November 6, 2020 UW Finance Association Biotechnology Industry Primer Industry Research Research and Education

Biotechnology Industry Primer

All amounts in $US unless otherwise stated. Authors: What is Biotechnology? Amogh Rajpal, Kyu Min Shim, William Wang Biotechnology is one of the strangest, riskiest, and potentially Research Analysts highly rewarding corners of the market. This industry has an Editors: aggressive agenda for R&D due to the scientifically intensive Ben Rawlings, Nipinder Ghuman operations of its companies. Co-VPs of Research and Education

Biotechnology is the development of new drugs that utilize novel and innovative biological methods and clinical research to treat diseases, usually of severe nature or with high unmet needs. Biotech drugs can be classified as biologics, drugs manufactured using biological processes, i.e. cellular therapies, gene editing, gene therapies, antibodies, RNA etc., or as small molecules, i.e. synthetic chemical compounds that are usually easier and cheaper to manufacture. Biotech drugs are often characterized by their lengthy development time, as it can take years to decades for a new drug from the discovery stage to obtain approval. Moreover, there is a significant chance of failure as most development drugs do not reach the counter. Therefore, R&D is the lifeblood of the industry, paving the way for new market segments and product lines and driving investments and profits.

Albeit similar, biotechnology is not to be confused with other pharmaceutical industries. Most biotechnology firms burn through hundreds of millions of dollars until a product has been commercialized, and they may have insignificant revenue. By comparison, large pharmaceutical companies typically have diversified product lines and revenue generating products, and more stable financial conditions. Specialty pharmaceutical companies are in the business of selling generic or repurposed/reformulated versions of drugs that have already been approved, saving companies the hefty R&D costs.

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Exhibit 1: See below the price movements of the S&P 500 (SPX Index), and NBI (NASDAQ Biotechnology Index) between November 2010 and October 2020. Over the 10 years, the biotechnology industry has almost doubled the performance of overall market.

Price on October 22, 2020 SPX Index 3453.49 NASDAQ Biotech index 4276.11

Main Players

Abbvie (ABBV) – Market Capitalization: $149.29 Billion

AbbVie Inc. discovers, develops, manufactures, and sells pharmaceuticals in the United States, Japan, Germany, Canada, France, Spain, Italy, the Netherlands, the United Kingdom, Brazil, and internationally. A few of the drugs offered by the company includes SKYRIZI to treat moderate to severe plaque psoriasis in adults; and MAVYRET to treat patients with chronic HCV genotype 1-6 infection. The company was incorporated in 2012 and is based in North Chicago, Illinois.

Alexion Pharmaceuticals (ALXN) – Market Capitalization: $25.90 Billion

Alexion Pharmaceuticals, Inc. develops and commercializes various therapeutic products. Some of the company’s products include ULTOMIRIS (ALXN1210/ravulizumab-cwvz), a C5 inhibitor for the treatment of paroxysmal nocturnal hemoglobinuria (PNH) and atypical hemolytic uremic syndrome (aHUS); and SOLIRIS (eculizumab), a monoclonal antibody for the treatment of PNH, aHUS, generalized myasthenia gravis (gMG), and neuromyelitis optica spectrum disorder. The company serves distributors, pharmacies, hospitals, hospital buying groups, and other healthcare providers in the United States and internationally. The company was founded in 1992 and is headquartered in Boston, Massachusetts.

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Amgen (AMGN) – Market Capitalization: $134.11 Billion

Amgen Inc. discovers, develops, manufactures, and delivers human therapeutics worldwide. It focuses on inflammation, oncology/hematology, bone health, cardiovascular disease, nephrology and neuroscience areas. The company's products include Enbrel to treat plaque psoriasis, rheumatoid arthritis, and psoriatic arthritis, and EPOGEN to treat anemia caused by chronic kidney disease. It distributes its products through pharmaceutical wholesale distributors, as well as direct-to-consumer channels. Amgen Inc. was founded in 1980 and is headquartered in Thousand Oaks, California.

AstraZeneca PLC (AZN) – Market Capitalization: $134.53 Billion

AstraZeneca PLC discovers, develops, and commercializes prescription medicines in the areas of oncology, cardiovascular, renal and metabolism, respiratory, autoimmunity, infection, neuroscience, and gastroenterology worldwide. Its marketed products include Arimidex for oncology diseases; Atacand/Atacand HCT/Atacand Plus for cardiovascular diseases; and Bydureon for metabolic diseases. The company serves primary care and specialty care physicians through distributors and local representative offices. The company was formerly known as Zeneca Group PLC and changed its name to AstraZeneca PLC in April 1999. AstraZeneca PLC was founded in 1992 and is headquartered in Cambridge, the United Kingdom.

Biogen (BIIB) – Market Capitalization: $42.57 Billion

Biogen Inc. discovers, develops, manufactures, and delivers therapies for treating neurological and neurodegenerative diseases worldwide. The company offers TECFIDERA, AVONEX, PLEGRIDY, TYSABRI, and FAMPYRA for multiple sclerosis (MS); SPINRAZA for the treatment of spinal muscular atrophy; and FUMADERM to treat plaque psoriasis. The company offers products through its sales force and marketing groups. The company was founded in 1978 and is headquartered in Cambridge, Massachusetts.

Regeneron Pharmaceuticals (REGN) – Market Capitalization: $60.90 Billion

Regeneron Pharmaceuticals, Inc., a biopharmaceutical company, discovers, invents, develops, manufactures, and commercializes medicines for treating various medical conditions worldwide. The company's products include EYLEA injection to treat wet age-related macular degeneration and diabetic macular edema (DME); myopic choroidal neovascularization; and diabetic retinopathy in patients with DME. Regeneron Pharmaceuticals, Inc. was founded in 1988 and is headquartered in Tarrytown, New York.

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Vertex Pharmaceuticals (VRTX) – Market Capitalization: $55.06 Billion

Vertex Pharmaceuticals Incorporated engages in developing and commercializing therapies for treating cystic fibrosis. The company markets SYMDEKO/SYMKEVI, ORKAMBI, and KALYDECO to treat patients with cystic fibrosis who have specific mutations in their cystic fibrosis transmembrane conductance regulator gene. The company sells its products primarily to specialty pharmacy and specialty distributors in the United States, as well as specialty distributors and retail chains, and hospitals and clinics internationally. The company was founded in 1989 and is headquartered in Boston, Massachusetts.

Biotechnology Comparative Analysis Market Data Financial Data Valuation October-22-2020 Market Cap Price EV Sales EBITDA EPS EV/Sales EV/EBITDA P/E Company Name (Ticker) ($B) ($) ($B) ($B) ($B) ($) x x x ABBVIE INC. (ABBV) 146.29 84.57 227.74 36.23 16.73 4.52 6.29 13.61 18.23 ALEXION PHARMACEUTICALS, INC. (ALXN) 25.90 120.01 25.87 5.54 2.91 3.81 4.67 8.89 31.66 AMGEN INC. (AMGN) 134.11 226.82 156.91 24.30 12.20 12.24 6.46 12.86 18.71 ASTRAZENECA PLC (AZN) 134.53 51.7178 152.75 25.70 6.90 4.82 5.94 22.14 63.04 BIOGEN INC. (BIIB) 42.57 263.99 88.64 14.49 8.05 34.04 6.12 11.01 7.88 REGENERON PHARMACEUTICALS, INC. (REGN) 60.90 571.38 59.31 8.69 3.03 25.83 6.83 19.57 22.16 VERTEX PHARMACEUTICALS INCORPORATED (VRTX) 55.06 210.53 50.13 5.40 2.21 7.92 9.28 22.68 26.72 Average 85.62 218.43 108.76 17.19 7.43 13.31 6.51 15.82 26.91 Median 60.90 210.53 88.64 14.49 6.90 7.92 6.29 13.61 22.16

Key Performance Indicators

The following are some key performance indicators that are specific to companies in the biotechnology industry.

Return on research capital ratio

Research and development expenses is one of the largest expenses for a biotechnology company. There is significant cost involved in every process of drug development, including drug discovery and clinical trials. A recent study from London School of Hygiene & Tropical Medicine estimated the median capitalized research and development cost per drug product to be $985 million, and its average to be $1.3 billion (Wouters, McKee & Luyten, 2020). The ratio represents gross profit earned per dollar spent on R&D.

Return on research capital ratio = Current year gross profit / Last year R&D expenditure

Liquidity and debt coverage ratios

Pharmaceutical companies carry high levels of debt to support their R&D expenditures, hence maintaining healthy level of liquidity is crucial. Quick ratio can be used to measure short term liquidity and the ability to cover daily operating expenses. Debt ratio can be used to measure leverage of the company.

Quick ratio = (Current assets – Inventories) / Current liabilities

Debt ratio = Total debt / Total assets

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Number of drugs in phase 1-3 clinical trials

Clinical trials of drugs are necessary for approval of regulatory bodies such as FDA. A complete set of trials may take months or years to complete. There are 3 main phases of clinical trials that a drug must go through before being made available to the public. Number of drugs in phase 3 clinical trials is a good indication of the company’s performance in the near future.

Phase 1 aims to find the best dose of a new drug with the fewest side effects, by starting with low dosage and measuring its effectiveness as well as the level of side effects for each dosage increase. Main goal is to see if the dosage necessary for treatment is safe. About 60% of drugs move on to phase 2 (Abrahams, MacKay & Eckler, 2017).

Phase 2 tests the drug on people with underlying conditions that the drug is meant to treat. Participants are monitored over months or years for any side effects that may arise over time. About 30% of drugs move on to phase 3 (Abrahams, MacKay & Eckler, 2017).

Phase 3 trial involves thousands of participants with underlying conditions that the drug is meant to treat. It aims to compare the effectiveness of the new drug with any existing drugs in treating the same condition. A control group is established for objective comparison of effectiveness. About 60% of drugs in phase 3 receive FDA approval (Abrahams, MacKay & Eckler, 2017).

Number of active patents

Brand name drugs can receive patent protection on their drugs for maximum of 14 years. Once the patent protection expires, generic drugs flood the market at significantly lower cost which eliminates the profitability of brand name drug manufacturer. Hence, number of active patents and years left on those patents are good indications of profitability over that period of time.

Industry Trends

Industry Outlook

Despite the recent economic downturn and investor uncertainty, the biotechnology industry is well- positioned to grow over the next 5-7 years. Rapid surge in the biotech market is credited to the development of regenerative medicine and genetics in diagnostics. Shifting trends towards personalized and regenerative medicine is expected to drive market growth of the biotech industry. As time passes and investor sentiment recovers, biotech could be a safe and secure investment, especially as the COVID pandemic creates a need for the development and manufacturing of vaccines.

M&A Trends and Activities

Almost every major industry player took part in an M&A activity or deal over the past five years. Biotech firms tend to face tremendous barriers for their R&D activities and development of new drugs. This process requires an incredible amount of capital over the course of a decade or longer, while not generating any revenue, and many times can end in failure. Thus, it is common for biotech companies to work together with larger, more established players to achieve their research and development goals. At the same time, large pharmaceutical companies may look to expand or further invest in their R&D

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pipelines by acquiring other firms in the discovery or commercialized stage. They may leverage M&A activities as a mean of protecting themselves from revenue loss or to support continuous revenue growth, which may limit the number of industry operators.

Top 2020 Deals

Gilead Sciences acquires cancer drug maker Immunomedics in a $21B deal

In September this year, Gilead sciences (Nasdaq: GILD) announced its acquisition of Immunomedics, a New Jersey biotech firm highly focused on breast cancer innovation. This marks the largest M&A deal of the year so far with a 108% premium, sending Immunomedics shares more than doubling in pre-market trading the next day. The deal will provide Gilead with access to Trodelvy, a drug granted accelerated approval by the US FDA for the treatment of metastatic triple-negative breast cancer (mTNBC). In an interview with the CEO of Gilead, he revealed that the cutting-edge protein will not only “help patients with difficult-to-treat breast cancers but potentially patients with other types cancer as well as strengthen Gilead’s cancer portfolio in both solid tumors and blood cancer”.

Bristol-Myers to buy heart drugs developer Myokardia for $13B

In early October, Bristol-Myers Squibb (NYSE: BMY) has agreed to buy Myokardia (Nasdaq: MYOK), a clinical-stage biotech company to bolster its portfolio of heart disease treatments, in a $13.1B cash deal with roughly 61% premium. The acquisition gives Bristol-Myers rights to mavacamten, a treatment for chronic heart condition known as obstructive hypertrophic cardiomyopathy – a disease that affects up to 200,000 people across the US and Europe. Bristol-Myers said it expects to explore the use of mavacamten for other diseases and develop MyoKardia’s portfolio of experimental drugs.

Industry Risks and Catalyst

Catalysts

1. Approval of Vaccines & Drugs

Following the much-anticipated pricing decision on Gilead's remdesivir:

▪ Focus turns to expected initial clinical data from Regeneron's antibody cocktail and Moderna's vaccine programs. ▪ Beyond COVID-19, Biogen's aducanumab for Alzheimer's disease remains under the spotlight, with the FDA deciding whether to accept the filing and possibly grant it priority review status, which would likely have a large impact on sector sentiment. ▪ AMG 510 (sotorasib) data at ASCO showed limited activity outside of lung cancer but await potentially pivotal monotherapy data for this tumor type in 2H. ▪ In addition to AMG 510, Amgen is on track for Phase III readouts in asthma and heart failure, two programs that have flown largely under the radar.

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2. Increased Collaboration leads to validation and faster innovation

Collaboration empowers SMEs and provides access to technology and resources to develop their early stage inventions. Support with venture capital helps small companies fund the riskier stages of validating their ideas, allowing them to gain a foothold in the industry and develop ideas towards products. Venture capital builds value for later stage partnerships or acquisition by a partner or group of partners that are able to fund later stage development and commercialization. In this way there is a steady flow of new ideas that are investigated and validated, and progress towards development.

Risks

1. Liquidity & Debt

While biotech companies have adequate liquidity, it's less healthy than in other parts of the health-care industry. Their credit ratings are slightly lower than those of pharmaceutical companies. Biotech's relatively large dividend and share buyback policies could be reduced to provide additional liquidity buffers. Any increase would be negative for credit ratings.

Operating cash flow and cash on hand are healthy, especially for larger biotech companies like Amgen, Gilead and Biogen, but the former two businesses also have large amounts of debt -- about $30 billion and $25 billion respectively, comprising about 85% of the total debt held by the five larger biotech companies, which also includes Regeneron and Vertex. The group's operational cash flow was about $30 billion in 2019 -- 90% contributed by Amgen, Biogen and Gilead. Near-term debt maturities are relatively high at about 40% of annual cash flows -- $12 billion, from total debt of $65 billion. Biotech companies tend to have smaller bank lines than pharmaceuticals

2. Margin Pressure post COVID

Longer term, the COVID-19 crisis could lead biotechs to re-prioritize their pipeline and resources, especially those companies facing cash constraints. As government debt and unemployment increase, the drug-pricing debate won't fade from the spotlight, which could offer further opportunities for the makers of biosimilars. In the U.S., rising job losses may push more people into Medicaid coverage, hurting biotechs' profitability.

3. Biotech 2021 Consensus May Also Be at Risk

Consensus revenue expectations for major U.S. biotechs may be at risk if recovery from the coronavirus pandemic stretches through 2021, given the disease's current resurgence trends. With a few exceptions, this view has been relatively unchanged since 1Q earnings, yet it's likely based on the premise that COVID- 19 disruptions have already peaked.

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Citations

B. Abrahams, K. MacKay & M. Eckler. (2017). RBC Biotechnology Primer. RBC Capital Markets

Creep, C. (2020, August 21). Biogen: There Are Risks, But There Is Value Too

Curran, J. (2020, May). IBIS World: Biotechnology in the US.

Fidler, B. (2020, October 05). Bristol Myers to buy MyoKardia in $13B bet on targeted drugs for the heart.

Grant, C. (2020, August 26). Biogen Stock Is a Big Risk Worth Taking

Million Insights (2020, August 12). Biotechnology Market Outlook To 2025: Global Industry Size, Share, New Trends, Opportunities, Growth Overview and Future Trends Forecasts by Million Insights.

Newburger, E., & Lovelace Jr., B. (2020, September 14). Immunomedics shares double after Gilead agrees to buy the cancer drug maker in $21 billion deal.

O.J. Wouters, M. McKee & J. Luyten. Estimated research and development investment needed to bring a new medicine to market, 2009-2018. JAMA. DOI: 10.1001/jama.2020.1166

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