Biotechnology venture capital is evolving to exploit the changing dynamics between the pharmaceutical and biotechnology industries. Pharma’s increasingly urgent need for marketable products to drive future earnings growth has increased the price that pharma executives are willing to pay for synergistic assets. In response, well-capitalized venture firms are now funding product-focused biotechnology companies to allow them to deliver highly valued late-stage products to Pharma.
In years past when top line Pharma growth was stronger particularly in 2000 and earlier – pharmaceutical dealmakers were motivated to find technologies that enhanced their early-stage pipelines and to preserve their long-term competitive position in the face of the “genomic revolution.” Pharma looked to biotech to fill its productivity gaps and was willing to ink rich strategic partnership agreements, often in the very early development stages. Pharma’s priorities were clearly productivity-driven, based on the assumption that sustained earnings growth could be most readily achieved with greater efficiencies in research, in particular, from discovery platforms where genomics information could be easily translated into future drugs. Not surprisingly, venture capital investors responded by investing in companies that addressed this need.
Today, with Pharma top line growth rapidly decelerating due to product-specific market saturation trends and patent expirations, the emphasis has shifted. In 2002, the U.S. Pharma industry saw an average decline of 6% in earnings, the first such average net decline in more than 20 years, and projected growth in U.S. pharmaceutical sales has slowed to 10%-11% through 2004. According to Wall Street analyst consensus, the Pharma industry in 2003 is expected to recognize roughly $1.5 billion in new product sales compared to $2 billion in potential patent losses. Against this backdrop, paying large sums of money to access novel marketable products has become a justifiable if not compulsory practice in the pharma industry. Their focus has shifted to replenishing internal product pipelines, with a goal of minimizing the top-line slow down – if not fully rejuvenating revenue growth.
Publicly traded biotechnology companies with later stage products of strategic interest to Pharma have dominated the first wave of companies to exploit this shift. While the deal between ImClone (IMCL) and Bristol-Myers Squibb (BMY) for IMCL’s Erbitux EGF receptor inhibitor to treat cancer has received more press for its subsequent trials and tribulations, it does illustrate the relative strength of recent Biotech-Pharma product collaborations. Even with the renegotiation of this deal following the FDA’s refusal-to-file letter for the Erbitux license application, the clinical potential of IMCL’s antibody allowed the company to command a significant amount of upfront cash ($340 million), even more in potential milestone payments ($560 million), and a substantial share of downstream product revenues (39%), not to mention a staggering $1 billion payoff to IMCL shareholders.
Similarly, and despite the scandal that surrounded the IMCL deal, both Neurocrine (NBIX) and Amylin (AMLN) were able to command significant terms for their Phase III compounds-indiplon to treat insomnia and exenatide to treat diabetes, respectively. NBIX can receive $400 million in upfront and milestone payments from Pfizer, while AMLN can receive $325 million in upfront and milestone payments and an equity investment from Eli Lilly. And in addition to funding for their Phase III compounds and potential loans from their Pharma partners, both companies obtained the right not only to co-promote their products but also to promote one of their partners’ marketed drugs (Zoloft and Humatrope, respectively).
On the other hand, recent platform technology deals have not been nearly as rewarding. In fact, companies that were once labeled as “platform technologies” are broadly shifting their focus to product-based collaborations rather than relying on the more modest returns available with enabling technology deals. For example, Exelixis in its November 2002 agreement with GlaxoSmithKline is providing compounds to GSK only after they have generated Phase II clinical data, a far cry from its previous target-stage deals. In return, EXEL is eligible for a reasonable return: $44 million upfront in cash and an equity investment plus $90 million in development funding over six years, milestones, royalties, co-promotion rights in North America and an $85 million loan facility. But these figures depend on actual Phase II compounds, not EXEL’s functional genomics platform technology.
Although public companies were the first to attract the attention of Pharma’s business development teams, privately-held, venture-backed biotechnology companies that are able to advance drugs of their own into late-stage clinical development have the opportunity to sign lucrative deals of the same scale, as well. Venture investors have taken note of these dynamics and are positioning their portfolios to capitalize on the trend. Furthermore, they are participating in necessarily larger financings for well-positioned young companies since it is clear that attracting Pharma deals worth hundreds of millions of dollars is dependent on generating clinical proof of concept data – typically the byproduct of expensive Phase IIb studies. With specialized and deep-pocketed venture capital firms now able to fund these biotechs to relevant value creation end-points, entrepreneurs and biotech venture capital firms can position themselves to profit substantially by addressing the needs of Pharma.
For venture capital investors to take advantage of this trend in Biotech-Pharma alliances, venture capital will clearly need to be directed toward companies with products either in the clinic or about to enter clinical development. While clinical development requires significantly more capital over the lifetime of an investment than might an enabling platform technology, the return from a major product-based collaboration more than offsets the accompanying risk, especially when such investments can be made later in the development timeline. And the increase in company valuation that is attainable through product development can become apparent well before an IPO, leaving venture investors in an excellent position to realize significant gains.
Eyetech Pharmaceuticals is a recent example of a privately held company that managed to move a drug forward into clinical development and realize a major Pharma deal. Using privately raised capital, Eyetech has been able to bring its Macugen pegaptanib aptamer against VEGF into Phase III testing to treat age-related macular degeneration (AMD). In its recently signed partnership with Pfizer, EyeTech received $100 million in upfront cash and up to $645 million in milestone payments through commercialization of Macugen. In addition, EyeTech has U.S. co-promotion rights and royalties elsewhere, while PFE will fund the majority of ongoing development costs.
To justify a transaction of this magnitude, EyeTech required significant financing to fund clinical development. Firms such as MPM Capital and JP Morgan Partners had invested $108 million in a Series C financing that allowed Eyetech to get into Phase III trials. Having completed this partnership for a Phase III compound as a private company, venture investors in EyeTech stand to realize significant gains as the company is poised for a significant IPO once the public market financing window re-opens.
There are many other companies that are positioning themselves to attract these kinds of large deals; and so we expect more transactions of this nature to occur over the next 12 to 18 months. For example, Idenix Pharmaceuticals is in Phase III clinical trials with telbivudine for the treatment of Hepatitis B a blockbuster indication of obvious interest to many large pharmaceutical companies. GeneSoft Pharmaceuticals recently received an FDA advisory panel recommendation for approval for Factive (gemifloxacin) for the treatment of respiratory infections a product that has clear synergies with both large and specialty pharmaceutical company product portfolios. Additionally, as their clinical programs advance, companies such as Metabasis (in Phase II with a gluconeogenesis inhibitor for the treatment of diabetes and in Phase I with Hepavir B for the treatment of Hepatitis B), BioVitrum (with Phase II clinical trials underway in obesity and diabetes) and Sention (in Phase II for the treatment of Age Associated Memory Impairment) could be well-positioned in the near term with meaningful clinical proof of concept data that would enable them to access significant partnering dollars.
Perhaps not surprisingly, the partnering potential behind all these programs has attracted the attention of venture capitalists – including firms like MPM Capital, which in its BioVentures I, II, and III families of funds controls more than a billion and a half of capital and which has implemented a major product-driven biotech strategy. As a result of the competitive positioning, late-stage product based biotech companies in this category have had an easier time accessing funding and are well situated to exploit the current pharmaceutical-biotechnology industry dynamics.
Thus while the platform technology business model was previously thought to confer certain advantages, namely the opportunity for near-term revenues and lower risk than pharmaceutical product development, the dynamics of the Pharma industry have only served to emphasize that in terms of creating value, there is no substitute for a drug. As venture capital funds become increasingly able to adequately support private companies through the expensive process of drug development, and allow those companies to sign the types of large collaborations that their publicly traded counterparts have done, certain venture investors will be able to reap the significant rewards of a shifting balance of biotechnology power.