Real math on bio-bucks….

The LifeSciVC takes a look at the payout rates on pharma partnerships.

We all know that pharma-biotech partnerships & acquisitions usually launch with press releases touting huuuuge potential financial implications, with the eye-popping figures referred to as "bio-bucks" - headline figures that probably won't ever be completely reached. ("Bio-bucks" aren't limited to pharma-biotech partnerships. For example, LIFE bought Ion Torrent for a headline figure of $725M, which amounted to $350M at closing, with $375M contingent on performance. (Of which LIFE might have already made good - though some reports say the milestones are based on future (2012) revenues.))

The link at the top of this post is some very clever analysis of actual versus expected payout since 2005. In summary:

-38% of the announced value is captured up front.

-the remaining 62% of value is split among paid (24%) the amount still possible will ultimately , still possible (40%), and canceled (37%).

-so, $4.3B of a possible $7.0B in milestones have been resolved - either paid or negated, with 40% achieved and 60% categorized as "nevergonnahappen." (Since the deals analyzed reach cover the 2005-2009 period, you could make a strong case that the likelihood of payout on not-yet-achieved milestones is likely much, much lower than 40%.)

-If you optimistically assume that milestones TBD follow this same pattern, $1.1B of milestones will likely be realized, and $1.7 are nevergonnahappen.

Extrapolating this:

38% paid upfront
25% milestones likely to be paid.
37% "vapor," likely nevergonnahappen.


That's actually a LOT better than I expected. To think that most deals are likely to pay out 63% of their headline value is a surprise to me.

Accounting for the time value of money makes for a simple rule for pharma acquisitions ~50% of value realized on a net present value basis, 50% vapor.

(Note: connected to my post of 2 days ago regarding changing business models for early stage biotech, I suspect that the asset-lite, specialized biotech companies being developed may experience a better milestone payout rate, since their specialization would suggest more focus and understanding of milestones in a given therapeutic area. However, a by-product of the specialization is that there are likely to be less deals; more focus = a smaller target market of potential acquirers.)

What I would be curious to know is how milestones fall into the nevergonnahappen category. How much of the milestone failure is related to management of the acquiree taking their eye of the ball post-deal? How much of the milestone failure can be attributed to cultural & communication divisions between pharma and biotech? How much of the failure is related to pharma screw-ups and changing priorities? And finally, how much milestone failure can be explained by pharma being snookered by high expectations into buying crap assets. Any guesses?

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.

Read this!

Will New Business Models Enhance or Endanger Drug Discovery?

A great thought piece by Stewart Lyman at Xconomy, well worth a read. Lyman analyzes the business models that have generated biotech "wins," and concludes that the current vibe is that VCs are oriented towards creating limited, focused companies (tending towards virtual) instead of the ambition a decade or more ago to built fully integrated drug discovery operations.

This reflects the fact that the end consumer (in this case the pharma companies that buy successful or promising therapeutic programs) wants to buy specific assets and nothing else. Lyman doesn't mention it, but this is as much due to the fact that the public markets are closed for any venture with less than half a billion in valuation. 

(This is mostly due to 2 reasons:

-the fact that Sarbanes-Oxley imposes costs on smallish companies that make it impractical for companies of <$500M to be public. In yet another example of regulation trying to close the barn door after the horse has escaped (see also: Dodd-Frank Financial Reform), Sarbanes-Oxley has killed the US IPO market for small to mid-size companies.

-while $100M-$500M in capitalization for a young company may seem large to you and me, it is a tiny number to Wall Street, making analyst coverage unreasonable, and not profitable enough to justify underwriting efforts.

(end rant))

Since VCs can only get liquidity from pharma acquisitions of their investments, companies are not being built to last, but rather built to flip. At the same time, the size of seed VC investments has risen, so biotech  start-ups need to have a quick use of $5-10M in seed capital AND a clear path to liquidity. Gone will be the days where therapeutic assets slowly incubate via SBIR funding (and other non-profit vehicles.)

(Luckily CROs now enable quicker and less expensive R&D. Young biotech companies don't need to build and staff non-core departments in order to progress a lead compound.)

The problem with this model as I see it (and not emphasized in Lyman's article) is that the smallish, asset-lite "disposable" biotech model now in vogue is absolutely terrible for anyone on the day-to-day team at the biotech company. Sign on to one of these "lite" companies and you take a GIGANTIC career risk. 

Scratch that - it's not a risk if something is practically guaranteed - and unless you believe your compounds and company will smoothly grow and progress from discovery to phase III without a hiccup at any stage, you almost certainly will go through restructuring, replacement, or a reduction of one form or another.

To the VC, each $5M biotech investment is a bet with a 1:20 likelihood of payout, but with a 50X payout with a win. The VC wants to take 40 "shots on goal" with their $200M VC portfolio, with the probabilities suggesting 2 "wins" worth a total of $500M.

To the scientific and business staff, though, that means that there's only a 5% chance that their specific efforts will result in a profit. With these odds, a career in academia, at a big pharma, or at a CRO looks a LOT less risky.

So until someone comes up with a business model for VC investment that ISN"T built to flip, start-up biotech's will have a hard time attacking the talent they need to run rings around big pharma. It seems strange to suggest it, but perhaps VC needs to be mindful of the business case for talent, not just for ROI.

Personal note: my opinion is also based on my experience starting a therapeutic discovery start-up.  It was a great experience, but the risk/reward math is just not favorable for biotech employees, and I won't ever work in early stage therapeutics again, if I can help it.

NGS & DX?

There's an interesting conversation going on about error rates in DNA sequencing in the Genomics (NGS) group on LinkedIn. Some are wondering if development of DNA sequencing diagnostic applications will be delayed by the experienced error rates (up to 4% on some platforms, including Oxford Nanopore.)

My take: I think the barriers to adoption of sequencing technologies as diagnostics are:

-any error-intolerant application is still likely to rely on RT-PCR for a while to come. (Example: detecting specific BCR-ABL mutations in CML patients.)

If you have a specific gene of interest, or even genes (up to about 10 or 20, depending on who you listen to) 

-PCR still wins the day, because of accuracy, speed, cost, privacy concerns, and the fact that PCR apps have familiar payor and FDA tracks. (Many PCR assays code for reimbursement <$300, so NGS still has a way to go to win on price.)

NGS, on the other hand will be used for broad discovery and in cases where patients are willing to pay out of their own pocket at least until the economics change, and the FDA approves a platform/assay combo such as Foundation Medicine. I'd say that we're at least 2 years away from that, regardless of error rate.    

Two other NGS points, neither worth a dedicated post for now: now that Oxford Nanopore and LifeTech are both promising ~$1,000 genome from new tech platforms:

-what does the future hold for BGI (Beijing Genomics Institute) that has made a name for itself by buying roomfuls of largely Illumina sequencers? I'd like to be a fly on the wall when someone suggests that they put 10's of millions of dollars of Illumina equipment out to pasture and invest further millions in new GridIon or Ion Torrent equipment.

-will Roche drop their Illumina takeover bid? A ~$6B hostile takeover of the former leader makes less sense now. It will also be interesting to see if ILMN's board changes their mind, and sells now. 

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.