2011 Dealmakers Outlook - Pharmaceutical Executive

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2011 Dealmakers Outlook
Call it spit and risk—hitting it


Pharmaceutical Executive


DeBenedetto: All of the areas where future growth is perceived to be high carry with them an equally high threshold of uncertainty and risk. The best example is the emerging country markets. Breaking out from the pack to succeed in China is becoming harder every day. What this means is it's more of a challenge for two parties to get to an agreement on valuing a deal, which is why about three-quarters of the deals being negotiated today include contingent valuation rights clauses, because uncertainty is so hard to measure.

Melincoff: We also have to acknowledge the impact this has internally within many of the smaller companies in biotech, where you have a board of directors that expects the company to do the "big deal" and the management team which has to confront these on-the-ground realities. This perception gap is frequently overlooked as to why so many negotiations fall short of goal.

John Craighead, Biotechnology Industry Organization (BIO): Public policy has a deep impact on industry investment. Large pharmaceutical companies are sitting on a lot of cash, but the unfavorable US corporate tax rate makes it more challenging to expand investment with this capital. One possible driver of success is to structure investments around offshore entities that moderate the tax exposure.

Fordham-Meier: Another trend is the insistence of payers that new medicines demonstrate clear clinical differentiation against existing therapies. This poses more challenges to the drug developer, but on the positive side it forces everyone to be more innovative and demonstrate clear benefit to patients.

Guggenheimer: The current pipeline emphasis on specialty orphan drugs has not been evaluated in terms of the impact on pricing and future innovation. The prices for many of these inventions are staggering, the treatment effect is sometimes quite modest, and the eligible population is low. If the industry allows the perception to root that these "designer drug" prices represent the norm, then it is in trouble politically.

WL: Considering that collectively these drivers are making the deal-making environment more volatile, what practical measures are companies taking to mitigate risk?

Davis: Companies are doing more realistic evaluations to determine whether a licensing candidate is likely to cross the finish line in gaining registration approval. The key criteria is not being tagged as a "me too" product. The candidate has to be different and show a real clinical benefit to get paid. There is also a strong focus on new models for risk-sharing. These include monetizing existing royalty streams; moving beyond the traditional funding/financing models to embrace scalable, short-term JV financing linked to a defined outcome; enhancing the quality of licensing agreements through a contract approach; and leveraging contingent value rights (CVRs), which are licenses structured as a public security holding. In addition, more deals are being structured around rights that might vary by region. Although this requires a higher degree of complexity in the agreement, it can lessen risks. For example, obtaining rights in Europe is an easier play right now because much of the pricing risk we are confronting here in the US has already run its course there. The IP environment is also more settled in Europe.

Fordham-Meier: The outreach to academic institutions and medical centers is another way to address volatility in the environment. I wonder whether this approach might be better focused on the smaller biotech—or consortia that involve biotech, the academic centers and Big Pharma working together on projects that lead to proof of concept.

Melincoff: There is reputational value in industry supporting the work of academia. The commitment is a modest one. Basically, these arrangements give the pharma company rights to examine interesting streams of research and to have right of first refusal for ideas that could eventually lead to a commercialized compound. It's all about early access at low risk. And we know that the VC community is less interested in early stage, so this fills a gap.

Guggenheimer: The best protection against risk is the new product that can be acquired or licensed right after FDA approval. Despite the other options, this remains the gold standard. The problem is there are fewer such products, which increases the appeal of these alternative approaches.

Davis: Risk mitigation is being advanced through good P&L management and new approaches to project financing [i.e. using other people's money]. But many traditional sources of outside funding are drying up; about a third of all VC firms are just not raising any new funds, or are exiting the biotech/pharma business altogether, with the remainder either decreasing the amount of their commitments or staying the same.

Overall, our research at Cowen Royalty concludes that the VC community is at half the financing strength it once commanded. So if the VCs have walked away, and Big Pharma is not filling the gap, then the only option is to consider a new model. One such model is project financing with a shared platform, containing defined criteria for moving projects to the next stage of development , and a guaranteed exit where you can get bought out.

WL: Given the challenges of replacing the old VC model for financing licensing and M&A deals, what are the implications for the pace of future innovation in medicines?

Fordham-Meier: The obvious thing to say is, with less money invested across fewer companies, we are going to have less innovation. To reverse that mindset, new ways have to be found to convince investors to part with their cash. Co-investment is one way to build investor confidence and reduce their risk: another is to demonstrate differentiation as early as possible, not just in the clinical sense in treating the disease but in showing value against competing products and a path to reimbursement.

Bonifant: I am a little more optimistic. There will continue to be money for innovation, but the process has to adapt. Studies will no longer be structured to ensure the best arguments to secure registration, but to provide real learnings for the entire scientific enterprise. That's just one change that must take place to maintain the industry's credibility.

Simes: The US government is not creating a policy environment to support innovation. The debate is all about limiting budgetary exposure to high-cost drugs. We are at the point where Medicare and other public payers might be motivated to encourage the FDA to refuse authorization for drugs because they don't want to be exposed to reimbursement. That's a cycle that only leads in one direction: less innovation.


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