Key Takeaways

• Within the outsourced pharmaceutical services sector, drug discovery is a high-growth space, with the global R&D pipeline reaching a record high in 2022.  

• Fragmentation offers many opportunities for investors to build platforms through consolidation and service expansion in both small and large molecule R&D, and Harris Williams continues to see strong interest from M&A investors.  

• Providers that can demonstrate advanced go-to-market and technology strategies as well as a breadth of services and expertise stand to be highly valued.

In their ongoing quest to develop and monetize treatments more quickly and efficiently, pharmaceutical companies are partnering with outsourcers throughout their value chains. As a result, the outsourced pharmaceutical services sector provides wide-ranging opportunities for strategic acquirers and private equity investors.

In this article, professionals from our Healthcare & Life Sciences Group focus on the drug discovery subsector. They share a brief introduction on the drug discovery process, industry trends driving opportunities for investors, and winning traits of attractive drug discovery platforms. (See Return on Innovation: An 8-Part Series.)

The Fundamentals of Drug Discovery

Before going into clinical trials, pharmaceutical companies typically spend two to four years in the drug discovery process, and one to two years in the preclinical testing stage. It’s an essential process during which tens of thousands of compounds are screened to identify the handful that move forward into in-human trials.

The starting point of this process is a hypothesis about a biological pathway or molecule called a target. This target is involved in the development of a specific disease, and therefore a drug must be created that effectively modulates it. This is the core of what drug discovery accomplishes: companies specializing in these services and technologies help identify the right target to influence and develop the drug to modulate it.

There are five stages in the drug discovery process that are important to know: target identification, target validation, target to hit, hit to lead, and lead optimization. Drug discovery contract research organizations (CROs) typically become involved in stage three after the target is validated by the biopharma company.

The approaches and techniques are different between small and large molecule drug discovery. Small molecule drug discovery still represents more than half of the total pharmaceutical R&D pipeline.

“Although it’s generally a lower-growth segment compared to large molecule discovery, it continues to be the largest drug class with plenty of ways to create value and differentiate,” says Julian Feneley, a managing director. The most common approaches to identify hits in small molecule discovery are high throughput screening (HTS) and DNA-encoded libraries (DEL).

In large molecule drug discovery, example approaches for screening, analyzing, and producing leads include phage display technologies, ELISA and ELISpot, and hybridoma technologies, among others.

Figure 1: Drug Discovery Stages and Exemplary Methods 

Factors Driving Increased Investor Interest

The drug discovery sector is a high-growth space, with the global R&D pipeline reaching a record high in 2022.  

Please contact PharmaServicesandTech@harriswilliams.com to access the full market map.

Over the past decade, the R&D drug count has been growing at around 7% CAGR, and the R&D spending of the largest pharmaceutical companies reached $138 billion in 2022 (approximately 19% of their sales).¹ While 2022 saw a significant slowdown in biopharma funding, it was still very substantial at $61 billion, which is above pre-COVID-19 levels.² Venture capital (VC) funds decreased their capital deployment into biotech over the past 12 months, yet the new capital commitments to the leading VC funds are strong. 

In addition, the structure of the R&D pipeline today is a lot more complex and innovative compared to a decade ago, making it more difficult for biopharma to cut spending on breakthrough therapies that have the potential to change the treatment paradigm in areas of high unmet need. As a result of greater cautiousness from early-stage biotechnology companies, the growth rates for some drug discovery and bioanalytical companies have slowed yet are still often in double digits. 

There are also examples of highly differentiated platforms that have relatively narrow menus of tests yet are best-in-class in their niches. Such platforms are thriving in today’s environment and gaining market share from larger CROs that cannot deliver tailored service at low cost. 

All the above factors keep investors optimistic about the sector’s long-term fundamentals as they manage the recent slowdown in biopharma funding.

Figure 2: Strong Pipeline and Funding Activity

Positive outsourcing trends persist, driven by the high growth in the number of druggable targets being identified, the high growth in the volume of data that can be collected and analyzed per inquiry, and the rising complexity involved in the drug discovery process.

More specialized drugs that target complex therapeutic areas and narrow patient populations are taking a larger share of expanding R&D pipelines. Such in-demand precision therapies require more bioanalytical testing using advanced techniques such as mass spectrometry, liquid chromatography, novel biomarkers, and immunoassays. This, in turn, drives a greater need for the expertise of best-in-class drug discovery services companies.

Drug discovery also appeals to investors because it is relatively asset-light. Furthermore, the drug discovery space is one of the most fragmented, with a wide breadth of M&A targets and attractive consolidation opportunities. 

“Emerging biopharma companies dominate the R&D pipeline in this space,” says Dan Linsalata, a managing director. “There’s a large volume of small, niche-focused drug discovery service providers serving these biopharma companies, which means there are numerous opportunities to consolidate and differentiate through scientific expertise in particular drug modalities, regulatory proficiencies, and technology-driven capabilities.” 

Large molecule drug discovery can be an attractive play for investors as well. Historically this research has been done in academia. Andrey Dvorkin, a director, notes that very few large molecule drug discovery companies have successfully brought these services out of universities at any scale. 

Pharmaceutical companies' interest in these businesses is high as they seek partners to provide the advanced methods required in large molecule discovery. These conditions offer the opportunity for investors to help large molecule drug discovery providers in building industrialization and scale. Large molecule drug discovery is a highly bespoke, high-touch service with close-knit client engagement, making it very resilient to technological disruption and offshoring risks. 

An Attractive Landscape

The pharmaceutical R&D pipeline remains strong, and the volume of drug discovery activity continues to increase. Pharma companies of all sizes are turning to outsourcers that can provide the modern capacity and expertise they need, while helping them to increase speed to market and efficiency. As drug discovery service providers become more integral to successful and efficient R&D, the subsector is well positioned for growth.

Fragmentation offers many opportunities for investors to build platforms through consolidation and service expansion in both small and large molecule R&D. As a result, Harris Williams continues to see strong interest in this space from M&A investors. Providers that can demonstrate advanced go-to-market and technology strategies as well as a breadth of services and expertise stand to be highly valued.

To learn more or request the market map for this subsector, please contact our senior bankers. 

1.  IQVIA Institute, "Global Trends in R&D 2023," Pharmaprojects

2.   ibid