Biotechnology

What Is Biotechnology?

Biotechnology is a science-driven industry sector that uses living organisms and molecular biology to produce healthcare-related products. Biotechnology companies also develop therapeutics or processes (such as DNA fingerprinting). Biotechnology is best known for its role in medicine and pharmaceuticals, but the science is also applied in other areas such as genomics, food production, and the production of biofuels.

Understanding Biotechnology

Biotechnology involves understanding how living organisms function at the molecular level, so it combines a number of disciplines including biology, physics, chemistry, mathematics, science, and technology.

Modern biotechnology continues to make significant contributions to extending the human lifespan and improving quality of life, including providing products and therapies to combat diseases, generating higher crop yields, and using biofuels to reduce greenhouse gas emissions. Hungarian engineer Karl Ereky reportedly coined the term “biotechnology,” which is often referred to as “biotech,” in 1919.

Companies in the biotech space tend to face significant barriers to success. One critical reason for this is that research and development costs for biotechs tend to be incredibly high. While a company is focusing its time and money in these areas, there's usually little revenue. It's not uncommon, therefore, for biotech companies to work together with larger, more established firms to achieve their research and development goals.

Biotech vs. Pharmaceutical Companies

Biotechnology and pharmaceutical companies both produce medicines. However, the medicines made by biotechnology companies are derived from living organisms while those made by pharmaceutical companies generally have a chemical basis.

The term biopharma describes companies that use both biotechnology and chemicals in their research and development. Common products of biopharmas are anything made of plastic, laundry detergent, vaccines, beer, and wine. Common products of pharmaceutical companies are drugs and vitamins.

Biotechnology firms use the processes of living organisms to solve problems with new products. The use of DNA has helped to create pest-resistant crops, biofuels like ethanol, and gene cloning.

On the pharma front, the Cleveland Clinic recognizes the top 10 medical advances yearly. In 2022, these included a new dual injectable drug treatment for type 2 diabetes and prostate-specific membrane antigen (PSMA) targeted therapy in prostate cancer treatment. Also predictive analytics for hypertension, which harness healthcare data to forecast disease risk, prognosis and treatment response, offering providers an opportunity to strip hypertension of its nickname--the silent killer.

Top biotech companies include Amgen, Modena, and Regeneron Pharmaceuticals. Top pharmas include Johnson & Johnson, Pfizer, and Roche.

A History of Biotechnology

Biotechnology in its basic form has existed for thousands of years, dating back to an era when humans first learned to produce bread, beer, and wine using the natural process of fermentation. For centuries, the principles of biotechnology were restricted to agriculture, such as harvesting better crops and improving yields by using the best seeds and breeding livestock.

The field of biotechnology began to develop rapidly from the 19^th century with the discovery of microorganisms, Gregor Mendel’s study of genetics and groundbreaking work on fermentation and microbial processes by giants in the field such as Pasteur and Lister. Early 20th-century biotechnology led to the major discovery of penicillin by Alexander Fleming, which went into large-scale production in the 1940s.

Biotechnology took off in the 1950s, spurred by a better understanding in the post-war period of cell function and molecular biology. Every decade since then produced major breakthroughs in biotechnology. Some of the highlights are the following:

• The discovery of the 3D structure of DNA in the 1950s
• Insulin synthesis and the development of vaccines for measles, mumps, and rubella in the 1960s
• Massive strides in DNA research in the 1970s
• The development of the first biotech-derived drugs and vaccines to treat diseases such as cancer and hepatitis B in the 1980s
• The identification of numerous genes and the introduction of new treatments in decades for managing multiple sclerosis and cystic fibrosis in the 1990s
• The completion of the human genome sequence in the early 2000s, which made it possible for scientists worldwide to research new treatments for diseases with genetic origins like cancer, heart disease, and Alzheimer’s

Biotech Today

The biotechnology sector has grown by leaps and bounds since the 1990s. The industry has spawned giant companies in the medical space, such as Gilead Sciences, Amgen, Biogen Idec, and Celgene. At the other extreme are thousands of small, dynamic biotech companies, many of which are engaged in various areas of the medical industry, such as drug development, genomics, or proteomics, while others are involved in areas like bioremediation, biofuels, and food products.

There also have been big product introductions in biopharma drugs. Some of the most frequently used biotechnology medical products recently introduced include the following:

• AbbVie's Humira is used to treat arthritis, psoriasis, and Crohn's disease.
• Roche's Rituxan, which is used to slow the growth of tumors in several types of cancer.
• Amgen/Pfizer's Enbrel, which is used to treat several autoimmune diseases.

The top U.S.-based biotechnology firms in terms of market capitalization are Johnson & Johnson, Eli Lilly, Merck, and AbbVie.

Investing in Biotech Companies

Biotech and pharmaceuticals are very different propositions for investors. Biotechnology companies typically have high operating costs because their extensive research, development, and testing take years to complete. New products can hit regulatory roadblocks; for example, some countries ban the use of genetically modified plants and gaining approval from the U.S. Food and Drug Administration (FDA) can be a lengthy and expensive proposition. In short, investing in biotech is risky.

According to The Motley Fool, some of the best biotech stocks are Axsome Therapeutics, Exelixis, Novavax, Regeneron Pharmaceuticals, and Vertex Pharmaceuticals.

Investors don't have to buy individual company stock to invest in biotechnology, however. One of the easiest ways is to invest in a biotech exchange-traded fund (ETF). These funds have holdings in many biotech companies, offering investors a well-diversified portfolio in a single trade.

How to Value Biotech Companies

It's not easy to value biotech companies because small companies can show no earnings yet have a pipeline of groundbreaking drugs in the works. In 2017, the biotech giant Gilead bought Kite Pharma for $12 billion. Kite was showing significant losses and had a deficit over $12 billion. Why did Gilead buy Kite? Kite was working on a pipeline of CAR-T cell therapies, which treat cancer. According to Raphael Rottgen, CFA FRM, of Toptal.com, what this shows is that a company's pipeline often determines its value.

Many biotech firms do not show revenues because they invest so much in R&D, and new drugs or products take a long time to reach the market, if they ever do. According to Rottgen, a new drug typically takes eight years to reach the market post regulatory approval, and total development time for a new drug is ten to fifteen years. At any time, a drug can fail in clinical trials, so the risk profile of a biotech firm is quite different compared to companies in other industries.

Measures for Biotech Company Valuation

Cash flows prior to the approval of a drug are often significantly negative. Therefore, typical valuation measurements like earnings before interest, taxes, depreciation, and amortization (EBITDA) or the price-to-earnings ratio (P/E) may not reflect the true value of a company that has breakthrough products in the pipeline.

According to Rottgen, two other measures that can be used are EV/invested R&D, which is essentially a cost-based valuation, and comparative value. Comparative value uses public market comparables or comparable M&A transactions.

The added risk associated with biotech investments must be considered in any value analysis. This calls for a discounted cash flow (DCF) using an appropriate discount rate. Rottgen recommends using risk-adjusted NPV and including projected cash flows and the likelihood of certain outcomes for various product scenarios.

Fundamentally, any valuation should consider the size of the asset pipeline, the development stage of the pipeline (e.g., Phase 1, NDA filing), and the company’s development stage (e.g., pre-revenue).

The Bottom Line

Both pharmaceutical and biotech companies face a costly process that, when successful, can produce extremely profitable products. However, the process is extremely unpredictable, which for a small biotech firm can prove all too detrimental and unrecoverable.

Pharmaceutical companies, due to their larger size and diversified revenue base, are typically able to withstand setbacks and failures. Competition is more relevant and costly for biotech companies, creating a need for strong pipelines and non-organic revenues (such as through M&A or alliances). Consideration of these factors should be the basis for prudent investment in the biotechnology field.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.