Slower Bio/Pharma Investment Could Hurt CDMOs in 2017

Contract research organizations (CROs) and contract development and manufacturing organizations (CDMOs) may not be feeling it yet, but the downturn in external financing for early stage bio/pharma companies is real. The impact on CDMOs and CROs will be delayed, but there is no doubt that service providers will be feeling it in coming months.

Two recent articles in the financial press underscore what has been happening. An item on Bloomberg.com chronicled the challenges early-stage public companies are facing as they go out for further funding beyond their initial public offerings (IPOs) (1). The article highlights the plight of two bio/pharma companies, Aldeyra Therapeutics and Ovascience, whose stock prices took big hits when they floated secondary public offerings of their stock on May 26th.  The shares of Ovascience went down 30% on the day of the offering while those of Aldeyra fell 10%.

The Bloomberg article noted that Aldeyra and Ovascience’s experiences are reflective of what has been happening to many bio/pharma companies trying to tap public markets. According to the article, the number of secondary offerings from bio/pharma companies is down 40% in 2016, with 64 offerings vs. 106 in 2015; but the amount raised is down 70% from $9 billion to $2.6 billion. So it’s not just the decline in the number of offerings that is hurting early-stage bio/pharma; they are also raising fewer dollars per offering.

The market has also not been friendly to young bio/pharma companies trying to tap public markets for the first time. There have been half the number of IPOs, 8 in 2016 vs. 17 in 2015, but the amount raised, just $483 million by Bloomberg’s count, is down 75%.

Data compiled from the PharmSource Lead Sheet (Figure 1) confirms the Bloomberg analysis and also shows that venture capital (VC) investment has held up well despite the public market travails. Nevertheless, an article in the New York Times described how the balance of power has shifted from entrepreneurs to investors in the venture capital world (2). According to the article, VC firms have been able to demand much tougher terms from companies they are investing in, including lower valuations and the hiring of more experienced executives. The article focuses on Internet companies, but the pinch is being felt across the start-up spectrum.

Figure 1: Venture capital investment 2014 to 2016. All figures courtesy of author.

Impact on early-stage companies
It’s not surprising that CROs and CDMOs may not be feeling the impact of the funding downturn quite yet. After the 2008 global financial crisis, it took two years for investigational new drug (IND) filings and Phase I clinical trial starts to reflect the funding decline (Figure 2). That’s because early-stage companies focused their remaining cash on getting their lead candidates into the clinic as quickly as possible in hopes of demonstrating proof of concept (POC). POC is typically the prerequisite for licensing deals and other partnering arrangements from larger bio/pharma as well as funding from public sources. Funding from partnering arrangements is probably the most secure funding source because large bio/pharma companies now depend on in-licensed and acquired candidates for at least half of the products they ultimately take to commercial markets.

Figure 2: Investigational new drug filings 2009 to 2015.

Early-stage companies trying to get into the clinic are an important source of business for CDMOs because most are dependent on service providers to manufacture APIs and formulated dose forms. Those companies represent the majority of customers at most CDMOs, but they typically have just a small number of new drug candidates, so CDMOs need to constantly replenish their customer portfolios to thrive. That replenishment is highly dependent on a rebound in public bio/pharma equity markets: venture capital might get candidates through discovery and into preclinical but emerging bio/pharma companies need the larger tranches of public funding to sustain a clinical development program.

Impact on CROs and CDMOs
The most recent downturn in external financing is barely a year old, so CROs and CDMOs aren’t yet feeling the pinch. Emerging bio/pharma companies are using the funds they have to get their candidates into the clinic, as in past funding cycles, which is good for CDMO business in the near term. But without public markets, the industry could see a sharp drop in IND filings, and in the demand for CDMO services, as it did in 2010.

One way for CDMOs and CROs to prepare themselves for the worst case is to focus on resurrecting their business development skills. After several years of just answering unsolicited external inquiries, they will soon have to be prospecting for new business and selling the customer on why they should use them rather than a competitor. As they were in the last downturn, new business development skills will be a key to sustained success.

References
1. M. Nilsen, “Biotech’s Vicious Secondary Cycle,”Bloomberg.com, May 26, 2016.
2. K. Benner, “Start-Ups Once Showered With Cash Now Have to Work for It,”New York Times, May 20, 2016.