Biotech's Turnaround Potential: Navigating the Funding Drought

The biotech sector has navigated considerable turbulence over the past few years, primarily driven by a sharp reduction in early-stage funding and macroeconomic volatility. Rising interest rates and cautious investor sentiment have constrained preclinical research investments, deeply affecting the broader drug discovery and development ecosystem. While service providers heavily reliant on biotech clients have been notably impacted, these challenging market conditions also present cyclical rerating opportunities, particularly for differentiated, temporarily undervalued companies.

Evotec: navigating industry headwinds with strategic differentiation

Evotec, a Germany-based global drug discovery and manufacturing company, exemplifies such an opportunity. Historically, Evotec generated a substantial portion of revenue from standard preclinical contract research organization (CRO) services. However, recent strategic shifts have positioned the company for higher growth and profitability through differentiated, capital-efficient platforms:

• Advanced drug discovery capabilities: Evotec has developed sophisticated multi-omics and AI-enabled platforms integrating clinical databases, highly automated stem cell screening processes, biologics and targeted protein degradation technologies.
• Just-Evotec Biologics (JEB): This biologics-focused subsidiary emphasizes continuous manufacturing, a more scalable and cost-efficient approach compared to traditional batch methods. JEB has secured significant contracts, including recent agreements with Sandoz and the US Department of Defense, underscoring its strong growth potential.
• Optimized R&D model: Evotec has strategically shifted from entirely self-funded R&D to a more sustainable shared or partnered research model. The company is deliberately reducing its exposure to internally funded clinical trials, thereby mitigating risk and costs while leveraging collaborations with key pharmaceutical partners.

We believe these strategic pivots not only improve Evotec’s profitability but also align the company closely with emerging industry trends, setting the stage for potential valuation rerating when the broader biotech funding environment improves.

Market dynamics supporting Evotec’s rerating

Recent industry data from several companies in the CRO industry offer early signs of a cautious but improving biotech landscape. ICON, another SJF International holding, reported sequential growth in bookings, primarily driven by biotech rather than large pharmaceutical companies, indicating a tentative recovery in early-stage research demand. Although cancellations remain high and market volatility continues, the small increase in biotech spending is a positive sign.

Evotec is similarly positioned to capitalize on this evolving environment. While approximately half of its business, the traditional CRO segment, is still facing challenges, the other half comprises high-value, rapidly-growing, differentiated platforms. Evotec has undertaken aggressive cost optimization initiatives to enhance profitability, significantly reducing its fixed-cost structure without sacrificing critical growth capabilities.

Intrinsic value and cyclical rerating opportunity

Drawing on deep health care expertise, our analysis distinguishes between temporary setbacks and lasting structural strengths. In our view, Evotec’s intrinsic value is underpinned by:

• A strategically repositioned core CRO segment poised for eventual recovery.
• High-growth biologics and technology licensing opportunities driving profitability improvements.
• Effective management execution, emphasizing profitability, risk mitigation and capital efficiency.

These strengths are largely overlooked by standard market valuation screens, providing a compelling cyclical rerating opportunity as biotech spending gradually rebounds.

Conclusion

The market has yet to fully appreciate Evotec’s strategic shift towards profitable, differentiated growth. We think patient, long-term investors are well-positioned to benefit from substantial valuation upside as industry funding dynamics normalize and Evotec’s growth platforms realize their full potential.