Podcast Summary: Thoughts on the Market

Episode: A Turnaround in Sight for Healthcare?

Date: October 28, 2025

Hosts:

• Sean Larman: Morgan Stanley U.S. Small and Mid Cap Biotech Analyst
• Terence Flynn: Morgan Stanley U.S. BioPharm Analyst

Overview of the Episode

This episode explores the drivers behind a recent rally in the healthcare sector, focusing on factors such as shifting macroeconomic conditions, regulatory changes, tariff dynamics, patent expirations, valuations, monetary policy, AI-driven innovation, and risks and catalysts for small and mid-cap (SMIDCAP) biotech firms. The conversation provides insight into both near-term and structural trends influencing performance and investment within healthcare and biopharma.

Key Discussion Points & Insights

1. Macro and Regulatory Tailwinds for Healthcare

• Recent Rally & Market Context:
  • Healthcare sector has “lagged the broader market year to date and valuations have been near historic lows,” but recent weeks display improving performance.
  • Initial concern over tariffs has lessened due to companies reshoring supply chains and investing in US manufacturing.
    • “A number of companies in our space have subsequently announced significant US manufacturing investments to reshore supply chains and hence the market's less focused on tariffs in our space right now.” (Terence Flynn, 00:41)
• Drug Pricing Policy Changes:
  • The "Most Favored Nation (MFN)" drug pricing policy aims to align US drug prices with those of other developed countries.
  • Several companies have entered agreements with the administration, providing investors with more regulatory visibility.
    • “We've seen several companies announce agreements with the administration along these lines, which importantly has provided investors with more visibility here.” (Terence Flynn, 01:02)

2. Patent Expiries & M&A Dynamics

• Looming Patent Cliff:
  • $177 billion is at risk from patent expirations by 2030, pushing big pharma to prioritize both internal pipelines and external innovation.
    • “Patent expiries are a normal part of the life cycle of drug development. Every company goes through this at some point... This does put the focus on companies internal pipelines... while also being able to access external innovation via M&A.” (Terence Flynn, 01:36)
• Recent Trends in Deal Activity:
  • Increase in mergers and acquisitions could benefit SMIDCAP biotech firms.
    • "Recently we have started to see a pickup in deal activity which could bode well for performance in SMIDCAP biotech." (Terence Flynn, 01:54)

3. Valuation Landscape and Investor Positioning

• Large Cap Biopharma Valuations:
  • The sector is trading at about a 30% discount to the S&P 500, similar to prior seasons of policy uncertainty.
    • “On a price to earnings multiple, the sector's trading at about a 30% discount to the S&P 500 right now. Now that's in line with prior periods of policy uncertainty.” (Terence Flynn, 02:12)
  • As regulatory clarity increases, focus is expected to return to fundamentals.

4. Impact of Rate Cuts on Biotech Investments

• Interest Rate Sensitivity:
  • SMIDCAP biotechs, typically net capital consumers, are particularly sensitive to interest rates.
    • “Small and midcap biotech companies... are particularly sensitive to the current rate environment. Therefore they're sensitive to spending on pipeline, they're sensitive to M and A. So as rates come down, we expect more spending on pipeline and more M&A activity.” (Sean Larman, 02:42)
• Past Performance Linked to Rate Cuts:
  • Historically, biotech outperforms in the 6–12 months following the first rate cut.

5. The "SMID to Big" Thesis in Biotech

• Drivers of SMIDCAP Biotech Growth:
  1. Profitability Transition:
     • Around one-third of SMIDCAP biotech companies are newly profitable, with cash balances expected to grow from $15B in 2025 to over $130B by 2030.
       • “About a third of those are newly kind of profitable companies. Those companies are turning from being capital consumers to capital producers. We see about $15 billion of cash on balance sheets for 2025 going to north of 130 billion by 2030.” (Sean Larman, 03:24)
  2. Valuation Opportunities Due to Regulatory Uncertainty:
     • Clinical stage companies have become more attractive.
  3. M&A Waves Driven by Patent Cliffs:
     • Anticipated high M&A activity fueled by large-scale LOE (loss of exclusivity).
       • “We expect generally that M&A activity will be quite high amongst our sector.” (Sean Larman, 03:53)

6. The Increasing Role of AI in Healthcare

• AI’s Transformative Potential:
  • Still early in adoption, but AI is starting to accelerate:
    1. Trial recruitment
    2. Regulatory submission
    3. Targeted molecule discovery
    • “There's three things to think about. The first one is faster trial recruitment. The second one is faster regulatory submissions. And the third one, which is the most interesting but we're really at the beginning of, is faster time to appropriately targeted molecules.” (Sean Larman, 04:18)

7. Risks and Catalysts for SMIDCAP Biotech

• Primary Risks:
  1. Pipeline failures
  2. Regulatory risk at the FDA
  3. Rising competition from China biotech
  • “As always we're focused on pipeline failures in terms of risk. Secondly, in terms of risk, we're looking at regulatory risk at the FDA. And thirdly, we're looking at the rise in China biotech and the competitive dynamic there.” (Sean Larman, 04:42)
• Catalysts:
  • Increased M&A, improved cash positions, clarity in regulatory environment

Notable Quotes & Memorable Moments

• “With the Fed moving toward rate cuts, how do you see this impacting your sector on the biotech side?” (Terence Flynn, 02:35)
• “Biotech sector is generally the best performing sector on a 6 to 12 month time frame post the first rate cut.” (Sean Larman, 03:03)
• “Whether you're watching large cap Biopharma's M and A moves or the rise of cash rich mid cap biotechs, the healthcare sector setup is unlike anything we've seen in years.” (Sean Larman, 04:56)

Timestamps for Important Segments

| Timestamp | Segment Description | |-----------|---------------------------------------------------------------| | 00:10 | Macro drivers of healthcare outperformance, regulatory shifts | | 00:41 | Tariffs and US manufacturing reshoring | | 01:02 | MFN drug pricing agreements | | 01:24 | Patent cliff and impact on M&A activity | | 02:12 | Sector valuations and historical comparison | | 02:42 | Biotech rate sensitivity and performance after rate cuts | | 03:20 | The “SMID to big” thesis detailed | | 04:09 | AI’s growing impact in biotech | | 04:42 | SMIDCAP sector risks and catalysts |

Conclusion

This episode provides a concise yet comprehensive view of why healthcare, particularly biotech, may be poised for a turnaround. Factors include favorable macro tailwinds, regulatory clarity, accelerating M&A, valuation opportunities, the emerging impact of AI, and distinct risks and potential catalysts. The insights highlight both challenges and reasons for optimism across large cap and SMIDCAP healthcare segments, appealing to investors assessing the sector’s outlook.