Market tailwinds are driving development of an exciting new class of oncology drugs: antibody drug conjugates, which are specifically engineered to tackle difficult-to-treat cancers.
In March, Pfizer made headlines when it announced a binding agreement to buy Bothell, Washington-based biotech company Seagen in an all-cash deal that valued the business at approximately USD 43 billion—a 44% premium on its year-end 2022 trading price. The deal ranked as one of the largest-ever acquisitions of a listed U.S. life sciences company.
But why the hefty payout? Seagen, founded in 1997, had developed a rich pipeline of novel cancer therapeutics known as antibody drug conjugates (ADCs) that use modified antibodies to deliver cell-killing drug “payloads” to malignant cells. At the time of the acquisition, Seagen had four Food and Drug Administration (FDA)-approved ADCs for different cancers. For Pfizer, which is starting to see some of its older drug patents expire, the promise of delivering effective new cancer therapies to market—minus the development risk, time and cost—was enough to justify the price tag.
Make no mistake: Powerful fundamental drivers are propelling value creation in life sciences, and specifically in biotech, where complex drugs like ADCs are becoming the norm. Of those drivers, innovation is perhaps the most important, because it is fueling development of new therapeutics. Post-COVID 19, regulatory and financial tailwinds are also driving innovation by supporting faster drug development and enabling companies to bring novel compounds to market more swiftly. And finally, government funding for life sciences has increased sharply in recent years, easing the costs associated with early-stage research.
The sheer size of the Seagen deal can be seen as an industry-wide validation of the clinical promise of ADCs, an exciting class of oncology drugs. Since the first compound was approved by the FDA more than 20 years ago, biotech company scientists have worked diligently to make this family of complex, large-molecule drugs safer and more clinically effective—and ADC development is now catching fire. Over the past five years, ADC drug development has driven the creation of USD 120 billion in shareholder value as small, privately held specialist companies have either listed their shares or merged with global pharma companies (Exhibit 1).
We see this latest development as yet another indication that the payoffs have begun for biotech innovators—and more are likely to follow. Even before the pandemic struck, the FDA had begun to focus on streamlining drug review and approval pathways to ensure that promising new therapies could reach the market more swiftly. That momentum is still going strong.
As the Seagen deal shows, the most promising new therapeutics are destined to attract attention from pharmaceutical companies eager to replenish their drug pipelines. Although 2022's broad market decline of 26% in U.S. biotech stocks may have spooked some investors, we believe it has created a compelling entry point for venture capital and early growth stage investment.1 With valuations for life sciences companies looking more modest, private market investors now have a timely opportunity to explore what may turn out to be a golden age in biotech investing.
Understanding ADCs: The science of cytotoxic “magic bullets”
Ever since physician and pioneering immunologist Paul Ehrlich—the founder of chemotherapy—introduced the idea more than a century ago of developing cytotoxic “magic bullets” to target specific diseases, generations of scientists have sought to tailor drug regimens to match the specific characteristics of malignant cells. The hope was selectively reducing or eliminating tumors.
The groundbreaking concept of ADC biologics makes the magic bullet real. To create an ADC, researchers leverage modified antibodies, the integral tools the human immune system uses in fighting viruses and malignancies, to deliver cell-killing small-molecule drugs directly to cancerous cells. The idea is that the antibody, which is designed to target specific antigens expressed on the surface of a malignant cell, draws the ADC’s cytotoxic payload into close association with the cell. The linker, or chemical binding agent that ties the antibody to the chemotherapy drug, then releases the drug on target.
The science is technical and complex. During the earliest years of ADC development in the 2000s, new compounds were unexpectedly dangerous because the drugs occasionally caused wider, systemic damage. As ADC technology has evolved, innovation has focused on identifying and selecting the correct target associated with specific types of cancers, modifying the antibody structure to match the target and developing extremely durable linker molecules. The chosen linker’s strength and durability are particularly important because if the drug that it delivers is released into the body prematurely, it can kill healthy cells.
Producing ADCs (and other large-molecule drugs) requires molecular manufacturing capability. That is technically challenging to develop and scale, and biotech startups are inevitably capital intensive. Young companies require substantial funds to support the early research, pre-clinical and clinical stages of drug development. It’s no secret that most novel therapies fail to clear all of the FDA’s regulatory hurdles; only a small fraction—approximately 8%—of all drug candidates succeed.2
Despite the obvious difficulties, however, investment capital continues to flow into this therapeutic approach, allowing the scientific community to refine and improve its safety profile.
Staking a claim to the next generation of ADCs
As the global market for this new class of biologics evolves, investors and pharmaceutical companies are paying close attention to industry developments. From an investor’s perspective, the key determinants of a startup’s success include the quality of the science evident in its approach to drug development, the richness of its emerging drug pipeline and its potential to leverage new therapeutics to combat a broader range of diseases and tumor types.
For pharmaceutical companies, the stakes are high. Because of how the U.S. patent system works, the pharmaceutical industry is expecting to lose USD 138 billion in sales revenue due to patent expirations in the next five years.3 Pfizer anticipates losing up to USD 11 billion in annual sales by 2027 as a result of patent expirations for its market-leading drugs and vaccines (especially as demand for its COVID-19 products declines).4
Unsurprisingly, Pfizer and other big pharma companies, such as Amgen and Merck, have an enormous appetite for new acquisitions to offset these future patent-related losses. Those financial losses will likely be compounded by the drug pricing provisions included as part of the Biden administration’s Inflation Reduction Act (IRA). For the first time, the U.S. government will be able to penalize drug companies for charging Medicare recipients and the disabled prices that rise faster than inflation.
For large pharma companies, however, the prospect of losing patent exclusivity may be more of an immediate threat to their profitability than federally mandated pricing curbs. In this regard, ADCs—which are classed as large-molecule drugs—have an advantage over small-molecule drugs, since their patents last for 13 years vs. nine years. And ADCs appear to have built-in protection: Given the complexity of the process required to design, test and manufacture ADCs, this drug class is expected to be nearly impossible to genericize even if patents do expire.
All of these factors played a part in Pfizer’s decision to grow its oncology pipeline by acquiring Seagen. Since the first ADC was approved by the FDA in 2000 for the treatment of acute myeloid leukemia, a total of 14 ADCs have received regulatory approval worldwide5; currently, more than 500 ADC candidates are being investigated in various clinical stages (Exhibits 2A and 2B). Seagen, which already has four FDA-approved ADCs on the market (for cancers of the lymphatic system, breast, colorectum, bladder and cervix), boasts a deep pipeline of new cancer therapeutics, including 11 novel molecular compounds in development.6
Looking ahead, we expect venture-backed biopharma entrepreneurship to continue to be a source of clinical innovation and value creation for years to come. Seagen was itself a venture-backed drug company that grew over time: In 1998, series A financing put the company’s pre-money valuation at USD 13 million; just two years later, in a series B round, that pre-money valuation had climbed to USD 57 million.7 By 2001, at Seagen’s IPO, the company’s pre-money valuation had reached USD 156 million.8 Seagen’s remarkable story is indicative of the huge value creation potential associated with the development of important therapeutic innovations. As new advances propel research into biologics, the improvements—including but not limited to ADCs—will likely transform the treatment of different cancers and enhance patient outcomes.
Innovation has always been at the heart of life sciences investing, and we see a confluence of market tailwinds driving an accelerating pace of idea generation. Government funding for research and development is empowering life sciences innovation, easing the startup costs for many biotech companies, while faster FDA reviews are speeding up a product’s time to market. As a result, biotech companies are increasingly the source of new drugs (Exhibit 3).
For private market investors, the potential to access biotech innovation at an early, growth stage is not without risk, but value realization in the industry is closely correlated to clinical developments—and much less correlated to, or even dependent upon, broader financial markets.
Technical market tailwinds may also help. This year, a combination of weakening U.S. economic growth and greater public market volatility means better entry points for those committing capital to private biotech and life sciences investments. And at a time when financing is both harder to access and more expensive for startups, new investment funds launching in 2023 and 2024 may also prove to be some of the best-performing vintages of the coming decade.
We can help
As always—but especially in private markets—due diligence and selectivity are essential, as performance can vary widely. If you’re interested in exploring private investing opportunities in life sciences and biotech, speak to your J.P. Morgan client advisor to determine which opportunities would be the most appropriate to help you meet your long-term financial goals.