Dangerous Liaisons

Why do most biotech?pharma alliances fail? The answer, in this first of two parts, begins with the messy reality of corporate relationships. Two case histories demonstrate the good, the bad, and the ugly side of strategic partnering.
May 01, 2004

Alliances are a favorite of corporate strategists everywhere. More than 10,000 interfirm collaborations were formed worldwide in 2000, double the number of five years before. Alliances now generate 25 percent of the top 1,000 public US companies' revenues, up from 7 percent in 1990.

Pharma and biotech companies are particularly prone to partnering. The 20 biggest pharmaceutical firms formed nearly 1,500 alliances with biotech companies between 1997 and 2002. According to Strategic Decisions Group, a consulting firm, "40 50 percent of products in development by global pharmaceutical firms are externally sourced," and "more than half of the current 20 best-selling prescriptions drugs are co-developed, co-marketed, or in-licensed." By 2007, in-licensing alone is expected to account for 40 percent of the revenues of pharma's top 20 companies.

What's driving biotech and pharma into each other's arms is the need to find complementary resources pharma's innovation gap meets biotech's funding crisis plus the desire to share risk and access new markets and information. Given these trends, it seems there are two kinds of pharma executives today those participating in biotech alliances and those who will be soon.

What is the reality of alliance life? Two of the most celebrated biotech pharma alliances in recent times can serve as an introduction. One, a phenomenally productive venture, scientifically and commercially, has degenerated into a bitter squabble over the spoils. The other, just formed, bears a striking resemblance to the most successful biotech pharma hookup of all time.

Let's Make an Ordeal In 1993, Knoll Pharmaceuticals, a divison of BASF, the German chemical company, called on UK-based Cambridge Antibody Technology (CAT). Knoll had six autoimmune disease targets. CAT had an advanced phage display technology ideal for identifying high-quality, lead-optimized candidates for human antibody drugs. CAT also had a vast library of antibodies (now more than 100 billion, according to the company). They were a perfect match.

The two signed an agreement (updated in 1995) that committed Knoll to pay up-front research fees to CAT and milestones along the way. Knoll would license promising products, assume their development and commercialization, and pay CAT royalties on any resulting sales.

Royalty or Loyalty
Amazingly, the first target they selected, tumor necrosis factor-alpha (TNFa), was successfully neutralized. The partnership was off to a promsing start, then, in 2001, BASF sold Knoll to Abbott Laboratories for $7.1 billion. The key asset was the TNFa candidate developed by CAT called D2E7.

In 2003, D2E7 was approved for the treatment of rheumatoid arthritis in the United States and Europe as Humira (adalimumab). That year, its first on the market, sales hit $280 milllion. This year they are expected to exceed $700 million, then rise to nearly $1.2 billion in 2005.

It took 10 years but the alliance hit a home run in its first at bat. Humira, Abbott claims, is "one of a few new potential blockbuster drugs to emerge from a collaboration between biotech and Big Pharma." CAT became not only the first British biotech to produce a potential blockbuster but also one of the few European biotechs to get anything to market.

In March 2003, with royalties due but not yet paid, Abbott told CAT it intended to cut the royalty rate from what analysts estimate to be between 5 and 6 percent to the contractual minimum, perhaps 2 percent. Multiply the difference by strong sales over a long time and it amounts to hundreds of millions of dollars at net present value. (CAT is not the only one affected. It owes a portion of its royalties to the Medical Research Council, the UK equivalent of NIH, the originators of phage display technology. MRC, in turn, owes something to the Scripps Institute.)

The timing of Abbott's pronouncement couldn't have been worse for CAT, which had made an all-stock bid to acquire Oxford Glycosciences (OGS). Investors responded to the news by knocking down CAT's shares, and OGS went to Celltech instead.

CAT, of course, disputed Abbott's decision. The parties first held private talks then engaged in four mandated mediation sessions, all of which proved fruitless. In November 2003, CAT filed legal proceedings in the UK High Court. A trial before a specialist judge in the patent division is likely unless a settlement is reached within 7 13 months.

Contract Killers The source of the dispute in this uncommonly successful collaboration is two overlapping and possibly conflicting contractual clauses, Articles 5 and 12. Both relate to royalty offsets, a common element of biotech pharma licenses that offers protection to licensors of intellectual property (IP).

To get a drug like Humira to market, you need three pieces of IP: one for the target, one for the product, and one for the downstream manufacturing process. Knoll owned the target IP, they came to CAT for the product IP, and they licensed the manufacturing IP from Genentech.

A company's claim to own intellectual property may not free and clear. Sign a license with one party and you may have to deal with others claiming their IP rights have been infringed. If that happens, the offset clause kicks in, letting you cut payments due the initial claimant in order to pay the rest.

Knoll had more than the usual reasons to request an offset (or anti-stacking) provision because CAT's patents were still pending when the contract was signed. Even Peter Chambre, CAT's CEO since 2002, admits: "It was quite natural for Knoll to seek some protection in the event that it had to take multiple licenses to operate the phage display technology described in our patents."

Back to the Future
This provision, Article 5, is fairly standard stuff. Translated from the legalese, it says that if Knoll needs to pay anyone else (other than MRC) to use CAT's technology, those payments will come out of CAT's end.

CAT, in any event, got its patents. Knoll and, for that matter, Abbott never had reason to pay anyone else for CAT's IP. So CAT had every reason to expect a full royalty. But it seems that Abbott is reading another clause, Article 12, to mean any patent royalties paid for any purpose even those on the target (owed to Serono and Peptech) or the manufacturing process and not just the IP licensed from CAT, could be used to offset payments to CAT.

Article 12, available from an SEC filing, says: "In the event that Knoll or its Collaborators must pay royalties or license fees to third parties under one or more claims of one or more patents to enable Knoll or its Collaborators to utilize or have utilized the inventions of the Patents, [content omitted] shall be credited to Knoll's royalty obligation to CAT for sales in that country where the patents exist." But it then goes on to state: "This offset shall not include royalties or license fees which are beyond the scope of the technology described in the Patents, for example fees paid to third parties for delivery systems."

The same language applies to the other five targets Knoll brought to CAT as well as the five additional indications for Humira now in late-stage clinical trials. Presumably, any resulting products will be subject to similar dispute. There's a lot to quarrel over. Abbott estimates Humira, all told, has a market potential of $14 billion by 2010.

In a statement, Abbott says, "The dispute is related to the proper interpretation of the royalty offset provisions of the agreement under which Humira was developed," but makes no attempt to square that interpretation with what the contract says. Meanwhile, Chambre says, "We strongly believe that the offset provisions were not designed for the purpose to which Abbott is putting them. We are seeking an outcome consistent with that, and are determined to get it."

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