Before analysing trends in the pharmaceutical and biotech sector, one fact should be kept in mind: only vaccine producers have benefited from the covid pandemic. Other players have had to deal with a crisis situation that has accentuated pre-existing imbalances.

Since a market peak in February 2021, the decline in pharmaceutical and biotech stocks has been continuous, according to Marco Minonne and Lydia Haueter, members of the Pictet-Biotech fund team. Since February 2021, the decline has been around 60%. The last three months have also seen an increase in volatility. While volatility in the biotech sector has historically tended to be extremely high, its conjunction with current underperformance appears to be exceptional. So much so that an all-time low has been reached.

This may seem paradoxical given the enormous need for therapeutic innovation. "It's obvious that rising interest rates are not a good environment for capital-intensive industries, which tend to underperform. And that's exactly what we're seeing," say the two managers.

Destabilising capital inflows

But it is the low interest rates of recent years that have laid the foundations for the sector's poor performance.

Very favourable financial conditions with persistently low interest rates have led to massive investments in biotechnology, which were reinforced by the covid crisis. “In 2020 and 2021, we have seen a huge peak in IPOs," say Minonne and Haueter. This has led to an increase in the number of companies on the market, "which is incredible".

This influx of money has had a first twisted effect: it has increased competition between players, particularly in the search for patients to enrol in clinical trials. Faced with a shortage of patients, enrolment rules have become less strict, which has increased the clinical risk of these trials. Logically, "the results of clinical trials over the last 12 months have worsened".

The second effect is that, given the relative lack of companies to invest in, investments are being made earlier and earlier, at the pre-clinical stage. "This is the riskiest stage," say Minonne and Haueter. "Usually, private equity and venture capital firms fund these pre-clinical companies until the 'proof of concept' stage, i.e. until the drug shows that it works in humans. Only then do the companies enter the 'public' stock markets. The massive influx of capital has accelerated the access of these start-ups to the public markets. This has shifted the risk curve from private to public markets. 90% of the companies that have gone public since 2021 are performing negatively."

Another aggravating factor was the launch of the ARK Genome ETF, which added fuel to the fire by opening the market to retail investors. An additional influx of liquidity has put biotechs in a whirlwind of buzz that has allowed unprofitable companies to take off, say the managers. "There was a real euphoria in the market for all these unprofitable companies." A euphoria that has negatively impacted the sector's performance and contributed to its fall in recent months, according to Minonne and Haueter. Spacers, which have been very fashionable in recent months, have also contributed to this trend.

In the end, the risks have not been rewarded to the extent that they should have been for investors. Investors have been scalded by the increasing number of clinical failures in recent months. "A flurry of negative news has weighed on the sector."

The negative effects of covid

The sector has been hit by other covid-related headwinds.

One would have thought that the pandemic would benefit the sector. In the end, only vaccine manufacturers really benefited, not treatment manufacturers.

On the ground, the pandemic has meant fewer "face-to-face" visits to the doctor, with fewer prescriptions and fewer tests; a drop in cancer diagnoses of around 5% to 20% compared to pre-pandemic levels; a lack of patient volunteers for clinical trials, which has led to delays and lower quality results.

Finally, the FDA--the US Food and Drug Administration, the industry's key regulator--has been overwhelmed by applications for covid treatments, leading to significant delays in processing applications for other drugs and erratic dossier reviews. The FDA's strong risk aversion led it to suspend clinical trials very easily--too easily for the taste of both analysts.

Towards a saving return of M&A deals

Finally, mergers and acquisitions--one of the keys to the sector's stock market performance in recent years--have been very rare in recent months. "Faced with valuations driven by the influx of money and excitement around vaccines, Big Pharma and biotech companies, while they had needs--and financial firepower--were waiting for valuations to come down to levels consistent with the fundamentals of the target companies. But even when valuations fell, executives, exhilarated by the levels achieved, were not prepared to sell. However, faced with a decline in their cash flow and balance sheets, the pressure is on and trading is picking up." What is new, say Minonne and Haueter, "is that a record number of biotechs are trading below their cash levels in terms of market capitalisation, which is incredible.”

For the two analysts, the first virtue of a resumption of mergers and acquisitions would be to revive interest in the sector and improve the management of the players. The acquisition announced earlier this month by Pfizer of Biohaven Pharmaceutical Holding Company for $12bn heralds this recovery, they believe. "We expect the second half of this year to see a resurgence in M&A activity." Big pharma and biotech companies will face the loss of $150bn in sales between 2025 and 2030” as many blockbuster drugs go generic. "So it's clear that they need innovation, assets, in order to maintain current growth rates in their revenue base."

Minonne and Haueter also believe that the tightening of funding will have beneficial effects. First, by allowing a return to valuations based on economic fundamentals. Secondly, by allowing good quality clinical trials to be conducted, which will limit the accumulation of bad news. Both analysts hope that once the covid crisis is over, regulators such as the FDA will be able to focus on their mission and provide the industry with greater predictability in the development of new treatments that everyone is waiting for.

This story was first published in French on . It has been translated and edited for Delano.