Next-Gen Sequencing, AI Driving Investor Interest in Diagnostics Sector

There is "intense" investor interest and "substantial" investment occurring in the next generation of diagnostics and tools companies (Dx/Tools), according to a year-end report published by Silicon Valley Bank (SVB). Driven by interest in the use of big data and artificial intelligence (AI) to inform care, big-name technology firms are now leading investment in the diagnostics sector.

"Generalist investor and tech corporate investment activity in Dx/ Tools has surged," write the authors, led by Jonathan Norris, managing director at SVB. "We expect today’s top tech companies to also become the next generation of top Dx/Tools companies. With dedicated Dx/Tools teams, these tech giants could drive sector growth for the next decade."

The report, Technology Advancements Redefine Promise of Dx/ Tools, defines Dx/Tools as including proprietary tests, actionable data analytics to determine or direct necessary treatment, and research equipment and services.

Who is Receiving Funding?
In total, eight rounds of financing in the Dx/Tools sector have exceeded $100 million since 2015. Dx/Tools fundraising increased 40 percent in 2017, reaching $2.8 billion. However, 60 percent of this total—or $1.6 billion—came from "mega" investments in liquid biopsy companies Guardant Health (Redwood City, Calif.) and GRAIL (Menlo, Park, Calif.), an Illumina spin off.

"Like any other diagnostic technology, liquid biopsy will require insurance coverage," explains Norris. "Widespread insurance adoption will require multiyear cost-benefit analyses. Early-stage cancer diagnoses reduce personal and financial burden, and we predict that the majority of insurers will cover these tests within the next five years."

  • Other testing companies, including point-of-care test companies saw increased investment, particularly for infectious disease tests, albeit at smaller denominations, SVB says.
  • Commercial-stage Dx analytics companies received early rounds of funding, reflecting the decreased risk associated with analytics, which don’t require the same regulatory approval as testing companies.
  • Investment in R&D tools companies was primarily reserved for commercial- stage companies, which have secured revenue-generating partnerships with large pharmaceutical or tools companies.

Who is Investing in Dx/Tools?
Generalist investors, in contrast to health care-focused investors, have quickly become the most active players since their emergence into the sector in 2015. This trend parallels the adoption of artificial intelligence technology. The top three generalist investors in the Dx/Tools sector include Data Collective (13 deals since 2015), khosla ventures (10 deals), and AME Cloud Ventures (nine deals).

SVB notes one challenge for companies attracting generalist investors is that they are accustomed to tech startups that have shorter development and commercialization timelines, compared to Dx/Tools companies. Interestingly, though, these investors appear to be more "risk-tolerant" than top health care investors, SVB says, investing in early-stage companies that still face regulatory and reimbursement hurdles.

Tech giants Amazon and Google have invested in the Dx/Tools sector and are trying to figure out how to integrate and leverage their computational resources in the health care industry.

"This is just the beginning, and we expect these giants to drive sector growth for the next decade," writes Norris. "They see the promise of an emerging ecosystem of companies that are focused on leveraging AI with genomic data to drive new diagnostic and treatment options. … Collaboration among tech and healthcare investors seems natural: It would create an enhanced team to take advantage of technical expertise and experience in health care market approval and adoption."

Despite the enthusiasm, Norris issues one cautionary note, writing, "The next few years will prove out the actual value of these technologies, as determined by key health care stakeholders (i.e., payers)."

Generating Returns for Investors
Driven by heightened investment, valuations are also increasing in the sector.

  • Dx/Tools now includes three unicorns, or companies valued at more than $1 billion — Human Longevity (San Diego), 23andMe (Mountain View, Calif.), and Illumina-spin out, Grail (Menlo, Park, Calif.).
  • Four companies are categorized as "breakouts" with valuations between $500 million and $1 billion (e.g., Gingko Bioworks, Guardant Health, Natera, and Pathway Genomics). Interestingly, unicorns’ investments are dominated by health care investors (67 percent), while breakout companies are dominated by generalist investors (66 percent).
  • Standout companies, those valued between $250 million and $500 million, including 10x Genomics, AssureX Health, Color, Quanterix, Twist, and Zymergen, are even further dominated by generalist investors (76 percent) and is the only of the three categories to include R&D tools companies.

However, these "lofty" valuations are making it difficult for Dx/Tools companies to generate high-multiple returns for investors. Unlike years 2013 to 2016 when there were 42 exits in the sector (26 mergers and acquisitions [M&A] and 16 initial public offerings), there were no "big exits," valued at $50 million or more, occurring in the Dx/Tools sector in 2017, according to SVB. Historically, Norris writes, Dx/Tools M&A activity occurred in the range of $100 million to $200 million. But, he says, based on current valuations, "robust exit multiples will be difficult to achieve."

Nonetheless, Norris is optimistic.

"We think this investment activity may be a precursor to acquisitions and lead to a land grab that could provide significant exit upsides and end the current Dx/Tools exit drought," he writes.

Takeaway: Investor interest in the Dx/Tools sector is surging, driven by general investors’ enthusiasm for next-generation sequencing, liquid biopsy, and AI.


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