Where next for biotechnology stocks?

22nd January 2015

Martin Wales, equity analyst at M&G Investments examines the outlook for the biotech sector…

The global biotech market is expected to grow 54% between 2012 and 2017. Biotechnology shares were a major driver behind the rise in the healthcare sector in 2014. The mix of exciting new product developments and attractive valuations has been a winner with investors.

Burgeoning European market offers attractive valuations

With the US biotech market currently trading on a higher multiple than the broader pharma sector and overall market, investors should look towards the less-developed European region, which offers similar prospects but at generally more attractive valuations.

US biotech appreciated strongly in 2014 and is currently benefiting from decades of research and development investments, leading to suggestions that the sector has become expensive,  though valuations today are relatively more attractive than they were in 2000.

In Europe, the sector offers a similar favourable mix of strong pipelines, accelerating growth and M&A options, but generally at more attractive valuations. As the sector is less developed in Europe than in the US, companies with similar positive attributes often appear to be valued quite differently and there are a number of large biotech companies that have only just begun to gain traction with investors. One example is GW Pharma, a UK-based biotech company that develops and commercialises cannabinoid medicines.

R&D productivity leads to M&A activity

Productivity from research & development (R&D) has been a substantial tailwind for biotech, with the industry now reaping the benefits of the increased R&D spending during the last decade. The improving pipeline and new drug success rates amongst the biotech companies have attracted the interest of the large pharma companies, which are keen to add biotech treatments to their pipelines.

Therefore not surprisingly, since 2006, merger and acquisition (M&A) activity involving biotech companies has picked up steadily, in both the number of acquisitions and deal value. Mega-deals in the sector have included the Genentech acquisition by Roche in 2009 and Sanofi’s takeover of Genzyme in 2011.

Positioned for growth

Biotech is ideally positioned in that it is focused on developing specialist medicines to treat life-threatening diseases. This is where the biggest need is, where the regulators are keenest to help, and the direction in which the industry is increasingly moving. Success with drugs in these areas should lead to strong growth and relatively little competition for an extended period of time, thereby supporting the valuation of the sector. Finding solutions to life-threatening diseases will address the real needs that we have as a society going forward. The emerging long-term outlook for the biotech industry is therefore very exciting.

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