Biotech stocks have not just been off to an incredibly start to 2014, but also showed impressive returns over the course of 2013. The iShares Nasdaq Biotechnology (IBB) index doubled the returns of the Nasdaq Composite (IXIC) over the past year, gaining 66.73% and 33.24%, respectively. In fact, two of the top performing biotech companies, Gilead Sciences (GILD) and Biogen Idec (BIIB), have YTD growth of over 20%. Despite this incredible growth, many people are still in the dark about the biotech industry and what it has to offer that justifies the recent increased investment.
Biotechs are, in a sense, a type of pharmaceutical company. While both produce drugs, biotech produces medicines, called biologics, that are often 200 to 1,000 times the size of normal pharmaceutical drugs (also called “small molecule” drugs) and are far more structurally complex due to the fact that they are derived from living cells. Biologics are created in living organisms by genetically engineering DNA and then modified to ensure the cell is as effective as it can be before being purified and manufactured.
Due to the complexity of creating biologics, R&D costs for biotechs are very high. There are benefits to this complexity as well though. Unlike regular small molecule drugs, it is impossible to make an identical generic biologic, as the living molecules from which the medicine is derived will have slight differences based on their characteristics, environment, and provided nutrients. Instead, biologics can only be imitated through the production of biosimilars. The minor differences exhibited by biosimilars may, however, create differences in the safety and effectiveness of the medicine. For this reason, biosimilars have only recently gained approval guidelines by the FDA as a part of the healthcare reform bill. Even so, the approval process for biosimilars is stringent, requiring it to be “interchangeable” with the original biologic. Additionally, the patent protection through data exclusivity is 12 years for biologics, compared to only 5 years for other pharmaceuticals.
Biotech stock’s risk is higher than standard pharmaceutical companies’ due to the high costs of R&D and the sensitivity to clinical trials and other regulatory obstacles. However, if a biotech company is able to create a “blockbuster” biologic, the pay-off is guaranteed exclusivity for at least 12 years, typically longer, as biosimilars take longer to develop than generics. Even biotech companies devoted to creating biosimilars have much to gain as their pricing points are anticipated to be between 70% and 80% of the original biologic, compared to generics that sell for 30% of the original drug’s price. Some biosimilars will try to out-do the originator and become biosuperiors. These have the potential to demand premiums on top of the originator’s price.
Investors decided that the possible success of the biotech industry is worth the risk it carries, and so far their decision has paid off. Currently in the US, no biosimilars have been approved but many have been accepted into the approval pipeline and other countries have had biosimilars approved through their own regulatory guidelines. It may still be early to tell what the full effect of these pseudo-generics will be, but for now investors seem to be content with the length of biologic’s exclusivity and their replication difficulty.