Bullish on Tools

by jtaylor on November 2, 2010

When most folks think of the biotechnology or pharmaceutical industry, they think of companies making pills to treat specific diseases.  Rightfully so.  These companies produce the end products that customers interact with, see the TV commercials for, and hold in their hand.  However, what is not obvious is the massive ecosystem of companies and technologies that drive medical research innovation to allow for the development of new drugs.  One large sector of this ecosystem, and the topic of this post, are those companies that are developing new innovative technologies to improve how medical research is conducted.  These are the Tool Makers and are some of the most interesting companies in the biological sciences and potentially some of the best investments of time and money for entrepreneurs, employees, and financiers.

To illustrate my thesis, consider companies at the start-up stage.  All early stage companies face significant risk that is usually bucketed into various categories:

  • Technology – there is still research to be completed before the product will work;
  • Market – it is unclear if consumers will adopt the product;
  • Capital requirements – will the company be able to raise the capital it needs before being sustainable;
  • Distribution – will the company secure the distribution required to get the product to the customer;
  • and others.

Different industries emphasize or de-emphasize these risks differently.  For instance certain web companies have a greatly reduced distribution risk, creating a significant ROI advantage for the sector. In contrast, drug companies seem to pile on the risk.  Technological risk is often higher than what is found in many technology companies (don’t know if your product really works until a large Phase III study) and the industry has unique regulatory risk (will the government let you sell you product).  This can make for significant challenges, limits the scope of products you can create, and introduces extreme volatility into these businesses.

Tool companies on the other hand, don’t have the same risk profiles as their therapeutic counterparts.  These companies, which sell things like instruments and reagents for sequencing DNA, look much more like business-to-business technology companies than they do drug companies.  Technology risk is generally lower (or at least proof-of-concept work can provide greater confidence earlier) and often there is little to no regulatory risks.  For an investor that wants to participate in the biological sciences industry, this should be very attractive.

Additionally and importantly, these companies are no less exciting than those making drugs.  Take for instance the public company Illumina, who provides DNA sequencing instrumentation and tools to medical researchers.  Illumina  arguable won the battle to become the leader in DNA sequencing over the last 5 years, has played a major role in significant advances in understanding diseases, and is on the forefront of exciting projects like the Personal Genome Project.  Obviously Illumina has made a major impact in the health sciences and importantly, their shareholders have been awarded as such in the public markets (the above plot demonstrates a 5 year comparison between Illumina and Apple for the previous 5 years).

Private start-ups in this space are having big wins as well with impressive acquisition and IPO exits.  Large pubic companies like Life Technologies are acting somewhat like biotech Googles/Microsofts by using acquisitions to drive a large part of their growth.  This creates acquisition opportunities for startups, for instance like that of Ion Torrent, a 3 year old sequencing company, that was purchased by Life Technologies this past August for $375 million.  Also, with the IPO window opening up, companies like Pacific BioSystems and Complete Genomics are going public at very reasonable valuations (see below links).

All in all, I’m a strong believer in this industry and see it as a very attractive space.  With biotechnology rapidly expanding beyond drugs into applications like diagnostics, agriculture, biofuels, synthetic biology, and others, these tool makers will become ever more attractive.

Related articles:

A good synopsis on the PacBio IPO from Xconomy

Complete Genomics sets price range for IPO

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