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Big pharma subsidizes biotech investors

Pharma relies on M&A to sustain revenue growth. Investors, who fund the companies that pharma acquires, benefit from the M&A premium.

This could be a healthy symbiotic relationship: pharma gets more revenue growth, and equity investors get a return boost from M&A.

But it looks less like symbiosis and more like dependence.

Pharma overpays for companies it acquires. It has no choice -- it needs acquisitions to sustain growth, and must pay the market price.

And investors need pharma to overpay. If pharma paid fair value, investors in biotech IPOs would have earned no more than Treasuries.

This sounds concerning. But does it even matter?

1. Pharma overpays by 63% when buying startups

We analyzed 143 companies that were acquired of the 439 US biotech companies that went public from 2009 through 2021.

For each acquired company with products that reached the market, we collected the revenue generated by products developed by the acquired company (reported in the acquiring companies' filings). We trained a model to project product revenue to loss of exclusivity. We estimated cash flow per product based on the modality and the acquiring companies' margins. We discounted that cash flow to the deal date using the acquirer's cost of capital.

Across 83 deals where sufficient revenue data existed (covering $239B of M&A), acquirers got back $0.62 of product value for every $1 they paid (90% CI $0.46–$0.80). In other words, they paid 63% more than the products turned out to be worth.

The finding is not sensitive to the choice of discount rate. Fundamental value is less than actual acquisition value at discount rates greater than ~2%, which is roughly the risk-free rate. Unless investors are happy with pharma generating the same return as Treasury bills, pharma paid more than fundamental value.

Some deals paid off: Novartis's purchase of Endocyte returned more than three times its price. Many of the largest did not. Gilead's purchase of Kite, Celgene's of Juno and Novartis's of AveXis each returned a fraction of the price paid.

On average, pharma pays more for biotech companies than their products return.

Select caveats and limitations

A few caveats: this is measured with hindsight. Acquirers set prices before anyone knows which drugs will succeed, so any single deal that lost money may still have been a fair bet. Across 83 deals, though, the hits and misses of fairly priced deals should roughly cancel, but our analysis shows they do not, and the 90% confidence interval excludes 1 (1 would represent fair pricing; the confidence interval excludes fair pricing).

The largest caveat to this analysis, in our view, is that most of the fundamental value is projected. About 80% of it (in present value) comes from forecast sales rather than sales already reported, ranging from about 65% for deals done by 2016 to over 80% for recent ones. Our projection model is trained on the revenue histories of 182 marketed drugs. We assessed the bias of the model by forecasting each drug with that drug left omitted from the training set, and found it is roughly unbiased in total: for still-growing drugs, actual peak sales came to 1.08× its forecasts (90% CI 0.99–1.16). It does under-forecast early launches, by about 16%, so if anything it understates what the products are worth. Across its range of outcomes (25th to 75th percentile of projected peak sales), deals return $0.46 to $0.69 per $1, so even at the optimistic end, the deals return less than the purchase price.

Drug sales are right-skewed: most drugs stay small and a few become blockbusters, even among drugs that look alike early on. A forecast based on the typical (median) similar drug misses the blockbusters and under-forecasts total sales by about a third, so our model forecasts the average outcome of similar drugs instead. Tested out of sample, that is roughly right in total (1.08×), though it still under-forecasts early launches by about 16%, and for any single drug the upside is wider than our range implies.

We are open to feedback on the methodology -- if you have questions or comments, let us know.

2. Without the IPO pop and strategic overpayment, biotech IPOs had a negative return

We calculated a pooled, money-weighted IRR to an investor that bought each IPO at the offer price and held to the terminal date (3/31/2026 for this analysis), date of acquisition, or date the company failed.

The overall pooled IRR is 7.5% (90% CI 3.4%-11.5%). The estimated time-varying cost of capital for the pooled cohort is 8.4%.

However, if we exclude the M&A premium and the IPO pop, the IRR is -2.4% (90% CI -6.3%-1.2%).

For reference, the risk-free rate during this period was 2.0% (weighted by % of cohort IPO capital raised in each year).

If we include the IPO pop but exclude the M&A premium, IPOs returned 2.0% -- the risk-free rate.

In other words, pharma shareholders have been subsidizing biotech investors. Essentially the entire return above the risk-free rate of the 2009–21 IPO cohort is generated by strategics overpaying for M&A.

This -2.4% "intrinsic IRR" values each acquired company based on the actual + projected cash flows generated by products it developed, discounted at the biotech cost of capital at the time (the quarterly CAPM rate an IPO investor would have used). Failed programs are valued at $0. For acquired companies where the fate of the products are unknown (ie, they have at least one material unapproved product or approved products with minimal commercial history), we value the company at its market value before the bid (42 trading days before the deal was announced). Valuing those companies instead at 58 cents per $1 of the price paid -- the ratio we measured, at the same discount rate, on the deals whose products we could track -- gives roughly the same answer (-2.2%).

3. Pharma has to overpay for M&A (but maybe not for long)

Pharma has to pay up for M&A

Big pharma buys smaller companies because 1) large pharma companies need to replace revenue lost when drugs lose patent protection and 2) big pharma's in-house R&D is not productive enough to replace that lost revenue.

That said, pharma does not have to replace its lost revenue. Pharma companies can return cash to shareholders via dividends and buybacks (the 25 largest pharma companies returned about $150B to shareholders in 2025 in dividends and net buybacks). However, a strategy of purely returning cash to shareholders would significantly depress valuations, as companies would no longer be valued at a growth multiple.

So pharma chooses to sustain growth via M&A. Loss of revenue through patent expiry combined with poor internal R&D creates a recurring demand for M&A to supplement revenue growth.

At the same time, the supply of high quality acquirable companies is relatively constant. Capital markets have funded increasingly more biotech companies in the post-GFC period, but the intrinsic value of those companies (ie, the level of cash flow generated by drugs developed by these companies) has been relatively stable.

In our data, the cohort of companies that went public each year from 2015 to 2021 was worth $68–94B at exit with no upward trend, while the money raised in IPOs per year tripled, from $4.3B to $13.4B. The intrinsic value of biotech companies has not grown at the same rate as the capital invested in these companies.

More capital invested does not necessarily lead to more valuable drugs.

For example, 2020-2021 were the two biggest years for biotech IPOs ever. They also had the highest rate of low-quality companies. These vintages had the highest proportions of preclinical and Phase 1 companies on record. Their post-IPO stock performance was also poor: three years after going public, 83–88% of those IPOs traded below their offer price and about 70% had lost more than half their value, against 48–68% and 33–48% for every class from 2013 to 2019. Even controlling for XBI performance, 2020-2021 are the worst performing years -- the poor performance of these vintages was not just due to the 2022 biotech crash, it was due to the quality of the companies funded.

In short, pharma's demand for acquisitions seems to be price-inelastic, and the supply of good companies does not necessarily grow because there is more money being invested.

Thus, if pharma companies want to support revenue growth and garner premium valuations, they must pay whatever price the market demands for scarce, high-quality assets.

Enter China

Until recently, pharma had little alternative beyond expensive M&A and unproductive internal R&D to support revenue growth. The main third option was licensing or partnering to develop assets, but this strategy was still hampered by low R&D productivity (early-stage collaborations are less fruitful than hoped) and a competitive "seller's market" (companies with valuable licensable assets were often better off seeking funding at attractive terms in the equity market, and holding out to sell later).

However, the rise of China's R&D industry (specifically, China's increasing share of clinical assets -- China had already been doing a large share of drug discovery) has provided a better option: licensing promising drugs on good terms from Chinese companies.

In 2025, 39% of big pharma's in-licensing deals with at least $50M upfront were with China-based companies, up from 5% in 2022. Through September 2026 the share was 51%, and those deals took 65% of the upfront payments (cash and equity) (J.P. Morgan, Q3 2026 Biopharma Licensing and Venture Report, DealForma data). A license with a modest upfront and milestones paid on success costs pharma much less at the outset, can be much more attractive than buying overpriced startups.

The prices may not stay low. Average upfronts on China licensing deals rose from $102M in 2024 to $141M in 2025 (Evaluate, via PharmaVoice, among deals that disclosed an upfront), and US policy toward China-sourced drugs is uncertain. But China seems like it will only grow stronger as a source of innovative medicines, and that will put pressure on US-listed biotechs, as pharma will have an alternative to paying high M&A prices.

4. China's rise threatens the US IPO and venture markets

If licensing from Chinese companies displaces buying US-listed biotech startups as big pharma's preferred way to supplement revenue growth, the biotech IPO market will potentially face significant disruption. If we exclude strategic overpayment, biotech IPOs from 2009–21 generated negative returns for investors who did not get allocated at the offer price, and about the risk-free rate for those who invested in the IPO.

To sustain an IPO market where big pharma does not have to overpay for M&A, IPO valuations would need to be revised significantly downward. Upstream equity markets -- the venture capital and growth equity markets -- would also be impacted.

This is bad news for US biotech startups.

For US biotech investors, the picture is less clear, but still concerning. If US investors are able to invest in Chinese companies, they will come out ok (although probably will not fare as well as they would if US biotech startups remained the only large-scale source of biotech innovation). US investors could potentially invest at in Chinese companies at lower valuations that US startups, then help those companies list on US markets. A successful listing on NASDAQ or NYSE can result in better access to equity funding on more favorable terms than any other global stock market -- and a nice markup for the investors who shepherd this trade.

However, the US Treasury has recently proposed rules under the COINS Act that would restrict US equity investment in Chinese biopharma.

US biotech investors oppose this restriction on US investments in Chinese biotechs, arguing that, if they are unable to invest in Chinese companies, they will be unable to assess the competitive landscape, and may stop investing in US companies as well. Peter Kolchinsky, of RA Capital, said that if US investors cannot compare a US biotech with what is being developed in China, "the answer is, you don't invest [in US biotechs]. There's no rule that says that a U.S. investor has to invest in biotech."

5. Does it matter that pharma overpays?

Setting China aside: it may not even matter if big pharma overpays for M&A. Big pharma shareholders do not seem to care. As we showed in a prior post, pharma's valuation multiples rose while return on capital fell to the cost of capital post-GFC (7.8% against 8.0% in 2016–25), and R&D productivity remained stagnant after decades of decline and Eroom's Law.

Why they don't seem to care is the subject for another time. But as long as investors credit pharma with healthy multiple, overpaying for M&A isn't a big deal. If pharma was highly indebted, overpaying for M&A would be more concerning. But big pharma is still conservatively levered, despite the sector's debt rising steadily over the last 15-20 years (often tied to large M&A deals).

Does it matter for society if pharma overpays for M&A? On its face, pharma subsidizing early-stage investors seems good for society, as more drugs get funded. In practice, however, society does not seem happy with the pharma status quo (although much of the blame pharma gets fairly belongs to PBMs and the rest of the healthcare system).

However, there are serious questions about incentives and allocation of resources. If the pharma industry can cover its R&D productivity problem by buying growth at unfavorable prices, and shareholders are on board, the industry has little incentive to get better at developing drugs and reverse Eroom's Law. And if pharma R&D returns are below the cost of capital, then society should probably pay more attention to other ways of bringing scientific innovation to patients, though other efforts are unlikely to garner much funding as long as shareholder returns in pharma continue to be ok.

Personally, I'm not sure what to think about all this. On the one hand, it seems wrong and inefficient that the industry allocates capital so poorly, and it makes me less optimistic about the future of the industry and the ability of US biopharma to compete with China. It seems like a classic "grey rhino". On the other hand, if it means more drugs getting developed, that seems like a good thing.

The more concerning aspect to me is that there doesn't seem to be much energy around finding a better alternative. As long as shareholders keep accepting R&D and M&A that return less than they cost, there is little pressure to find a better way.