ARTICLE | August 24, 2023

While other industries and sectors show signs of uncertainty, life sciences services companies remain resilient and attractive investment opportunities to public and private investors, as well as strategic buyers in the life sciences sector. There are few signs of a slowdown as the industry looks to meet the increasing demand for clinical research, drug discovery and manufacturing.

What the biotech funding slowdown means for research and development

Corresponding with the spike in inflation that began in early 2021, emerging biotech company valuations have taken a hit, capturing headlines that underscore private and public funding challenges. Many emerging biotech companies look to IPOs to bridge the gap on research spending needed to gain Food and Drug Administration approval. Given the funding challenges, many have wondered how funding would impact overall clinical research and the demand for services at clinical research organizations (CROs) and contract development and manufacturing organizations (CDMOs).

R&D spending at biotechs has been disproportionate. Small to midsize public biotechs, which represent just 10% of the overall sector, saw spending levels fall by 25% to 35% through March 31, according to public company filings. By comparison, spending at midsize to large biotechs increased by 15% to 100% of pre-pandemic averages in the same time period. While spending shortfalls among the emerging biotech companies capture headlines, most CROs and CDMOs that were focused on the emerging biotech have pivoted to focus on the midsize to large biotechs and are not feeling a significant impact. R&D spend remains healthy and one of the many reasons that life sciences is somewhat insulated from the recession risk in the overall economy.

Mergers and acquisitions will underpin activity in 2023 and into 2024

In spite of the uncertainty surrounding small to midsize biotech deal flow, the life sciences services sector remains a focus and priority for investors. During the decade preceding the pandemic, the median deal size for mergers among U.S.-based CROs and CDMOs ranged from $5 million to $50 million, according to PitchBook. Public valuations have decreased since then, with median deal size consistently lower and focused on private investors. Lower deal counts and a few megadeals have led to greater volatility in the median for CROs; however, both CROs and CDMOs have retained strong fundamentals pre- and post-pandemic as a result of their service-based models and strong cash flows. 

With strong tailwinds—including one publicly announced large CRO acquisition, one large CRO spinout, various other announced middle market CRO acquisitions, robust clinical research demand, and increasing demand for complex manufacturing services—we expect strong equity investment through 2023 and into 2024. Leveraged buyouts and mergers of equals will continue to lead investment.

Partnerships will be critical to the success of life sciences services companies

In the dynamic landscape of life sciences, partnerships will drive the future success of middle market CROs and CDMOs. In an era of robust clinical research demand coupled with the increasing need for complex manufacturing services, the importance of establishing and nurturing strategic ecosystems cannot be overstated.

Consider the upsurge in therapeutic modalities such as gene therapies, cell therapies and targeted small molecules. These cutting-edge innovations present manufacturing complexities that are beyond the capacity of traditional production facilities. This trend not only necessitates an investment in technological upgrades but also emphasizes the significance of technical know-how and bespoke capabilities, such as aseptic filling, lyophilization and high-potency active pharmaceutical ingredient handling.

In this context, middle market life sciences services companies should actively foster partnerships with technology providers, platform biotechs and larger CDMOs to bolster their advanced manufacturing capabilities. Partnering allows these organizations to navigate the nuances of complex biomanufacturing while sharing the risks and rewards inherent in new technology implementation.

Simultaneously, relationships with biotech startups, academic institutions and research centers will be pivotal in the pursuit of novel therapeutics and drug delivery systems. These alliances ensure a steady influx of innovative projects, mitigate concentration risks and foster a pipeline of future business opportunities.

The takeaway

Given the capital-intensive nature of life sciences services, particularly complex manufacturing, relationships with financial institutions and investors will be indispensable. The ability to leverage these relationships to raise the necessary funds for technological advancement, capacity expansion and strategic acquisitions will differentiate the most successful players in the middle market.

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