Biotech companies are the biggest Research and Development spenders proportional to their revenue numbers. As of 2019, many of the largest pharmaceutical firms spend nearly 20% on R&D. Of the 20 largest R&D spending industries in the world, the pharmaceutical industry makes up nearly half the list.

But does the R&D spending have an effect on revenue growth? This article finds if an increasing R&D spending account to an increase in revenue and vice versa.

First of all, does R&D spending correlate with revenue in the first place?

The companies in the Global Innovation 1000 spent about 750 billion dollars on R&D in 2018. This represented record-high spending, and a 10 percent increase over 2017. Year-on-year growth in 2018 was nearly four times as high as growth between 2016 and 2017, when spending increased by 3.2 percent.

Revenues for the Global Innovation 1000 also increased by 11.4 percent, leaving R&D intensity, or innovation spending as a percentage of revenue, unchanged from 2017 and maintaining the 14-year high.

It is understood from this that there is a general correlation between Revenue and R&D spending. But what about the sector most sensitive to R&D, Biotech?

The biotech industry is an ever-changing and evolving one. Companies need to invest a good portion of their budget into the future if they wish to stay competitive.

They do that by investing in their industry’s lifeblood, research and development. The success of drug companies is almost wholly dependent upon the discovery and development of new medicines, and their allocation of capital expenditures reflects that fact. Although the average spending is 17% of revenues, some companies spend substantially more.

PwC recently came out with the latest version of their annual R&D spending report, and while there is a lot of interesting information to digest in this report, there are a few companies in particular that stand out in the field of biotechnology.

And they happen to be the low cap Biotech companies. On average they spend as much as 60% of their revenue to R&D, and the percentage is only increasing with time.

Low cap biotech’s R&D intensity shows in new patents as well. Emerging biopharma companies patented almost two thirds of new drugs in 2018, while larger biopharma patented one quarter, Clarivate Analytics shows.

One might think that high cap biopharma are low in company numbers, but with their resources and different subsectors they are in, it is expected that they produce most of the patents. But reality is that small biopharma are pulling more than their weight in R&D success, with the help of FDA’s higher approval rate.

Now let’s check R&D — Revenue correlation on US Biotech stocks.

The data consists of information about 120 biotech stocks from the US. For each company, there is quarterly revenue and research & development spending numbers. The stocks are divided into 4 categories: low, low/mid, mid and high cap Biotech stocks.

First of all, we will see what is the R&D intensity of different tier of Biotech firms. If we look at the average R&D spending as percentage of revenue, we see that the smaller biotech firms spend a staggering %60 as opposed to the 5% range of large tier biotechs.

Now coming back to our main question — what is the relationship between R&D spending and Revenue? We can see the Revenue — R&D spending correlations in the figure below.

We can see that the bigger the market cap, the higher the correlation in general. Smaller companies showed scattered results, with correlations ranging from 1 to -1.

Conclusion

R&D has been the main driver of growth in the west, starting as early as the end of WW2. Biotech has relied especially heavy on R&D to generate growth. The bigger pharmas lately have been overshadowed by smaller companies though, both in patent numbers and R&D intensity.

Therefore, the assumption was that smaller Biotech companies must show corresponding growth to its R&D spending. After checking US Biotech stocks, my assumption proved to be incorrect, as bigger Biotech firms had higher correlation with R&D spending.

This might have many root causes, such as the time it takes for a new product to generate revenue and research experiments failing. As a result, investing in small Biotech stocks based on R&D is a very risky idea.

Originally published on medium

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