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.

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:

(Live link to chart)

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. 

Xcovery blog revisited (state of targeted Rx)

About five years ago I started a blog dedicated to targeted therapeutics, especially kinases inhibitors. The blog was an outgrowth of Xcovery, the kinase discovery spin-out from the Scripps Research Institute that I started and served as EVP of Business Development. 

I was already tracking developments in biopharm so the blog was an outlet for some of basic analysis and a fun way to share my opinion and connect with others in the industry. 

One of the regular bits of analysis was tracking the performance of FDA approved targeted drugs. Just for fun, here's a five year update, with some analysis:

 

Of note:

• The 17 approved molecularly targeted drugs accounted for $27B in global sales in 2011. Think about that for a second, then consider that most of these drugs have been on the market for only 5-6 years, and their approved indications are still growing. Consider too that most have not been applied as combination therapies.

• Even the senior citizen of the group (Herceptin, approved in 1998), has seen prolonged growth, averaging 36% per year over the last five years.

• With 8 blockbusters and several more close and still growing (Tasigna, Sprycel, etc), almost all of the targeted drugs are either blockbusters, or well on their way. So much for the concern that targeting drugs might limit the market potential.

• The top 4 (Avastin, Herceptin, Gleevec, and Lucentis) have made a mockery of their projected sales ceilings and are still growing strongly.

• On the other hand, the only assets that appear to be underperforming expectations are Amgen’s Vectibix, GSK’s Tykerb, and Pfizer’s Torisel (specific sales data isn’t available for 2011, as Torisel is listed under “other oncology,” totaling ~$130M across several drugs.)

• Vectibix is still playing catch up to Erbitux, and Tykerb hasn’t gained much traction against the Roche juggernaut.

• I wonder what Amgen’s new CEO will do about Vectibix. It seems that there’s 2 choices: go big (invest in expanding trials for more indications and in comparison with Erbitux) or go home (sell the product to another biopharm.)

• 4 of the top 6 are Roche drugs, which means that they were discovered by Genentech. Hats off again to the DNA team in South San Francisco for their amazing science and productivity. I wonder if we will ever see any other drug discovery effort be so inventive and productive for a prolonged period.

• Also: I don’t think anyone is doubting the wisdom of Roche buying the piece of DNA that Roche didn’t own. I haven’t run the numbers, but I’d be shocked if the DNA acquisition wasn’t a resounding financial win for Roche.

• Unfortunately, OSI’s acquisition of Macugen was a tremendous dud.

• I am encouraged by the progress since my last analysis in 2006 – an average of two new approvals each year, with most new products addressing new targets or diseases, in contrast to the incremental “me too-ism” in other pharma areas like ED or cholesterol drugs.

A few sweeping generalizations:

• FDA approval and sales success seem to be connected to corporate resources. Small to mid-cap biotechs have been chasing targeted therapies for ~15 years without much output. (I’m talking about companies such as Exelixis, Vertex (pre-HepC), Ariad, etc., though I don’t mean to pick on specific companies.) With three exceptions (Onyx’s Nexavar, OSI’s Tarceva, and the former ImClone’s Erbitux), the targeted therapies have largely been developed in-house by “old” companies with multi-billion dollar market caps and the resources to match. (You could make the case that Amgen’s Vectibix came from a small targeted effort at Abgenix, but I suspect that it was Amgen’s resources that got Vectibix through FDA approval. Similarly, Sutent started at Sugen, but Pharmacia and Pfizer seemed to have provided the big push.)

• A gross generalization: the small to mid-caps tend to lack broad biological or disease-specific expertise, instead investing in target-specific expertise, or platform-specific expertise, thinking that broad expertise (ancillary to their target or disease of interest) is expensive overhead. I wonder if the results to date argue for the big pharma discovery model, or just reinforces the need for a broad portfolio to be successful in drug discovery and development.

• With rare exception (as in Pfizer’s Xalkori and Novartis’ Gleevec), the path to FDA approval has been arduous for these drugs. There are a number of targeted drug developers who hold out hope that their P2 or P3 results will be so clear and strong that their clinical trials will be stopped early and approved quickly. That’s definitely the exception, unfortunately, and even in the positive trials for targeted drugs, the data has tended to be good, not great. I suspect that is a function of the requirements of clinical trial design and comparison to first-line chemotherapies. As a result the “new” drugs are posting smallish survival benefits when compared to the “old” therapies, with no accounting for how certain patient segments have had dramatic benefits. (Thus starting the vicious circular argument that targeted therapies ought to have stratified patient populations in clinical trials, but stratifying patients shrinks the market potential for such drugs, bring the business viability of the targeted therapy into question.) It seems that the FDA could take the Xalkori experience and develop a novel process for rapid approval based on patient stratification without derailing or obviating more broad approval for the drug.

The $27B in revenue in this segment (likely to grow past $50B in 2014) has hopefully served to further de-risk pharma R&D in molecularly targeted therapeutics. Coupled with advancements in medicinal chemistry, we will hopefully see more and better targeted therapies in the future. 

R&D efficiency

Forbes' Matt Herper takes a look at the cost to develop a new drug, and now current estimates put that figure at $1B-$4B.

While the current estimate is newsworthy, folks at places like Tufts have been conducting this exercise for years, and the numbers are always eye-popping (and debatable.)

What makes this particular article interesting is how you can also use the analysis conducted by Herper to compare pharma productivity over the last 15 years. Take a look at the R&D productivity of the top 12 pharmas:

Here's my takeaways:

-There's two tiers of productivity in the analysis: the "productive" cluster (AMGN, NVS, BMS, MRK, ABT, and LLY) all cluster between $3.7B and $4.6B in cost per new drug, while the "less productive" ranged from $5.9B to 11.8B per drug. While half of the companies studied, the "productives" account for 66 of the 135 drugs (49%) these 12 companies introduced in the last 15 years. So you can't say that higher R&D productivity is also a factor of scale - the productive and less-productive companies produced roughly the same number of drugs. 

-The "less-productive" companies tend to be the product of mega-mergers. Each of these companies has done deals to one extent or another, but think of the "biggies" and you're generally thinking of the "less productive" group. Careful, though, when thinking about the time element here - MRK, for example, only did their big SGP acquisition in late 2009. This brings up the question: do mergers depress R&D productivity, or is it mostly companies with declining R&D productivity that have the urge to merge? (My guess: a bit of both, but considering that the 6 most productive companies are generally considered the least involved in the M&A game due to a bias towards internal efforts, it may be a moot point. M&A either distracts from focus, or results in sub-efficient R&D orgs.

(I'm being charitable to NVS, which is a product of a mega-merger (Sandoz and Ciba-Geigy), but that occurred in 1996 - prior to the analysis period. Either NVS did a much better job of integrating R&D, or it takes 15 years to overcome the M&A inefficiencies.)

-I think it would be appropriate to believe that these results also project future R&D efficiency and likely future stock performance.  (e.g. over the next 15 years, AMGN is likely to be much more productive than AZN.) The 15 year period (and $75B in R&D spend) should account for short-term spikes and likely demonstrates which companies have the best R&D people and organizations. I am especially impressed with Novartis (21 products over 15 years) and most disappointed by AstraZeneca (5 products over the same period.) Perhaps this reflects one company choosing easier/harder targets, but I think it more likely reflects capabilities.

-For all of the news and criticism, Pfizer's R&D isn't too bad. The criticism that failures like torcetrapib reflect diminished R&D productivity due to repeated mergers seems misplaced, as Pfizer was almost middle-of-the-pack in R&D efficiency over the last 15 years.

-You might expect that the broadest R&D portfolios would have the smoothest results (success in one area, say cancer, making up for failures in another, say neuroscience.) However, the more productive companies are to me the least broad. Rightly or wrongly, I think of BMS & AMGN biased towards cancer research, while GSK and JNJ are the most diversified. Does this mean that there is R&D value in specialization?

Any other insights to be gleaned from the Forbes analysis?

A couple of caveats to the analysis: 

-The best analysis would weight productivity with resulting product sales. (In other words: you'd accept lower R&D spending efficiency if the output were blockbusters.)

- I can't tell from the Forbes analysis exactly what is included in the figures. I suspect that Roche data includes historical Genentech R&D spending and output. I think DNA has been one of the most efficient AND effective R&D organizations, so I would be very curious to see DNA split out from pre-merger Roche.