Monday, April 30, 2012

I admit it: I don't "get" the generics business.

On one hand, I see the appeal of the generics business - there's ALOT of profit to be made by undercutting traditional pharma companies in off-patent drugs. Who doesn't like the idea of winning 30% of pharm.'s revenue with an investment of 1% of pharm.'s revenue?

On the other hand, any generics company really has only one variable to compete on: cost. (Who wants to compete solely on cost? Not me.)

By definition, the generic chemicals manufactured are identical, so there is no competing on product performance, and presumably every generic company's cost to manufacturer a particular chemical is roughly the same (though the difference in labor costs between, say Dr. Reddy's in India, and Teva (Israel and USA) isn't insignificant.)

So why would one generic company pay a premium to acquire another, as Watson did to acquire Actavis last week? At 14X EBITDA, the deal doesn't work on a purely financial basis, unless the combined operating margin roughly doubles (requiring a $1.2B improvement in operating margin, on $8B in annual revenue. That ain't happening.)

Watson will be acquiring Actavis manufacturing assets, which adds a mild amount of strategic value, but it seems to me that the only two ways that this deal ends up being rewarding for Watson is 1) if success in the generics business is entirely based on scale, or 2) the greater fool theory takes hold.

So with generics M&A occurring roughly monthly and big boys like Pfizer stomping into generics, I need someone to correct me, or otherwise explain this industry to me, because I just don't see an investment rationale, or why risk capital would chase this industry, other than to lock-in a modest annual ROIA.

(And it's not like I'm the only one not questioning the wisdom of generics investment - Deutsche Bank is taking a ~$375M hit on their investment in Actavis, as a result of the Watson-Actavis deal.)

Help, anybody?

btw: I think the manufacturing challenges inherent in bio-similars makes this subset of the generics industry much different than the chemical generics discussed above.

Gen-Probe sale validates molecular future

Hologic, the "Woman's Health Company," announced today that they're betting the company on genomics.

Well, that's not exactly what HOLX announced, but practically speaking, when a $5B company with a mild amount of DX exposure decides to pay $3.75B to buy a nucleic acid testing firm (Gen-Probe), they're really betting the company on genomics.

I like the deal for both HOLX and GPRO - HOLX gets exposure to growing markets and technologies which nicely complement their core business. (Tthe combination of HOLX's focus on women's health and GPRO's HPV tests is a perfect fit.) GPRO - who's growth was slowing - gets a nice bump in valuation, and probably a good amount of independence.

It'll be interesting to see what becomes of the non-women's health applications of Gen-Probe. Will HOLX punt the cancer testing business to QGEN or Clarient (GE)? Since the deal is all-cash, HOLX might want to later de-lever by punting the cancer tests or other assets.

Two unfortunate side effects of the acquisition: Gen-Probe is/was the largest, most prominent molecular DX pure-play. With Gen-Probe losing its' independence, we're losing both a bellwether for MDX, and losing a buy-side specialist. Gen-Probe is/was in excellent position to commercialize interesting DX coming from smaller players, as is the case of their PCA3 product sourced from Diagnocure.

One other impression from the HOLX-GPRO deal: re-reading Roche's rationale for their pursuit of Illumina, it sure seems to me that Gen-Probe would have been a better fit for Roche instead of Illumina. I wonder if they'll try to top HOLX's offer. (Or maybe GE or Danaher will.)

Wednesday, April 25, 2012

Structural problems in VC-land

Fascinating blog post and commentary by Noah Smith suggesting that VC returns have lagged the S&P 500 for nearly a decade.

Here's a graphical representation of his point:

Head to Noah's site to get all the details of the study.

(The study seems to be across ALL industries - with biotech/life sciences composing only a fraction of the investing universe for these VCs, but the core lesson probably holds for biotech: VC returns have plummeted.)

The explanation for the plummeting VC returns is an oversupply of risk-capital (and risk-capitalists!), beginning during the dot-com bubble. However, it isn't clear if this is because deal pricing and other investing terms have changed post-bubble, or if the oversupply of capital led to the funding of marginally rewarding portfolio companies, or any of a dozen other explanations. Perhaps it is simply that there had been an artificial constraint on risk capital before the bubble, allowing VCs to earn rich returns by cherry-picking only the best deals.

One commenter at Noah's site provided evidence that VC returns also tend to correlate with the history of the VC team. (In other words, long-term VC groups have done much better than Johnny-come-latelys.)

Whatever the explanations, there are implications for life sciences:

-we're in the midst of a correction in the VC market - many marginal VC players will disappear, and with that, pricing power will begin to return to the survivors.

-if they weren't already, VCs are desperate for returns. Expect them to ALWAYS take the option that cashes them out now at a lower price, than later at a higher price. (If you thought they were short-term thinkers before……..) This is good news for strategic buyers.

-seeing these returns, LPs (those who invest in VC funds) are more likely to "go direct" by investing in PIPES and follow-ons and forego investing with VC funds that 1) don't deliver risk-approproate returns, and 2) charge 2% a year, plus a carry. If this is true, there's more hope for older small cap biotech's, and less hope for early stage companies.

-I'd guess that a side effect will be a decline in risk appetite, which would be a nudge towards tools and tech platform companies, and away from discovery pure-play companies. I'd also guess that target discovery is no longer a viable business - if there's an over supply of VCs, the last thing they'll want to do is add to the oversupply of targets.

-seek quality. All else being equal, the life science VC firm in its' 2nd decade of investing is likely to be a better choice than a firm just beginning in biotech investing.

-as before, there is still a big opportunity for corporate (Big Pharma) VC$.

Hat tip to Tyler Cowen's Marginal Revolution blog for pointing out Noah's post.

Interesting pharma M&A stat….

From this Bloomberg article: recent pharma acquisitions of >$500M have been at an average 71% premium to their pre-deal market price.

The article suggests that this is driven by the large number of Big Pharma's products going off-patent and therefore needing to be replaced. This is true, but I think there's also the partial explanation of a cost of capital arbitrage.

Pharma companies tend to have a cost of capital just a few points more than the borrowing from the Fed. This figure can be calculated for each pharma company, but let's just assume 8% over the long run, but with today's low interest rate QE2 environment, that might be more like 6%.

Biotechs, - even public biotech's - have a MUCH higher cost of capital. This too varies based on company, disease-focus, maturity, etc., but probably somewhere in the range of 12-18% today, or 2-3X big pharm.'s cost of capital.

Big Pharma companies (generally) trade based on earnings multiples, while biotech's tend to trade on the value of growth, which is risk-adjusted by the biotech firm's MUCH higher cost of capital.

Consider the forward and trailing P/E ratios of the first 7 pharmas that came to mind:

So let's say that you've got a blockbuster ($1B in revenue) at typical pharma margins (27% operating margin - we'll use that as a stand-in for EPS.)

That suggests that on a forward basis, the blockbuster is worth $3.25B (forward P/E of 12 x ($1B x .27)) to the pharma.

But if the blockbuster has sales of only ~$250M at this point, and $1B in revenue is still years off, the discounted (risk-adjusted)  value is much less perhaps half the value of its' forward value under the wings of a pharma company.

This example is pretty much a reflection of the setting of the HGSI-GSK merger talks. HGSI had $130M in revenue (JV revenue) and a market value of <$1.3B immediately before GSK launched their $2.6B takeover offer.

What I've described above - pharma's lower cost of capital relative to biotech driving M&A activities - is nothing new, but with interest rates today low enough that borrowing costs are almost negative for big pharma, it should really only be news if Big Pharma WASN'T buying, irregardless of the oncoming patent cliff.

Thanks to FierceBiotech for pointing out the article.

Monday, April 23, 2012

Sequencing hardware: who's best?

An academic group ran similar experiments on Ion Torrent PGM, Illumina MiSeq, and 454 GS Jr DNA sequencers. And the winner was……….well, there was no clear winner - performance was differentiated by machine - the PGM was the highest throughput, MiSeq most accurate, and the 454 had the longest reads.

I think this is a problem because currently the incremental customers that represent sequencing moving from a niche to a mainstream activity are unlikely to have a full understanding of their needs. For example, while the team at the Broad Institute knows why they'd prefer machine 'A' over machine 'B', a typical pathology lab does not know enough to decide if they would get the most benefits from hardware producing the greatest accuracy or the longest reads? What's acceptable accuracy? I'd argue that the path lab at the University of Whatever can't answer these questions.

Until the answers here are more obvious, customer demand will be for a slice of a shared sequencing resource (a sequencing core) rather than for their own sequencing hardware, thus limiting the growth of the hardware market. (Though this is good news for Oxford Nanopore and other NGS hardware suppliers - the longer it takes for the market to mature, the more prospects who remain uncommitted to any certain hardware platform.)

DNA, RNA, and….XNA?

A UK team synthesized DNA-like and RNA-like chemicals with similar properties, though using never seen-before chemistry to act as the structure for the nucleobase genetic information. (In other words, traditional A's, G's, T's. and C's, but novel structures in place of the ribose or deoxyribose sugar scaffolding. Good scientific over views can be found here or here.)

The resulting molecules are referred to as XNA - xeno nucleic acids. The implications of XNAs are profound, and I'm not even counting the conclusion that it now seems that life need not be based on DNA or RNA. (I can't wait to see how the evolutionists and creationists spin this news.)

The UK team's research represents the dawn of a new research modality or at least a re-definition of the science of biochemistry. XNAs could be a new source of therapeutic compounds or a source of new biomaterials. XNAs could be a key component of quantum computing (it would seem that XNAs could represent organic memory storage).

My first thought, as I contemplate how to explain the significance of XNAs to a non-bio-geek, is to suggest a mainstream analogy: DNA & RNA are traditional operating systems that we have grown up with and almost mastered, like Linux or Windows. The development of XNA is like the establishment of a different but ubiquitous operating system like Java. Like Java, XNA could enable exciting new applications in a breadth of industries or operating systems.

I think XNAs will kickstart a wave of interest in chemistry and synthetic biology research, not just in traditional biochemistry groups, but probably as far afield as NASA (XNAs as an analog for extraterrestrial life?) and Dow Chemical (why synthesize a chemical when you can express it?)

A couple of questions to chew over as a result:

1) while XNAs represent a change in the basics of life's chemistry, is an improvement possible, or has evolutionary biology optimized our chemistry?

2) what does this mean for large synthetic biology ventures like Intrexon? Their existing IP likely just became less relevant (or valuable), but their core capabilities are now more relevant. (I'm probably getting ahead of things - the XNA technology is still a long way from commercialization.)

3) what groups will be the first to incorporate XNA in their grant proposals? Will it be drug discovery groups, who would consider XNA another lead class on the order of siRNA or aptamers or will it be chemical engineers?

4) what can be down to mitigate the inevitable new, larger, louder round of synthetic biology fear-mongering among bioethicists and bio-Luddites, as XNAs could possibly do very bad things - intentionally or unintentionally.

Of course, XNA was not the biggest scientific advance this week. That prize goes to the research team who discovered the cause of brain freeze. I wonder if the research was underwritten by Slupree Corp.

HGSI in play, an era comes to a close

It's been a long, long, long road for Human Genome Sciences, but congratulations are due for their $2.6B buyout offer from GSK at a roughly 50% premium to their previous trading price of $7 per share. HGSI rejected the offer, but it is widely expected that HGSI and GSK close a deal at a slightly higher price ($3B?), though it would be fun to see GSK hold firm on the pricing of their offer - I don't think HGSI is likely to attract higher bids from any other companies.

By way of comparison, over its' history, HGSI raised ~$3.8B in capital.

The buyout is driven by HGSI-developed Benlysta (for Lupus, partnered with GSK) and it's near term pipeline which includes a pretty exciting atherosclerosis drug. Once again, we see big pharma buying a partner who has been substantially de-risked, something to consider as Vertex, Onyx, and others approach this stage.

But HGSI will forever be to me a lesson in buzzword-investing.

Rewind to very late 1999-2000 - the peak of the internet investing bubble and the dawn of the genomic age. Tech investor fervor and the news of the success of the Human Genome Project ran up the stock prices of all things genomic. HGSI peaked at a split-adjusted price of 103 in 2000. (Reminder: GSK's current offer is ~$13 per share.) Here's a crazy chart of HGSI's stock price over the last 13 years:

But genomics shares (including Celera, Incyte, etc.) cratered quickly once the hot money cooled and once the realization hit that genomics products seriously lagged, for a variety of reasons. What followed was a lonely decade for genomics stocks, and I can't help but wonder if the 2000-era fervor was a net negative for genomics. (Did the investing bubble distract management from building a successful long term tech platform? Did the unreasonable expectations of the market poison the well for future genomics companies?)

The genomics bubble was nothing new - remember the gene therapy bubble or the angiogenesis bubble before that? Since the genomics bubble we've seen a stem cell bubble and an RNAi bubble, so clearly the investment community hasn't learned the lesson to ignore or at least devalue hype, but HGSI's sale to GSK shows that post-hype, post-bubble companies can still generate value. 

NOT in biotech's robust future

The main theme of this blog is that massive innovation currently underway in the biotech industry will improve health care globally and create exciting businesses. The hallmarks of this "molecular future" will be personalized medicine, genomics, and broad digitally-enabled technologies, such as DNA sequencing, arrays, and multiplexed assays.

But today - as a follow-on to last week's Top 10 Promising Cancer Drugs post - let's talk about one biotech 'innovation' that won't be powering growth or improving outcomes: cancer immunotherapy.

FierceBiotech collected the comments spawned by their original Top 10 article, and there was a surprising amount of positive commentary in support of cancer immunotherapies. (Sometimes referred to as vaccines.)

As bullish as I am on the "molecular future," I have the exact opposite feeling for cancer immunotherapy - partially due to my experience working at a cancer immunotherapy company in the late 1990's.

The concept of cancer immunotherapy is very appealing - train or otherwise get the patient's immune system to recognize and respond to a cancerous tumor as foreign, thereby empowering a non-toxic immune response. And, indeed, this has been shown to happen in various studies, dating back more than two decades.

An effective cancer immunotherapy could be extremely targeted with limited side effects. But the immune system is far, far more complex than anticipated and frankly humbling to most researchers. It is seductively simple to conclude that all one has to do is pick the right antigen to stimulate an antibody response (as in many immunological disease), but there are apparently many biological holes in this theory special to cancer. (For one, we're learning that cancer tumors are not homogeneous.)

Here's my rationale for immunotherapy skepticism:

1) There is a long track record of failure in this area.
2)  the core thesis is still lacking validation.
3) big pharma has virtually no investment in this research area
4) the regulatory approval path is not optimized for cancer vaccines.
5) cancer immunotherapy research is asset-intensive and effort-intensive. Pursuit of autologous therapies is particularly labor intensive. In contrast, 1 informaticist or 1 medicinal chemist is enough to launch a discovery/development program.
6) what little commercial effort in the area of cancer immunotherapy is being conducted by micro-cap companies. (I don't mean to denigrate any company successful enough to go public, but there is a load of history confirming that companies of this size and scale just don't have the assets/resources necessary to conduct pivotal research.)

In essence, cancer immunotherapy research has the challenge solving of incredibly complex disease biology using the an incredibly complex modality. In effect, cancer immunotherapy equals the complexity of cancer treatment squared, though with less pharma support.

Case in point: CEL-SCI (CVM). While spun out from the very credible Max Planck Institute and built on attractive scientific rationale, CEL-SCI has been chasing an immunotherapy solution ("Multikine") since 1983. Nearly 30 years later, CEL-SCI is a micro-cap, with a market valuation of ~$110M and likely insufficient resources to complete their Phase III trials of Multikine.

I really, really hope that CEL-SCI or the other cancer immunotherapy companies are ultimately successful, but my perspective is that there are more promising oncology technologies for pursuit and investment.

It should be pointed out, though, that there is an FDA-approved cancer immunotherapy - Dendreon's ProVenge for prostate cancer. Dendreon received FDA approval in 2010, but market response to date has been limited. It is unclear if the market's response to ProVenge is driven by technical skepticism, or by the complexities of creating and delivering an autologous vaccine.

Wednesday, April 18, 2012

ONYX under the microscope

Related to FierceBiotech's Top 10 Promising Cancer Drugs mentioned in my last post, there's one company with two drug candidates in the Top 10 - Onyx Pharma (ONXX).

Each Onyx program is reaching an important milestone/inflection point over the next year, making this an interesting year for the stock, which makes it worth putting under the microscope.

First a refresher: ONXX has an enterprise value of $2B, largely based on Nexavar, their FDA-approved small molecule multi-TK inhibitor. (Inhibiting VEGFR, PDGFR, and Raf, and approved for RCC and HCC.) What makes Nexavar unique is that it is the only approved MAPK inhibitor. (Indeed the only survivor from very intense pharma R&D over the last 15 years.)) Nexavar sales totaled $1B in 2011, and grew 8%. ONXX stock is up 20% over the last 12 months (vs. 10% for NAS), but at 57% vs 81%, ONXX lags the NAS over the last three years.

The partnership between Bayer and Onyx is a bit messy accounting-wise (and was very messy in every other way until last fall), but a half-interest in a growing billion dollar drug is probably worth ~$1.25B. (Quick n' dirty: 50% of $1B in annual rev * 2.5X average price to sales ratio for pharma industry.)

2012: this year Onyx might transform from a company with a single product for two disease indications to a company with three products for five disease indications based on developments in the two programs highlighted by FierceBiotech - Regorafenib for CRC and GIST (CRC is a big market, GIST is small), and Carfilzomib for multiple myeloma (huge market, with Velcade (Millennium) and Revlimid (Celgene) together accounting for >$4B in multiple myeloma drug sales.)

Regorafenib is an interesting story. Regorafenib is very similar to Nexavar, but Onyx's partner Bayer developed the drug on their own. Both sides wrestled over the IP, but eventually settled with Bayer sharing a 20% royalty to ONXX on Regorafenib. I am guessing the amended partnership agreement also included an agreement to market the two similar drugs at different markets, as Regorafenib is seeking approval in new markets relative to Nexavar.

An FDA decision on Carfilzomib will be announced before August, while Regorafenib will file for approval with the FDA later this year. (But with approval in 2013?). Both drugs have supportive late stage trial data.

So, what's ONXX worth? 

The sum of:

value of their interest in Nexavar + value of their 20% interest in Regorafenib, adjusted by the probability of FDA approval value of Carfilzomib, adjusted by the probability of FDA approval.


(Acquisition rationale: 1) pharmas buy growth products, 2) pharmas buy blockbusters, and 3) Bayer in particular is likely to want to buy out their partner.)

If everything was FDA approved, I think ONXX would be worth roughly

$1.25B for Nexavar
$500M for their 20% interest in Regorafenib (at $1B peak sales x 2.5 P/S ratio).
$2.5B for Carfilzomib (also $1B peak sales x 2.5 P/S ratio. $1B in revenue at peak assumes ONXX takes 25% of the $4B multiple myeloma market, likely displacing Millennium, not Celgene.)

Operating value total: $4.25B

Adding a modest 25% acquisition premium assumption would yield a predicted future value of ONXX of $5.3B, or 2.65X the current enterprise valuation.

(technically you'd discount back from the period of peak sales for each drug for it's present value, but let's keep things simple.)

The expectations for ONXX's prompt FDA approvals obviously would change (reduce) the final corporate valuation a great amount. I have absolutely no insight into what ONXX's chances are with the FDA, nor do I have any reason to make a prediction of ONXX's probability of prompt approval, so you need to adjust the ONXX valuation by your own expectations. But, another way you could look at ONXX is to infer the market's expectations of FDA and product success from today's valuation.

If ONXX's enterprise value is ~$2B, and Nexavar is "worth" $1.25B, you could infer that the discounted value of Carfilzomib + Regorafenib totals $750M. (I'm simplifying here - this analysis assumes no future value for anything else in ONXX's pipeline, which isn't fair.) By extension then, the market says that there is a 18% probability (750/($5.3B-1.25B)) of the scenario I outlined above, including acquisition of ONXX at a premium.

It's up to you to add your own perspective - this is not a recommendation to buy or sell ONXX stock. As of this writing, I hold no ONXX shares and can state definitively that this will not change over the rest of the week. If/when my disposition changes, I will update this page.

Please let me know in the comments section what you think of the above "under the microscope" analysis, and if you would be interested in my duplicating it with other bio-pharma companies in the future.

Top 10 promising cancer drugs in development

FierceBiotech - an indispensible web site (sign up for their daily news summaries) produces an annual list of most-intriguing/promising late stage cancer programs. Here's this year's edition - it's definitely worth a read.

I was struck by the diversity of approaches. The target/technology list includes:

cancer stem cells,
the proteasome,
androgen receptor signaling,
antibody-chemo conjugates,
tyrosine kinase signaling, and

The good news is that there is a broad and diverse anti-cancer effort underway. The bad news is……there is a broad and diverse anti-cancer effort underway….meaning we still don't know much about how to fight cancer effectively. From a decade ago, a few anti-cancer technologies have come (stem cells) and gone (gene therapy), and some technologies have increased validation (anti-angiogenesis) while others have fallen (immunotherapy), but the nature of the list hasn't changed a great deal.

One possible lesson from this list of candidates: anti-sense/RNAi and HDAC drug development are not currently as promising as they each were 3-5 years ago.

Tuesday, April 17, 2012

"Our life spans are much shorter than the FDA approval process."

Stunning story in today's WSJ about ALS patients who are making an experimental drug for ALS at home, on their own, and testing it on themselves. No FDA, no GLP, no IRBs, no control group - just patients in need doing what they can.

ALS (Lou Gehrig's disease) strikes fast, while the drug development, clinical testing, and regulatory approval processes moves slow. I understand the need of scientists and regulators for process, structure, and control, but I do not often enough see a reciprocal amount of flexibility or practicality in drug development. I've often wondered, for example, why we need placebo control arms in clinical trials targeting terminal diseases. Don't we already have a deep enough understanding of the life expectancy of a stage III lung cancer patient (for example)?

The one positive in the ALS article is the spirit of those with ALS who have taken up their own experimental effort. I admire their resourcefulness and fighting spirit. & genomics Isn't this a biotech blog?

In the last month I've commented on mainstream players like GE and Google getting involved in making our molecular future a reality. (Hint: it's a good thing.) Continuing this theme is the news that Amazon is hosting the 200TB of data for the (misnamed) 1000 Genome Project (really 2,500 genomes.)

(Best news coverage here.)

One of Amazon's side businesses (besides selling books, music, etc.) is selling computing power on demand. By publicly hosting the datasets from thousands of genomes, Amazon is making available immensely powerful computing resources to anyone with a laptop and a credit card who wants to do some genomic data mining.

(AMZN isn't being entirely altruistic (@ <$100/TB storage costs, Amazon is only committing $20k in assets) - their hope is that researchers will use their on demand computing capacity, but the bill for any particular research project is likely to be <$1000 (depending on computing intensity. The press release makes mention of a big pharma project using supercomputer-like power for ~$1,300/hr.)

What's exciting to me - besides the message that another mainstream business like AMZN, GE, or GOOG recognizes the molecular future - is that Amazon is substantially reducing the capital required to conduct bioinformatics R&D. Instead of building expensive computing clusters and hiring an IT staff just to keep the system "up," you can now conduct informatics research with virtually zero start-up costs. It may cost you more to incorporate your start-up than to do your first project.

Amazon will impact more than genomic analysis - their on-demand computing will be very helpful for many other computational-intensive areas of life sciences, like rational drug design.

You can learn more about Amazon's efforts in life sciences here.

(btw: I hope no US Federal government employees hurt themselves falling all over Amazon's announcement trying to gain credit. The sub-headline to the press release states "Project is exemplar of new White House Big Data Initiative," and the Scientific American article pointedly states "The deal is a part of a new initiative from the Obama administration that will invest $200 million…." (in genomic R&D), The NIH press release credits "at least" six different federal agencies for working together to make this happen. Does it really take 6 agencies and the executive branch to convince Amazon to invest ~$20,000 to make a whole lot more money? The cost of press coverage (including press contacts at BOTH NHGRI and NCBI) on the part of AMZN & the NIH represented almost as much of an investment as the storage capacity.)

Thursday, April 12, 2012

AMGN & AZN get creative

Suspicions are often aroused when two of the biopharma "big boys" partner up. Is the company originating the technology trying to hedge their bets and take some money off the table? Is the 'buying' partner inadvertently saying that their R&D efforts are inferior to their new partners'?

I would ignore the doubts in the case of last week's announced partnership between AZ and AMGN. The 2 companies will work together to develop 5 different anti-inflammation biologics, splitting costs and program responsibilities. The prospective costs and benefits are measured in billions.

Abbott's Humira (anti-inflammation biological) is a $9B product. No need to be greedy with a market that big. Both AZ and AMGN increased the chances of gaining a slice of that market, with the risk & costs roughly halved. Where some analysts are sour on the tie-up, I think it is good risk management, and I'd like to see more deals like these rather than less. (I also think this is very creative. More of that too, please!)

I like the deal a lot, but I'm not too sure that Wall Street does. Here's a quick look at how both stocks have performed in the <2 weeks since:

(Link to dynamic GOOG finance chart.)

So, AMGN is down with the market, AZ up 1.2%, so perhaps the Street thinks this is a win for AZ, and nothing new for AMGN.

I think the stakes for these two companies are higher than most recognize. For AMGN, this deal preserves their independence for a half of a decade. Without a partner, AMGN would either be betting the company on their inflammation program, or pruning the five programs just to save cash (or both.)

For AZ, they've just fattened their pipeline with high leverage R&D assets. If you believe that the cost of getting a drug to market is largely static independent of market size, AZ just gained some mid-stage leads that only cost half as much as usual to bring to market and while they only get half of the upside, halving a ginormous market 9X larger than a 'basic' blockbuster while halving the costs is a GREAT trade.

(Side note: I wonder how it would look if we similarly evaluated pharma pipelines not for risk adjusted expectations, but instead as a ratio of upside$ per R&D investment $. I'll put a little more thought into this, as my quick guess is that GENZ's rare disease approach would rank dead last in terms of upside per R&D dollar, even though we know it is a great business for them.)

Google gets it.

The NYT reports on Google's interest in working with life science data.

In the article a Google Ventures exec floats a trial balloon about the potential opportunity for GOOG which got me excited: "“In a given year, you have 200 million pathology slides. If that gets online, it is a Big Data problem.”

In other words, the company that has a huge effort underway in digitizing and sharing books could take on the same role in specimen data. Imagine how research might accelerate if the problem of accessing and curating specimen data became as easy as searching on Google, and if the accessible sample data population were to multiply at no cost.

This is very exciting. I don't see a viable business model yet (beyond NIH funding), but then again I don't really see a business model for GOOG's book scanning project. Perhaps someday GOOG will see your pathology data and play a role in reaching a diagnosis?!?

NIH to repurpose failed leads?

(Let's call them "shelved" leads instead of the pejorative "failed." Some of the leads just lacked the organization will, expertise, or budget necessary to justify the risk of further investment.)

I find Collins' idea VERY interesting for a few reasons:

- this seems like a good role for government DD investment - the NIH can provide some very worthwhile assets & expertise, especially as leads may be repurposed from one disease class to another. (say, cancer to allergy application.) No pharma company has the breadth of expertise that the NIH does across their Institutes.

- this looks like a high leverage role for the NIH - theoretically, a small incremental investment in a shelved lead that is already proven safe in humans could have a HUGE return. However, the nature of the quest says that there will be ALOT of failure along the way, so much failure that pursuit of this mission by the private sector isn't economical.

-Politics: Any clinical success can make the NIH's mission more tangible to those who fund the NIH. The NIH does some great research, but since it is heavily biased towards early, basic research, not a lot of it can be used as a 'trophy' to gain more funding. Also, from the NIH perspective, a "win" from repurposing can come a lot sooner than a "win" from de novo drug discovery by NCATS, and by the nature of the repurposing work, the NIH can't step on any toes. If a pharma has shelved a program, how can they object to the NIH building off their earlier work? (I think we all know how pharma execs run from failed programs like cockroaches when the lights are turned on.)

-Also, while I'm not in love with the idea of the NIH taking a formal role in translational research, this seems like a smart way to dip a toe into drug discovery. Perhaps the NIH's DD experience to come from repurposing will help improve the DD regulatory process.

The devil is in the details, and in this case, it's the IP. What happens if a chemical patented by Company A for Disease X is found to be effective in Disease Y? Who owns the resulting IPR? There's no shortage of failed/shelved leads for the NIH to consider, so might they only pursue leads off patent or nearly off-patent?

The only question that I'd ask the NIH is "why does the NIH believe they have a higher probability of success with the "shelved" leads than the originating pharma team?" I can think of a few reasons, but I'd like to hear their rationale from them.

Wednesday, April 11, 2012

biotech VC economics illustrated

HIG announced that they've raised another $268M fund to support drug development investments. (Congrats to them - the squeeze is on in VC, and most believe that VC limited partners are likely to concentrate their investments in 'survivor' VC funds. In other words, it's survival of the fittest, and having a number of LPs in follow-on funds means HIG is fit.)

Separate, Amgen announced the acquisition of KAI Pharma for $315M. (Congrats to them, as well.)

Seeing these two unrelated transactions, I wondered how many KAIs does HIG have to create to provide a worthwhile return to their LPs. (This is intended as general analysis, unrelated to HIG or KAI's specific performance or history, except that I'm using their numbers & press releases as representative of their industries.)

First, a bit about HIG's fund: according to the press release, the fund will support HIG's investment in 12-15 companies, with each investment to receive up to $20M, and liquidity targeted 4-6 years post-investment.

KAI, meanwhile, was launched in 2002, and has received $63M in venture funding over 10 years. So, using really simple terms, KAI generated a 5X return, or (on average) a 17% annual return. (This very simple analysis ignores the fact that the $63M invested in KAI was made a different times and valuations, and that some of the KAI equity is held by employees, not investors. You could assume that employee ownership was ~10% of the shares, but these are certainly common shares, vs. preferred for investors, meaning only that all of my figures could vary if you knew specifics of the KAI story.)

Any biotech that creates liquidity in excess of invested capital is automatically in the top half of all bioventure investments, but unfortunately, the 17% annual return is likely no better than half of the investors' expectations. There's some debate about what the discount rate should be for an early stage biotech - I've always used 40% at a minimum, so would argue this could be lower, particularly for later stage private investments. LP expectations for a biotech fund is for fund returns somewhere in the 20-30% (annual) range overall, which is the net of some positive returns and unfortunately some number of absolute failures.

Using 40% as the target IRR, and six years as HIG's average time to liquidity, the average new HIG investment would need to generate a 7.5X return in 6 years (40% annual IRR.) Overall, HIG needs to turn $268M into ~$2B in 6 years, though more and sooner would always be appreciated by the LPs.

So let's say that HIG funds 13 investments from this fund, and results are distributed as such:

4 x complete duds x $13M avg investment, zero return
4 x small return on original capital x $18M investment, 2X return
4 x modest return x $18M investment, 5X return (roughly equal to KAI's outcome.)
3 x big wins x $23M investment, 20X ROI

Here's what the total fund value becomes with these assumptions:

You can argue with my distribution of investments and ROIs (every VC would), but I've played with the numbers, and can't make it work - I can't come up with a plausible macro scenario for a drug development investor to turn $268M into ~$2B.

(One other observation: this analysis confirms the notion that VC fund success or failure is determined by the amount and magnitude of the big winners. One more or less 'big wins' makes the VC fund either a screaming success or honking failure.)

I tried one other approach to validate the VC drug development model: it is widely stated by Windhover that an anti-cancer compound in Phase 1 trials is worth ~ $100M. Assuming a cost of $5M per program from discovery to Phase 1, HIG would need to generate 20 of these programs, and they'd have enough capital to support ~40 targeted tries (after accounting for the friction of fund salaries, overhead at portfolio companies, etc.) Is there any reason to believe that HIG (or any other VC firm) could bat .500 in their attempts to generate phase 1 programs?

I'd disagree with any program IND success rate expectation of >25%, so my answer is no, though you could convince me that through the use of outsourcing maybe you could get the cost/program down from $5M, thus, reducing the required success rate.

In short, I can't see how the traditional biotech VC model could work, without abnormal success in portfolio companies or sooner or greater liquidity for portfolio companies. I'd say that KAI and other bioventures that have reached liquidity like Plexxikon - while representing above average success relative to the industry, show that the VC model is busted. (In biotech at least.)

I don't think this is a product of macro trends (Sarbox, competition from generics, medicare price cuts, etc.) but rather a by-product of the inefficiency of early stage drug discovery. For example, much of the earliest stage lead discovery is best described as a shotgun approach rather than rifle shots. Part of this is driven by how hard and imprecise drug discovery is, and partially by asset investment (if you spend millions on an HTS lab, you're biased towards quantity over quality).

postscript: just a reminder that this analysis isn't intended as a critique of HIG or KAI. I'm just using their #'s to illustrate.

Behavior + environment + epigenetics > genetics

A clever study by Bert Vogelstein & team of the impact of genetics on health outcomes was released last week. The study found that generally two people with the same genome (i.e. twins) were not significantly more likely than average to suffer from diseases with a genetic explanation. (n= 53,000 x 24 diseases.)

For some reason, the study's conclusion was trumpeted as revelatory, but I think this is overblown - we have long known that genetics does not dictate general health outcomes, but rather describes a general and remote tendency. We've also known that your "regular" genome does not equate to your "diseased" genome.

We've known for ~50 years that behavior and environment can have a tremendous impact on health outcomes (if you're a heavy smoker or work in a coal mine, your probability of lung cancer skyrockets regardless of your genome), and we're beginning to understand how other 'codes' such as the ribosome code and also epigenetics 'controls' DNA (though we're still far, far away from completing that understanding), so it shouldn't surprise that genetics is only a part of the health equation. If anything, the study above confirms once and for all that genetics - while part of the equation - isn't a majority explainer or even a plurality of the explanation. (Except for genetic disorders (like Tay-Sachs disease.) This isn't examined by the study.)

What I'm taking away from the Vogelstein study is that many of the public policy/privacy fears related to genomics are overblown - there are legitimate reasons to control access to your DNA - but in most cases, your insurance company learning that you have a gene that increases your likelihood of colon cancer by 10%, is less important than the insurance company knowing that you work at the Springfield nuclear plant.

Another good point here by Eric Topol: our current genetic understanding is based on a few dozen whole genome studies. It might be wise to wait until the 'n' = 1,000,000 or more profiles.

Monday, April 9, 2012

Carl Icahn: net positive or negative for the biotech industry?

I can't decide if Carl Icahn's activism in the biotech sector is a good thing or a bad thing. On one hand, his insight, activism, and capital drives stock appreciation in the biotech sector. (And even just his interest in the sector is a good thing.)

On the other hand, no one is more responsible for making mid-cap biotechs an endangered species.

I first looked at this five years ago on the Xcovery blog (Wanna scare a CEO? Just say these 7 words: "Mr. Icahn is holding on line 2.") At the time, Icahn was agitating for the sale of MedImmune, and had recently bagged ImClone. Since then, he's a had a big influence in the sale of Genzyme, and made runs at Biogen and Forest Labs. BIIB and FRX raids did not conclude with a company sale, but both companies had bumps in stock values due to Icahn, and a big profit for Icahn.

Now Carl Icahn is chasing Amylin.

On my old blog I listed 10 reasons why Icahn's interest may be a net positive, and they're worth another look:

1. Interest by corporate raiders validates the biotech industry as viable businesses, rather than a collection of high-risk experiments.

2. Raider interest will attract other sources (non-alternative investments) of capital sends the message that biotech may be volatile, but not necessarily risky. (As opposed to the current notion that biotech is risky, but not necessarily volatile.)

3. Corporate raiders will keep biotech more slim and agile versus big pharma. (Though I've heard rumblings that some hedge fund could take down a pharma one of these days, so maybe this edge won't hold for long.)

4. Raiders force target companies to focus on "what's next," rather than complacently focusing on the sales and marketing of existing products.

5. Raiding will bring about needed consolidation among mid-sized biotechs, as the raiders view the overhead for companies at this size as a bad investment.

6. Raiders will increase the amount of business discipline within the industry. (And likely instigate management turnover, which could also be management evolution.)

7. Raiders will increase attention on the biotech industry.

8. Biotech has (and probably will always be) a game of capital raising. Raiders will bring more capital to the biotech industry, though the capital will tend to be higher-velocity.

9. Attention to financial returns by biotechs will increase among industry folks, as raider interest is in part related to the very high margins earned by biotechs. The high margins decrease risk for raiders, and can generate large amounts of incremental cash to justify raider transactions, if the margins are believed to be improvable.

10. Raiders (and other private equity types) may innovate new vehicles to finance biotech. One of these 'innovations' is quite old, but new to the biotech industry: dividends. (Icahn, in particular, often presses target boards to increase their dividend to drive stock prices.)

In retrospect, I think the label "raider" is harsh and inaccurate - Icahn certainly has high short term expectations, but I think he's also well-intentioned, trying to find the best home for at-risk, underperforming assets. He's not squeezing companies to cut staff to take more cash out of a target, or leaving behind half-dead Zombie companies, but rather hastening the process of smaller company selling out to big.

However, as a result, there are less small-to-mid biotech's left, meaning there's a "lost generation" of companies that could aggressively or reasonably re-invest in early-stage biotech, thus having the knock-on effect of impeding early biotech. (Historically, mid-cap companies have been less risk-averse than big pharma when it comes to partnering with smallish/early biotech. Plus, focusing on fending off Icahn's advances takes attention and capital away from planting partnership "seeds," and may make a mid-cap less attractive to a potential partner.)

The counter-argument that Icahn might make is that capital gains from his activities generate more capital to be invested in the biopharma sector at all stages. I think, though, that the law of supply & demand trumps all: reducing the number of potential "buyers" of early stage tech (i.e. GENZ, IMCL, etc.) drives the prices down on such tech/leads.

There's one other way to look at this that is very much to Icahn's credit: economic impact. Since selling MEDI to AZN, MEDI's footprint in Maryland (MEDI's home) is much, much larger, as they've become AZN's biologics center of excellence (CoE), and it seems that GENZ is also likely to similarly expand in Boston as a CoE for Sanofi. If Icahn's activism provided purely return on capital (rather than labor or assets), you'd see talent and IP sucked up into the corporate parent, and a diminished physical presence as the acquirer cut costs. This was pretty much the case with IMCL, but that might be a factor of Lilly's management style, as much as anything else. (An entrepreneurial NYC company and a starchy midwest giant don't make for a great pairing.)

Ultimately, your opinion of Icahn's impact in the biotech world likely depends on who you are. If you're a shareholder at a target company, you like him a lot. If you're an executive at a target company, you definitely wish he'd go away.

Finally, while this post is centered on Carl Icahn, it is important to note who else has been a key player on Team Icahn, and now on his own: hedge fund manager Alex Denner, who is credited with generating $2B in profits (or is it value?) while chasing under-appreciated biotech stocks, mostly with Icahn.

related: Amylin (AMLN) management: BUSTED!

Slightly off-topic......

....but a very worthwhile read: Matt Ridley's 17 Reasons to be Cheerful.

Biotech folks might know Ridley from his excellent book Genome: the Autobiography of a Species, and much of his mainstream writing popularizes genomics/genetics. His most recent (also excellent) book, The Rational Optimist is a mainstream book, though with strong scientific basis, arguing for a very positive future and dispelling many current doom n' gloom concerns. His 17 Reasons article (linked above) is a condensed version of The Rational Optimist, and a very worthwhile and quick read.

Money quote:

"I cannot recall a time when I was not being told by somebody that the world could survive only if it abandoned economic growth. But the world will not continue as it is. The human race has become a problem-solving machine: It solves those problems by changing its ways. The real danger comes from slowing change."

See my links list in the left column to find a link to Ridleys blog, which he regularly updates with more insight.

Thursday, April 5, 2012

Biotech needs more GE

My Dad sold industrial electrical supplies for GE, and from that exposure, I always thought that the drug discovery tools supply & services industry was similarly attractive to GE's for its' scale, business fit, customer base, and exposure to a growth market. (Many of GE's businesses can be described as supplying essential component technology to Fortune 500 business, be they jet engines, electrical transformers, or wind turbines.)

I had been saying that drug discovery was ripe for GE since 1998, when on the executive team at Upstate Biotechnology, at my suggestion, a GE acquisition was listed in our business plan as an exit scenario. In 2003, GE entered the drug discovery market by buying Amersham, and I felt vindicated, and hopeful that GE would continue investing in the drug discovery industry.

That generally hasn't happened, though things may be changing - GE today announced the acquisition of SeqWright, a Texas-based sequencing CRO.

(btw: a good overview of GE Healthcare businesses is available here.)

The press release for the SeqWright acquisition trumpets SeqWright's connection with GE's existing Clarient molecular diagnostics business. (Clarient having been acquired just a year and a half ago), but even together GE still only has its' toe in the molecular diagnostics water. (Especially since the always awesome World Map of High-Throughput Sequencers lists SeqWright as having only 3 machines - one each of 454, SOLiD, and HiSeq.)

The release also affirms that GE's business model in this space is SERVICE, not proprietary R&D/assay development. In other words, both GE and Roche have roughly similar M&A appetites in this space, but GE chose to buy modest capacity in SeqWright, while Roche wants to own an entire technology platform, if the Illumina deal were to close.

(Ironically(?), WSJ's coverage of the GE's acquisition of SeqWright says that Roche is a customer of SeqWright, which I'd bet wouldn't continue if Roche buys ILMN.)

The SeqWright deal reinforces GE's interest in the biotech industry (and more specifically, molecular medicine) not only as a validation statement, but for the fact that more big-league, results-oriented capital is being committed to biotech, as GE invested to generate tangible cash & EPS, whereas the majority of biotech investment is done to create speculative future value (and often only equity value, not cash-flow value.)

Let's face it: biotech needs more investors like GE, and more of their business mentality. GE's acquisition of SeqWright was, in effect, more capital voting for biotech businesses with customers and cash flow, as opposed to transformative technologies or "cool" tech platforms. VCs: why fund any technology company (i.e. company not developing leads) that you couldn't imagine selling to GE? As an example, consider a genetic engineering company like Amyris - sure, they can do proprietary biofuel R&D that might someday pay off, but isn't the highest NPV likely to come from selling the company's capabilities to generate cash flow?

One reason that GE hasn't been more active in the drug discovery industry is that there are not many acquisition targets available to provide scale. Only LIFE, QGEN, VWR, and ThermoFisher could add >$1B in annual revenue to GE, but in general, these companies have generally been valued at a price that would make difficult a non-dilutive acquisition for GE. Still, I can't ignore that LIFE CEO Greg Lucier is a GE-alum, and that QGEN would make a just about perfect complement to GE Healthcare's Life Sciences business.

I could also see GE getting involved in the pursuit of ILMN (it's the Amersham of 2012), but their lack of public involvement to date suggests to me that they either can't make the price work for them, or that GE invests in more predictable technology. (Why make a multi-billion dollar acquisition in Sanger sequencing if other tech platforms (like nanopore sequencing) might overtake Sanger tech?)

(btw: Roche upped their bid last week. ILMN didn't budge at all. I don't think this deal is getting done right now, but rather in 6-18 months time, after the ILMN board of directors experiences an unfavorable quarter.)

As for SeqWright, congrats to them and to any other CRO that manages to get liquid. Deal terms weren't announced, but if SeqWright was growing fast with the rest of the sequencing industry, and cash-flow positive, they probably got a decent price, though, on the flip side for GE, trading GE stock for an ongoing, competitive DNA sequencing lab is more EPS efficient and less risky than opening a lab using their own cash to buy equipment and hire staff, so there is a limit to what GE would pay. GE may have even made acquisition overtures to many sequencing CROs to see who would bite at the lowest price.

Let's hope that GE has a good experience with SeqWright, and further invests in the molecular medicine industry.

ex-Pfizer R&D head vs. bank analyst on drug discovery strategy: who ya got?

Forbes magazine unintentionally hosted a good drug discovery strategy debate. It started with a prominent pharma industry bank analyst Jack Scannell critiquing therapeutic R&D productivity. His points: 1) targeted drug development has been less productive than other approaches, and 2) high-throughput R&D technologies really haven't been productive either.

John LaMattina, formerly Pfizer's head of R&D fired back, also in Forbes ("Analysts get it wrong again"), which attributes lower R&D productivity to.........pharma mergers and more demanding regulators and payors. (Never mind that increasing R&D productivity has been the rationale for much of the industry consolidation.)

Both make good points, though. HTS and genomic technologies have definitely under-delivered. But, while the industry in the early days of HTS and genomics truly WAS guilty of treating drug discovery as a numbers game, researchers have become much smarter more efficient in their use of these technologies. (Whereas some R&D centers initially built labs to maximize compounds screened per day ("100,000 per day capacity!"), most are using HTS (and other technologies) to more inexpensively examine smaller focused libraries.)

Note: neither side cites budgets (neither pharma nor NIH) as an inhibitor of R&D productivity.

Scannell says that the numbers don't lie - 33 of the 50 first in class drugs studied started from a phenotypic-centric philosophy, but LaMattina counters that this is explained by the lag inherent with tech adoption, and that a wave of targeted compounds is on the horizon.

This is tough analysis to choose a side on - I think the phenotypic approach has been the benefit of low-hanging fruit (i.e. development to date has benefitted from easy molecules, but there aren't nearly as many easy ones left), while the targeted approach just has an inherent intellectual appeal. ("If we know what causes disease "X," why not just target it?")

(That being said, one of the more significant tech flops of the last decade or so has been "Rational Drug Design.")

I'd also nominate one other reason for low R&D productivity not mentioned by Scannell or LaMattina: organization structure. Innovation becomes the exception and not the rule as organizations grow bigger, while risk tolerance seems to decline. That bigger organizations stifle drug development is reinforced by the notion that many of the successful therapeutic programs were once considered UNsuccessful programs, as LaMattina's story of the invention of Viagra indicates. Another reinforcing story is that of Gleevec's development from Daniel Vasella's book: only the singular efforts, passion,  and strength of Dr. Brian Druker kept a Novartis committee from killing off the lead that became known as Gleevec.

Let's hope that pharma R&D rises soon, whether because pharma mergers have slowed, or because productivity is catching up with the technology.

Monday, April 2, 2012

biotech as fantasy baseball

Luke TImmerman @ Xconomy compares bio-pharma to fantasy baseball in an interesting way. Since baseball DOES explain life (and vice versa), here's a few more bio-baseball analogies:

Bryce Harper = Intrexon. Harper - an outfield prospect for the Washington Nats - is arguably the game's greatest prospect, though it has cost a huge amount of money to sign and develop Harper to this point. Likewise, Intrexon, with great prospects in synthetic biology, has required a huge amount of capital investment to date. Both Harper and Intrexon are anticipated to be very productive, but neither is assured of being a net positive.

C.C. Sabathia = Genentech. Sabathia in Cleveland and Genentech on their own had prodigous success, but both have joined much larger 'empires' in the last few years in the form of the NY Yankees and Roche, respectively. Both Sabathia and Genentech have carried on their success in their new uniforms.

Jamie Moyer = GPCR research. Ancient by current standards, both Moyer (49 years old, and new starting pitcher for the Colorado Rockies) and GPCR research keep delivering.

A-Rod = Pfizer. Both are cash-rich giants of their respective industries, and based in NYC, but both have delivered only marginal results over the last few years, perhaps getting by on reputation.

David Freese = Biogen. Both are known for two big hits in particular (Freese in the 2011 World Series, Biogen with Tysrabi and Rituxan). Both really need to deliver in 2012 in order to stay in the big leagues.

Andrew Friedman = _________ (position open.) Friedman, the creative and successful General Manager of the resource-poor Tampa Bay Rays has through innovation and smart deals made Tampa competitive with teams with payrolls twice their size. Bio-pharma badly needs a few Andrew Friedmans to adopt innovative business models and generate R&D success far beyond what a meager budget might suggest.

Average college baseball player = average RX or DX IP from an academic center. Both are really, really, really far from major league success. The only difference is that the college ballplayer knows it.

Quick hits

Ho-hum, another $1B oncology product for Roche. Despite the mild reception in the business press, this is HUGE news: Roche is about to receive approval for T-DM1, a drug that combines the targeted therapy of Herceptin with the benefit of chemotherapy. Perhaps Herceptin is old news (approved in 1998), but this is a story where everybody wins: Roche gets a product with a "fresh" patent clock and an advantage over any biosimilar Herceptin clones, patients get better outcomes with fewer side effects, and the drug design & drug delivery folks now have another validated approach to beating cancer. Combos are the future!

This just in: science is hard! A research team at Amgen tried to duplicate the research behind 53 important cancer research advancements published in leading journals. They were successful in duplicating the original findings in only 11% of of their experiements. Let's hope that there's some selection bias in Amgen's research, or some other explanation - I'd hate to think that 89% of all cancer research is wrong - though this most likely reflects the pressure to publish among academics.

First setback for a PI3K inhibitor. PI-3 kinase targets have been in vogue for about 4 years, with several of the top 20 pharmas with active discovery programs addressing multiple isoforms of PI3K. The first Phase III clinical trials of a PI3K inhibitor - by Keryx & Aeterna have concluded, with negative results. This might, however, not be a reflection of the merit of PI3K as a target, but rather a reflection of how unlikely microcap drug developers are to successfully develop cancer therapeutics, and another lesson for investors that if a biotech's lead compound can't win a partnership with a big pharma company, you probably shouldn't put your capital behind it either.