As a venture capitalist, I believe the hottest investment of 2014 is in the healthcare sector. The beauty of healthcare investing lies in the fact that the demand for the sector is relatively inelastic; if a patient has a heart attack, or a new antitumor drug is discovered and developed, the demand will be completely inelastic. Such inelasticity makes healthcare as a sector more resistant to changes in economic cycle. There is a wide range of investments within the sector, from the smallest life sciences research service which addresses a profitable niche to a mega-cap multiline pharmaceutical giant.
According to a recent pool conducted by ChinaVenture, biomedicine is one of the most popular investments in healthcare subsectors by the GPs of global private equity and venture capital firms, with a preference rate of 78 percent, which was even higher than that of China’s TMT sector. Since 2008, 264 private equity and venture capital firms in China have invested a total of 599 biomedical businesses and products; the largest investors in the region are JD Capital (over 50 deals), followed by Shenzhen Capital Group, Qiming Ventures, and CDH Investments. I have spoken to investment managers of different regions during my business trips since December 2013, and many of them expressed that future multimillionaires would be those who lead the biomedical technology field.
Biomedical Sciences Investing: 50% Science and 50% Art
The therapy development model of the global biomedical industry has generally been pursuing basic science discoveries such as genetic sequencing, monoclonal antibodies, genomics, proteomics, high-throughput screening, and translate them into medicines that can treat human diseases.
Despite both traditional pharmaceuticals and biomedical companies develop and sell new therapeutic agents, the latter are unique in a number of ways:
- Biomedical companies focus exclusively on deriving compounds from living cells rather than from chemicals; traditional pharmaceutical products are derived from inorganic chemicals.
- Some biomedical companies develop technologies that other companies can utilize to either manufacture or produce therapies. Given the expense and complexity of developing and manufacturing a biologic compound, biomedical companies tend to focus on more acute and higher-value areas like oncology, where they are able to charge high prices.
- Biomedical companies focus on large molecules instead of small molecules – large molecules cannot gain entry into a cell easily and must act from the outside through receptors, while a small molecule can enter the cell and make changes in its machinery to bring about a therapeutic change.
- The R&D cycle for biomedicine is longer than that for traditional chemical products, although the out-of-pocket costs are typically lower and the success rates are higher.
- Manufacturing biomedicine often entails the use of recombinant DNA technology, which means that the genetic sequence of a cell is altered so that it produces a required substance. The cost of this method of production is high due to the level of complexity.
- The delivery mechanism of biomedicine is also different because the treatments are typically not amenable to absorption into the bloodstream via the gastrointestinal tract like small-molecule pills. In fact, they have to be administered by a professional healthcare provider. This delivery model creates an additional financial hurdle as well as logistical burden.
Biomedical contract research organizations (CROs) which provide outsourced services have also had good marketplace. In recent years, global pharmaceutical giants like Roche and Johnson & Johnson have largely employed CROs of the countries where they find relatively richer research resource and lower labor costs.
A biomedical company with both coordinated value chain and powerful sales channel will always win the competition; however, asymmetry of information among different parties on the industry value-chain sometimes will lead to principal-agent problem. The Nash equilibrium in game theory explains why non-cooperative actors make decisions, but insurance providers and hospitals can often seem to be at odds in determining which party should bear what risk. Smaller companies, on the other hand, will have to show their uniqueness while having exclusivity protection to survive.
Biomedicine is an inefficient industry, with variations in care, costs, process, and outcomes that are greater than those in most other industries. Innovations that improve efficiencies and drive profits provide ample opportunity for investors, although it typically takes seven to ten years between the therapy begins clinical trials and it reaches the market. Astute investors who get the trend right and who are able to tell if the biomedical scientist can succeed in the trials will be the biggest winners of the capital market.
However, the barrier to entry to biomedicine investing is fairly high. It requires investors to have deep academic background in biology, life sciences, as well as substantial clinical practices. It is also essential to fully understand how Medicare system of a country or region works and how various business models work, for instance, B2B, as opposed to B2C. Not every single investment manager on my team is an expert in life sciences and biomedicine, but thanks to our independent advisory board, we can make judgment on the technical validity of every company that we look to invest, then our investment ideas will be fully supported.
Thoughts on Market Failure and Government Regulation
Biomedicine investing has some unique qualities and factors that can lead to market failure, since they are beyond the scope of an investment book and have been the basis for several Nobel prizes. The major distinction between information technology and biomedical technology is that the time we spend on studying information technology is positively correlated with the innovation we have envisioned; there are no certainties in clinical trials.
Secondly, investors should also be aware that if a drug is at Phase III clinical trials, the company valuation will be very high. I have noted the P/E median of the universe was around 20 to 30 in 2013, almost equivalent to the P/E of an IPO.
Additionally, biomedicine is a highly regulated industry, with numerous bodies and requirements overseeing its operations. In the United States, a drug needs to be approved by the FDA; in China, it needs to be approved by CFDA. All these bodies require a drug not run afoul of patent, be advertised appropriately, and be eligible for reimbursement by insurance companies.
Measuring quality in biomedicine has been and will continue to be an inexact science. There is no one definitive approach to most medical problems, and any drug or service available to the market is subject to direct competition. There is often no consensus on optimal therapy. However, the flipside is intelligent venture capitalists can see substantial investment returns because the entrepreneurs and scientists they trust will eventually overcome the market failure and reach the market. Biomedicine has advanced significantly over the last decades, and new discoveries that are being made at the molecular level will continue to change the way we view disease.
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