The biotechnology sector has matured significantly since the first companies were started in the United States ("US") in the 1970s. Its principal benchmark, the NASDAQ Biotechnology Index, comprises 143 companies with a combined market value of $900bn as at 31 August 2015. The Index contains a number of companies with market capitalisations of greater than $10bn. Drugs developed by biotechnology companies generate tens of billions of US dollars in sales annually. Approximately two thirds of all new drugs currently being approved by the US Food and Drug Administration ("FDA") have originated at biotechnology companies, rather than their more traditional large pharmaceutical company counterparts.
The ultimate driver for the biotechnology sector, as with the pharmaceutical sector, is the requirement for more effective novel drugs to treat the rapidly growing number of people afflicted by highly complex diseases, such as diabetes, cancer, heart and lung diseases associated with living longer or unhealthier lifestyles. At the same time, rapid advances in the understanding of human molecular genetics are also enabling the development of new drug treatments for highly debilitating early-onset diseases caused by relatively rare inherited genetic profiles.
According to the Centers for Medicare and Medicaid Services, spending on healthcare in the US – for the time being the world’s largest healthcare market – topped $3.0 trillion (17.4% of GDP) in 2014 and on current projections is set to grow to $5.4 trillion (19.6% of GDP) in the 10 years to 2024. Under President Obama’s recent healthcare legislation, the US’s insurance based system is set to be expanded over the coming years to cover a greater proportion of the population, further enlarging the market.
Although the larger pharmaceutical and medical device companies are striving to deliver more effective healthcare products, their in-house research and development ("R&D") investment is struggling to meet the challenge. At the same time, the profitability of many of their branded drugs is being damaged by generic competition. The larger companies have become increasingly dependent on the innovation of their smaller biotechnology and emerging medical device counterparts, accessing new products through high value licensing deals or merger and acquisition ("M&A") activity.
Investing in smaller biotechnology and emerging medical device companies carries higher risk than their larger peers since earlier-stage companies typically have fewer products and more modest cash resources. Product successes or failures can therefore have a very significant effect on the prospects for these companies. While the odds are stacked against success in new drug development, the rewards for successful companies are very large, particularly for highly effective drugs and devices that treat largely unmet medical needs. This combination of high risk and high reward can create high variability in investment valuations.