Prepare For A Season Of Biotech Buyouts

Big Pharma relies heavily on acquiring small pharma drug assets to stock their pipelines with promising drug candidates. Starting in the mid-2000s, pharmaceutical giants went on a buying spree that totaled > $900B over 30 mega-deals (>$10B), and culminated in some of the biggest purchases in history (namely, the $81B acquisition of Allergan by Actavis in 2015 and the $78B purchase of Celgene by Bristol-Myers Squibb in 2019). To put this in perspective, the total dollar value almost doubled the volume of purchasing in the previous 10-year period.

So what influences deal-making behavior in the biotech space, and how might this play out in this unusual market environment?

The economics of deal-making are driven by three main factors:

1. Big Pharma’s need for novel drugs, which is influenced by the expiration of patents protecting their proprietary drugs from competition
2. The valuations of potential acquisition targets (i.e. small biotechs, both private and publicly traded), which is influenced by both market sentiment (i.e. human psychology) and company fundamentals (i.e. the strength of their drug development pipeline)
3. The amount of “dry powder” (i.e. cash) that Big Pharma has to spend on R&D and acquisitions

Let’s tackle each factor one-by-one.

Patent cliffs

Patent cliffs refer to the widespread expiration of patents in the industry. Patent protection gives on average 20 years of “market exclusivity,” during manufacturers make all of their revenue. Once patents expire, generic drug products flood the market and the proprietary drug manufacturers kiss their revenues goodbye. There is an imminent patent cliff in the industry which will wipe out over $230B in annual revenue from the loss of sales exclusivity between now and 2030 (this is more than half the revenue of the top 10 Big Pharma companies). We can expect more than 190 proprietary drugs to lose their patent protection within the next 8 years, eliminating up to 80% of revenues for the most “exposed” companies. The last patent cliff occurred in 2008, which spurred deal-making activity in the years thereafter. Clearly, Big Pharma will need to deepen their development pipelines now to prepare for this major hit to their future revenues.

Target company valuations

Something is only worth (i.e. it’s “valuation”) what someone else is willing to pay for it. This is a universal truth that influences everything from Pokemon cards to Bitcoin to entire corporations. Valuations are influenced by both market psychology (e.g., “FOMO,” fear of missing out) and company fundamentals (e.g., annual revenues, the strength of patent portfolios, research and development progress). In the last few months, we have seen a huge resurgence in the valuations of biotech companies, with the biotech index (XBI) outperforming the general market (S&P) by more than 2x over the past month. This is due in part to the obscene pessimism that destroyed all tech stocks in 2021 and the solid progress that many early-stage biotechs made during the last 12 months. Still, biotech stocks have fallen over 44% since their Feb 2021 high, and many of them are grossly undervalued at their current valuations. Tremendous buying opportunities are going to emerge from the pits of this bear market, and Big Pharma will certainly take advantage of this massive buying opportunity before valuations “correct” to more appropriate, higher levels.

Cash on-hand

For obvious reasons, a biotech buying spree is contingent on the amount of cash that Big Pharma acquirers have ready to deploy (also known as “dry powder”). The total amount of cash on-hand for the top 20 Big Pharma companies totals ~$300B. To put this in perspective, the total value of all publicly-traded mid-cap biotech companies (market cap under $5B) was $350B as of May 2022. This means that Big Pharma could purchase almost every mid-cap biotech in the public market. That’s crazy. Big Pharma has the cash on-hand to acquire promising, young companies with novel drug assets, now they just need to parse through the buying opportunities.

Mergers and acquisitions in 2022

The first half of 2022 has been off to a great start. Over $90B was spent on 481 deals in H1 2022, a decrease from the record dealmaking in 2021 but still ahead of pre-pandemic activity (37% increase compared to H1 2020). Pfizer has been a major player due to the revenues from their COVID vaccine and Paxlovid. The company is sitting on $21B cash and recently purchased BioHaven for $12B (which will add $6B annual revenue to Pfizer’s top line). Johnson and Johnson just lost a bidding war on Global Blood Therapeutics to the pharmaceutical giant, who purchased the sickle cell company for $5.4B. Many other deals are currently being negotiated, and we will likely see a large uptick in mergers and acquisitions in the coming months.

What does this mean for Cytonics?

The dealmaking forecast bodes well for us, as cash-rich Big Pharma companies look to spend their cash reserves (which have been largely untouched during the pandemic) to acquire novel, proprietary drug products that will replace the ones they lose upon patent expiration (by 2030). The goal of startup biotechs is to de-risk the development of their drug assets by getting human clinical data and then soliciting interest from larger pharmaceutical partners to complete the drug development. This is exactly what we are doing. With an imminent Phase 1 clinical trial on the horizon, we will begin to build relationships with Big Pharma and keep them apprised of material developments. We have a pre-existing relationship with Johnson & Johnson Development Corporation (J&J’s venture capital division) and keeps them looped into the company’s developments. This relationship will be critical once the competitive bidding process begins for our lead drug candidate, CYT-108, a treatment for osteoarthritis.

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