Healthcare Affordability: Policies that target drug pricing can have a limited impact on reducing the cost of healthcare borne by the patient, while also threatening to strangle investment and innovation. Insurance reform, focusing on capping out-of-pocket expenditures, would be a more effective approach.

If you have any questions about the themes discussed in this article, please do not hesitate to get in contact with us at info@bedrockgroup.ch

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