Truth from Booth: there is no correlation between the amount of venture capital raised by a biotech and it's ultimate outcome.
I suspect that huge VC rounds just incent management to take on more risks beyond their control.
Showing posts with label investing. Show all posts
Showing posts with label investing. Show all posts
Wednesday, August 29, 2012
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.
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.
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!
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!
Tuesday, March 20, 2012
"The gravy days are over." (WSJ)
This just in: financing for biotech companies is scarce.
The WSJ article reporting this has in-depth analysis and loads of figures. Depending on your view, any and all of the following are responsible for a general decline in biotech financing:
-big pharma being more selective
-FDA intransigence
-trouble getting liquidity/the difficulty of IPOs. (Due to Sarbox.)
-better options for investors in other industries, especially the internet
-generics and the threat of biosimilars.
-economic difficulties (and US budget pressures) are increasing pressure on basic R&D budgets.
The truth is, with a few very rare exceptions (1999-2000), biotech financing has almost always been scarce, and to think otherwise, or plan otherwise is just plain stupid. There's a high technical barrier to entry for investors, long turnaround times for investments, and enormous technical risk with any drug development effort. Revenue-generating companies - which more investors understand, and therefore have an expanded pool of investment capital for them - take 7-10 years to build in this industry.
This is a sector that SHOULD have a high cost of capital, and probably an undersupply of capital.
But I'd say that this is just about the best time to have a great idea to develop, because:
If anything, biotech may suffer from an abundance of good - new drug targets, under-validated lead compounds, and interesting but not bulletproof diagnostic technologies are very easy to find these days. Just walk into any university's tech transfer office - they probably have some promising target IP just waiting for the right investor/believer.
The scarcity of investment capital is probably a good thing, culling the herd such that (on average) only the best ideas go forward.
This is all small consolation to the team at a small company struggling to raise their next round, but it definitely seems that better days are ahead, and it'll be a Molecular Future.
The WSJ article reporting this has in-depth analysis and loads of figures. Depending on your view, any and all of the following are responsible for a general decline in biotech financing:
-big pharma being more selective
-FDA intransigence
-trouble getting liquidity/the difficulty of IPOs. (Due to Sarbox.)
-better options for investors in other industries, especially the internet
-generics and the threat of biosimilars.
-economic difficulties (and US budget pressures) are increasing pressure on basic R&D budgets.
The truth is, with a few very rare exceptions (1999-2000), biotech financing has almost always been scarce, and to think otherwise, or plan otherwise is just plain stupid. There's a high technical barrier to entry for investors, long turnaround times for investments, and enormous technical risk with any drug development effort. Revenue-generating companies - which more investors understand, and therefore have an expanded pool of investment capital for them - take 7-10 years to build in this industry.
This is a sector that SHOULD have a high cost of capital, and probably an undersupply of capital.
But I'd say that this is just about the best time to have a great idea to develop, because:
- pharma's need for new products has never been higher, and the aging US & European populations are increasing demand for pharmaceuticals
- start-up and operating costs have been driven down by outsourcing & virtual operations.
- the abundance of specialized CROs & consultants lets smallish companies rapidly access expertise and capacity.
- with big pharma continually restructuring, there is an abundance of talent and facilities available.
- the current FDA & NIH administrations are trying to streamline the regulatory burden. Also: more regulatory paths are opening. I've heard of plans to gain approval first in China by some companies.
- increasing globalization makes it easier to collaborate. (Design a molecule in the UK, synthesize in the USA, screen in China, on a faster AND more efficient basis than if you had a fully integrated operation at one site.)
- increased genomic understanding and lower sequencing costs are enabling more effective R&D.
- China, China, China: increasing the supply of capital, talent, ideas, and lab assets. And not just in China: I've been told by US & EU academics that it has never been easier to find talented, financially-supported post-docs, from China for their American or EU labs.
- increased IP clarity with the America Invents act, and probably lower patent friction, given developments in gene patenting court cases.
- a growing generation of successful firms and alumni to incubate, mentor, and lead new ideas. (Guys like Patrick Soon Shiong (Abraxis founder, among other ventures) Henri Termeer (ex-Genzyme CEO), and RJ Kirk. (Not that this is exclusively a new development (think Alejandro Zaffaroni), but their numbers are growing. I can't wait to see what emerges from the Genentech alumni in years to come.)
If anything, biotech may suffer from an abundance of good - new drug targets, under-validated lead compounds, and interesting but not bulletproof diagnostic technologies are very easy to find these days. Just walk into any university's tech transfer office - they probably have some promising target IP just waiting for the right investor/believer.
The scarcity of investment capital is probably a good thing, culling the herd such that (on average) only the best ideas go forward.
This is all small consolation to the team at a small company struggling to raise their next round, but it definitely seems that better days are ahead, and it'll be a Molecular Future.
Sunday, February 26, 2012
Common Biotech Investor Mistakes
Via the most excellent Adam Feuerstein on The Street.com is a link to 18 common mistakes by rookie biotech investors.
The list is somewhat tongue-in-cheek yet educational for all.
I'd add a few myself:
1) if an new technical theme ("stem cells," "RNAi," "genomics," "gene therapy,") emerges you MUST invest in it now before it is too late.
(reality: despite all of the hype about how such-and-such technology will change the world, there is always another opportunity to invest later. let the early adopter-investors de-risk the technology.)
likewise….
2) do NOT miss any possible inflection points for a stock of interest.
(reality: any new technology (or drug) will always have another news event to serve as an inflection point. FDA approval is one inflection point you might not want to miss, but behind that there's "first sale," "first quarter results," first year results," etc.)
3) the market rewards novelty.
(reality: as you can see with the current frenzy of Hep C deals, being 4th or 5th in a de-risked class of drugs is likely more valuable than being first in a novel class of drugs.
4) ignore Carl Icahn. He's just an agitator, not a biotech investor.
(reality: he's exactly what biotech investing needs: someone less enchanted with scientific potential, and more interested in business reality. If you don't believe this, consider his track record over the last 5 years, with big "wins" in Genzyme, MedImmune, ImClone, and Biogen, with profit in excess of $2B.)
5) the dollar amounts in press releases are money in the bank - your valuations should reflect them.
(reality: when big pharma X enters a half-billion dollar partnership with biotech Z, they've really agreed on just two things: funding for the near term of a specific project, and an understanding of what a "best case scenario" for the project might look like. The only way the biotech gets the press release "bio-dollars" is if everything works out as expected, and it NEVER does. That's why it is science, not manufacturing.
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