Jan 25, 2023

How Big Pharma Merger and Acquisition (M&A) Priorities Skew the Life Sciences Investment Landscape and Create Pockets of Exploitable Inefficiency

By Alex Munns

How Big Pharma Merger and Acquisition (M&A) Priorities Skew the Life Sciences Investment Landscape and Create Pockets of Exploitable Inefficiency

For investments in development stage biopharma companies, we focus on companies pursuing high-probability-of-success approaches to treat large unmet needs in areas of low competitive intensity. Given the accelerating nature of innovation in biopharma as well as the number of company-creators capable of pursuing fast-follower strategies, it is reasonable to ask how such approaches can evolve without attracting substantial competition? The conventional answer would likely suggest some combination of the concentration of intellectual property, specialized know-how, and the substantial energy, time, and capital required to create the necessary ecosystems for breakthroughs. Another contributor and probably less conventional answer would point to company creator incentives. As we will describe, we believe M&A priorities at Big Pharma can enable pockets of inefficiencies in the drug development landscape that, with our capital and industry, we believe can help well-positioned companies capitalize on.

Consider the following: an October 2022 McKinsey analysis juxtaposes population unmet medical need with Big Pharma’s innovation focus1 and finds substantial mismatches, whereby the biopharmaceutical industry’s energies2 are more concentrated in areas such as oncology, hematology, and immunology than anti-infectives, cardiovascular, and endocrinology, despite the latter categories representing larger or comparably large areas of unmet need (see Exhibit 1 below).

Exhibit 1: Juxtaposition of Unmet Medical Need in General with Pharmaceutical Resource Prioritization by Disease Type

Source: WHO, EvaluatePharma, PharmaProjects

If unmet need is relatively high in therapeutic areas such as anti-infectives, cardiovascular, and endocrinology, and competitive intensity is relatively low, then why aren’t more companies focusing there? There are many possible answers: nature of clinical practice, pace of innovation in biology, nature of diseases, predictability of preclinical models, regulatory incentives, capital efficiency, and many more that I’m not listing. An additional one to consider is financial incentives of company creators.

As a generalization, the majority of innovation in biopharma comes from privately-owned3, operated, and financed companies with a dual-mandate to develop life-improving drugs and provide a financial return to their sponsors4. While most company creators we know are personally driven to improve the lives of others, a tension can exist between this and financial returns when deciding which diseases get prioritized for investment. How is that tension managed? A 2022 Health Affairs article provides a clue.

The article5 is a summary of interviews from five leading life science venture capitalist (VC) professionals who were asked about how financial incentives impact investment decisions. Of the seven findings, the interviews found that:

  • Biotech VCs largely invest with the aim of being acquired by large pharma company; and
  • Many biotech VCs evaluate potential investments through the lens of expected returns to potential acquirers.

To put a finer point on it, the article stresses that, while developing drugs that meet unmet medical needs is the primary motivation of venture capitalists, when prioritizing which unmet medical needs to pursue, “the possibility of premium valuations of their investments, in part related to the premium pricing the acquirers can charge, drives them to invest in areas that they may not have otherwise invested in, such as gene therapy programs and early-stage oncology drugs.”6

To be clear: we respect and admire our company creator peers and friends, and believe they have provided much of the creativity, know-how, sweat equity, and capital to help propel many life-improving drugs to market. That being said: incentives drive outcomes, and from a financial return point of view, the most efficient and often most lucrative pathway to financial returns for company creators is often through Big Pharma M&A – if they can achieve it. As a result, Big Pharma’s priorities can and often do influence how and where venture capitalists choose to deploy their capital, thus skewing the biopharmaceutical development landscape in ways highlighted in the McKinsey report. We believe this creates an environment of pockets of inefficiency, where companies can pursue high probability-of-success approaches against large unmet needs in areas of low competitive intensity. And though these companies may not pursue areas that are currently high priority for Big Pharma, those priorities can and often do change with successful development over time.

Across the landscape of our life science investments, we are invested with many companies who fit these profiles of high probability-of-success approaches to treat large unmet needs in areas of low competitive intensity.

1Based on number of pipeline assets – a somewhat misleading metric, as development costs can vary widely based on prevalence and regulatory thresholds required for approval. That said, we still believe this to be directionally correct. The full article can be found here, https://www.mckinsey.com/industries/life-sciences/our-insights/the-helix-report-is-biopharma-wired-for-future-success. 2In our estimation, Big Pharma’s focus reflects the broader development stage life sciences ecosystem, from VC-sponsored private companies through publicly listed companies. 3Private, in this case, referring to non-governmental or state owned, rather than listed on a public exchange. 4This is a generalization supported by indirect datapoints. For example, according to a 2022 report from Vital Transformation (found here, https://vitaltransformation.com/wp-content/uploads/2022/12/Where-do-new-medicines-originate_FINAL2022_12_05.pdf), 64% of blockbuster drugs from the last decade originated in small companies. 5Gracia, “Incentives for Drug R&D: A Survey of Biotech Venture Capitalists’ Perspectives,” Health Affairs Forefront. Accessed 1/2/2013 from here, https://www.healthaffairs.org/content/forefront/incentives-drug-r-d-survey-biotech-venture-capitalists-perspectives. 6Ibid.

This information is not intended to provide investment advice. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, market sectors, other investments or to adopt any investment strategy or strategies. You should assess your own investment needs based on your individual financial circumstances and investment objectives. This material is not intended to be relied upon as a forecast or research. The opinions expressed are those of Driehaus Capital Management LLC (“Driehaus”) as of January 2023 and are subject to change at any time due to changes in market or economic conditions. The information has not been updated since January 2023 and may not reflect recent market activity. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Driehaus to be reliable and are not necessarily all inclusive. Driehaus does not guarantee the accuracy or completeness of this informa­tion. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

About Alex Munns

Alex Munns is an assistant portfolio manager and a senior analyst on the US Growth Equities Team with a focus on the health care sector.

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