2012 Dealmakers Outlook

Pharmaceutical Executive, Pharmaceutical Executive-06-01-2012, Volume 0, Issue 0

Pharm Exec convened a panel of heavy hitters in business development to crack the bat on best practices in licensing and M&A for the year ahead.

With Yankee Stadium as the backdrop, Pharm Exec convened on April 10 its annual panel of heavy hitters in business development to crack the bat on best practices in licensing and M&A for the year ahead. The 11 starters [see list, "Participants"] are our biggest group to date, and the discussion proved equally wide-ranging, building on the latest findings from co-host Campbell Alliance's 2012 Survey of Dealmaker Intentions. The detectable trend is the desirability of making a deal, with a particular focus this year on snapping up Phase II assets. The market is hungry enough to end its wait for that perfect, late Phase III compound ready to hit the streets at minimal risk. Oncologics remain the target of choice and there is more interest in claiming promising therapies at a much earlier stage of development.

Photo Credit: John Halpern

Overall, what the dealmakers panel found striking is the widening circle of players: academia has found its business roots and is proving a tough negotiator; patient/disease groups are beginning to pinch hit for sidelined venture capitalists as a source of development financing; and new arrivals from emerging countries are beginning to test the waters with deals to gain a foothold on the US market money tree. The conclusion is "know thy partner" will be crucial to a profitable marriage. With the cost of assets rising and payers demanding a more extensive up-front case for value, it's no time for rookies.

William Looney

William Looney, Pharm Exec: The Campbell Alliance Survey of Dealmaker Intentions is now in its fourth year. This is long enough to filter out the background noise and identify distinctive trends in the attitude of investors toward a sector with a historically high risk profile. What are the expectations for deals in 2012 and do we see a transition from the caution that branded previous surveys?

Jeff Stewart, Campbell Alliance: Our survey polled 160 decision-makers, about three quarters of whom were at the VP level or higher. Overall, the outlook for the year is positive. A key finding is that players on both sides of the negotiating table expect increases in the number of deals for Phase II assets. You will recall that in 2011 the emphasis was on sweeping up compounds that had progressed to Phase III because these are perceived as less risky in making it to commercialization. Clearly, investors are more confident about the science and market potential in some therapeutic areas and this has increased the allure of medicines that have established their bona fides at the Phase II (b) stage of testing.

Participants

What is interesting is a divide in expectations about deals at Phase III. While in-licensors among the group expect a rebound increase in Phase III deals, those who out-license are projecting a drop. This spread between the in-licensors and out-licensors is the most pronounced in the survey's four-year history. It's hard to identify precisely what is driving the gap, but it is clear that Big Pharma—flush with cash—is desperate to acquire late stage assets that complement their therapeutic portfolios. The desire to supplement their stretched in-house development pipelines is contributing to the tagline: it's a seller's market. What the out-licensors seem to be saying, however, is that they don't expect to have a lot to put on the table, or that financing conditions may improve so they can do the commercializing themselves.

WL: What therapy areas are attracting the most interest among in-licensors?

Stewart: Oncology leads the pack, followed by cardiovascular, CNS, metabolic, and respiratory drugs, respectively. At the bottom are dermatology, vaccines, and women's health. Oncology has a unique characteristic in that interest is high at all levels of the development cycle, including pre-clinical and Phase I and II; in fact, the interest in doing deals here is higher for Phase II and pre-clinical compounds than for those "sure bets" in Phase III. This is likely due to awareness that a good cancer drug open for licensing in Phase III is a rarity. All the other major therapeutic segments—with the exception of immunology, which has a market profile similar to cancer—show a preference for Phase III candidates.

WL: Is the continuing interest in oncology leading to saturation in terms of available opportunities? Has the "low hanging fruit" disappeared from the proverbial tree?

Stewart: There is no doubt that it is harder to find the perfect compound. But if you look over a multi-year cycle and compare the number of late-stage assets out there to the actual number of deals consummated each year, we estimate a 20-year backlog of unlicensed oncology assets are in the hands of parties that lack the wherewithal to bring them forward to commercialization. It's not exactly low hanging fruit, but it's an exaggeration to claim the oncology field is played out.

WL: Do the conclusions of this year's survey conform to the expectations of those of you engaged in active deal-making negotiations?

Rob Wills, J&J: There is a proliferation of proposals out there in the market—but not every one is an opportunity. Contacts today are like a form of speed dating: as an example, at each annual BIO meeting, my company will typically get more than 600 requests for a quick, 30 minute exchange. And most of these encounters revolve around potential oncology products.

Jack Talley, EpiCept: In oncology, I don't see much interest in pre-clinical deals; the preference is for Phase II and beyond. Demonstrating proof of concept and then building on it to make the case for an improvement over the current standard of care remains the mantra of choice in driving negotiations.

Al Altomari, Agile Therapeutics: What the survey data doesn't show is the fundamental issue of perception—how players approach the art of a deal. Today, Big Pharma dominates the deal-making environment. And what Big Pharma wants to acquire are products able to secure registration without extensive additional investments in development, to begin generating revenue as quickly as possible. What the biotech start-ups want is the capital to launch and grow their company. It is important to understand how these basic values shape the motivation of each party to finalize a transaction. I don't think there is adequate understanding of what the young start-up company needs, nor is there much clarity on how much Big Pharma wants to risk in paying out for an asset. The big companies are most comfortable with the classic textbook licensing deal, while young players are seeking a lot more flexibility in return for their commitment. It's a real disconnect.

Bart Dunn, NuPathe: Opportunity is finely parsed for small companies. Their bets are limited. So if you have a great late-stage asset, with a strong probability of success on the regulatory pathway, then why out-license when there is the potential to hit a home run by commercializing it? Yes, commercialization is costly and carries some execution risk, but out-licensing means you are giving away a lot of value over time. Many times it makes more sense to hedge your risk and keep a large chunk of the value through a commercialization partnership. But one plus one has to equal something north of three.

WL: What other factors might be driving decisions on therapeutic targets?

Talley: A challenge specific to oncology is an erratic regulatory climate. Standards imposed by the FDA for clinical trials are increasingly difficult to replicate successfully at the Phase III level. There is also a conflict between the FDA and the European Medicines Agency [EMA] on standards for approval: while the EMA continues to accept disease-free progression as a benchmark, the FDA is moving to embrace overall survival rates, which is a much higher hurdle of proof for sponsors.

David Lilley, SFJ Pharmaceuticals: Oncologics, like all specialty medicines, have to evidence a stronger value proposition simply because of their high cost to the payer. The assertion that oncology drugs are affordable because they are "targeted" and volume sales don't approach the level of a Lipitor is no longer defensible. There has been a threefold increase over the last 10 years in the cost of oncology drugs to the major PBMs.

David Thomas, Biotechnology Industry Association (BIO): It is interesting that the top therapeutic areas of interest for in-licensors in the Campbell Survey are inversely correlated to development success rates. BIO's study with BioMedTracker, which surveyed over 4,000 compounds from 2003 to 2011, found that oncology, CV, and CNS had the lowest success rates. Less than one in 10 compounds in these therapeutic categories makes it from Phase I to commercialization. Success rates are higher for the categories ranking lower in the survey.

WL: Building on the survey, can we identify some of the broader environmental and policy factors that are influencing the art of the deal?

Barbara Ryan, Deutsche Bank: I have covered the industry as an analyst for 30 years. I find there is a surprising consistency in the trends we see before us. For example, the current productivity gap in R&D is not unprecedented; we are an industry of cycles and there have been droughts and patent cliffs before. These pressures have driven consolidation. When I started my career, I covered 16 companies. It's now down to six. I would also say that the impact of the trends may be more intense. Certainly there are mounting financial pressures on R&D to get more productive. Consider how Pfizer has slashed its R&D spending by 40 percent. Why? Simply put, the market is impatient and is demanding a better return from that massive investment. The patent cliff is also higher today than in the past. Most companies have successfully navigated their way through the first wave—you could say we are currently at the "eye" of the LOE hurricane—by accelerating cash flow through aggressive cost reductions and applying the savings to dividends and share repurchases.

The current productivity gap is manageable, especially because of the strong appetite for deals. A few years ago, all we talked about in the analyst community was pricing and access for the big blockbusters. No one mentioned new products because there were none to talk about. Today, I actually have to go to clinical development briefings. Output from the labs is slowly improving and the market is showing a bit more tolerance for risk. There is still an enormous amount of innovation in the marketplace; it just comes from a more diverse array of sources. And when you have a real potential breakthrough against current standard of care, the money is there to follow it through.

What I find most interesting is that the progress we are starting to see has little to do with the current emphasis on restructuring R&D operations, because the innovation coming on stream now stems from actions companies took more than a decade ago. What is good about today is companies are limiting the earnings shortfall from LOEs through improved operational efficiencies. The focus is on executing on plan and avoiding the distractions of big, costly mergers in favor of low profile bolt-on acquisitions. Everyone is more sensible about valuations.

Laurence Blumberg, Kadmon Pharmaceuticals: A key driver of innovation in the West is the state of the capital markets, which variably support risk-taking behavior. Unfortunately, we face a stiff challenge from the progressive demise of the venture capital model which historically has funded the bulk of new product discovery coming from the biotech sector. There is less appetite among this group for backing the original science and the technology platforms that over time built real companies and yielded many significant therapies. Today, they frequently target late-stage products for quicker investment returns. There are examples like Vertex that started out with basic seed money where investors took big risks. Today, I doubt any investor group would go the distance to create a winner like Vertex.

WL: How do we restore vigor to the venture capital space?

Blumberg: It's a big challenge with the inherent high costs of drug development, long timelines, and other risks, with the growing demand for quicker investment returns. The business of venture capital is essentially unregulated, highly competitive, and tends to perpetuate a race to the bottom where the goal is to exploit the most broken situations. The way the race for capital has become today, I am not sure anyone ends up a winner. And the funds are so skittish about the longer timelines on commercialization to the point where I don't see venture firms returning as the solution to the innovation drought.

Altomari: The venture capital community is stagnant, if not in decline. Few if any new funds are being created. This is not necessarily a bad thing, because it ensures only the fittest will survive. What remains will be stronger, and maybe then we will see the community do what it should do: funding real innovation rather than just taking on the overflow of what Big Pharma doesn't want.

Jonathan Garen, Forest Labs: There is a clear overlap of roles among those who finance deals, but what all the players—Big Pharma, biotech, the VCs, pensions and hedge funds—have in common is a desire to reduce risk.

WL:Would a broader consensus on what innovation is in medicine lead to less risk and more certainty, unlocking the resources to bring more products to market? Isn't it the innovators' responsibility to anticipate what the payer wants in a product? And is it possible for the smaller biotechs to build, maintain, and expense that capability well before market authorization?

Altomari: Resources or not, we have to do it. Two things are required. First, you must have convincing answers for the payer about value. The evidence must be relevant and transferable. Without it, your ticket to access won't even get punched. The second is compliance with the growing complexity of the regulatory rules of engagement, including Phase IV follow-up studies. All this extra work on making the case for your product is expensive. People want their information in real time too.

Blumberg: Advances in molecular biology are raising the bar on clinical outcomes. The ability now exists in many disease areas—oncology comes to mind—to target therapy to the individual patient rather than to the broad population. The per patient drug costs can be higher but it is also more likely the payers will support a price premium for some guarantee of better performance among a defined group of patients.

Thomas: Regulators have taken some positive actions recently toward personalized medicines. The FDA has approved three drugs in the last 12 months whose mechanisms are intended for a specialized target sub-population.

Wills: I will say flatly that the overriding criteria for doing a deal is whether the compound provides added value to the payer and contributes to an unmet need for the patient. If we don't see that, we don't do it. Most of the products we work with have been in various stages of development for more than a decade before a payer comes into play. The cost is measured in billions. We are not going to wager an idle bet with that amount of money at stake. The value has to be visible up front and measurable. There is no choice—it is expected of us now.

Dunn: NuPathe is a small company, with 37 full-time employees. Yet we do a lot of work around assessing prospects for reimbursement in advance of registration and launch.

Wills: Amassing the right evidence is crucial. If you can show that 80 or 90 percent of the target population is going to benefit from your drug, then payers are less likely to have a problem in meeting your price. J&J did a deal with the UK National Institute for Health and Clinical Excellence [NICE] in which we basically guaranteed that if our drug [Velcade] did not work in a patient, we'd pay back the NHS. It was groundbreaking at the time and shows what steps a company may be willing to take to obtain payer buy in.

WL: Further to the point about funding innovation, who pays for process design and accompanying improvements to enable companies to target the right patients?

Blumberg: This is potentially a very fertile area for private equity investors, if only because a targeted therapy is likely to find its appropriate audience relatively quickly. It also lowers risks around efficacy and even safety. The more we unravel the molecular pathway and figure out targets that are amenable to diagnostics, the more it could spark venture capital interest.

Garen: Smaller companies gain from a targeted biologic therapy because it lowers marketing and promotion overhead. A good companion diagnostic could lower the investment needed to identify appropriate patients.

WL: Is the market getting more sensible—a better word might be sophisticated—about asset valuations?

Stewart: A decade ago the approach in valuing a target incorporated a lot of material that frankly is irrelevant, such as the number of patents on file, the number of employed scientists, or the square footage of lab space. None of this necessarily correlates to output in terms of real products. Valuation has since become more rational.

Ryan: Any attempt to link the number of compounds in development with productivity and returns is not credible. Such information is irrelevant. Pfizer consistently spent the most money on R&D and employed the most scientists, yet the return from its effort was poor. R&D is not a numbers game. It is true, however, that companies are valued on the basis of their strong cash flow, and little credit is given for development stage assets. Such assets are seen as little more than a lottery ticket—if you hit the jackpot, so be it.

Blumberg: The early 1990s saw enormous valuations for "ideas" with early stage IPOs, but with investors unable to sort through the good from the bad and value assets appropriately. Many companies subsequently failed. Investors know more today because there is a strong track record where we can see how the game played out commercially, after a Phase II asset has proof-of-concept data. There are many examples like MedImmune, which had a market cap of only a few hundred million dollars after the Phase II Synagis data, then hit the therapeutic jackpot with a definitive Phase III data set and commercial success, which led eventually to it being acquired by AstraZeneca for upwards of $15 billion. An enormous amount of value was also unlocked by that pipeline. Ironically, a lot of value now gets baked in to companies post Phase II as investors have a sense of how big the product can be. The pool of potential investors has also evolved somewhat with the participation of hedge funds as private investors, who tend to be less valuation-sensitive than the traditional private equity players. The challenge remains getting the true innovation to Phase II.

WL: Speaking of truth to power, what are the most important actions that should be taken to enhance the climate for productive partnering around more and better innovation?

Blumberg: Companies need to behave responsibly. Science is tricky and much damage has been done over the years when companies flogging a development-stage product take advantage of the unknowing public investor. The goal always has to be not just to sell shares but to provide value. The same can be said about partnering transparency and reasonable expectations driving fair and successful deals.

Altomari: Big Pharma, small biotech, and the financing community all tend to speak different languages. It is important to keep bridging this gap in business cultures, by bringing in people who understand the other side because they've been there.

Dunn: It would be helpful to smaller companies if Big Pharma companies could settle on a single point of contact within the company. A critical pre-condition for success with a partner much bigger than you is to find the right people who can make the decisions. I've seen situations where you are speaking to an internal group that eventually declines interest, only to be discovered by another internal group who insists "we have to talk." It can be frustrating since business development is rarely centralized within Big Pharma.

Lilley: Better coordination between the FDA and the EMA on defining risk-benefit is essential to improving the stability of the innovation cycle. That coordination should tie into a commitment to collaborate with industry as well. Both would help clarify the market prospects for deals.

Garen: While regulators continue to seek evidence for product claims, and payers are seeking value for cost, the industry and the investment community should continue to evolve ways to best address these demands and maintain the pace of innovation.

WL: What can industry do on its own to create the infrastructure that facilitates good deal making? Is the business development function keeping pace with the urgent task of finding good deals that supplement the internal pipeline? AstraZeneca has tried to increase the information flow by moving business development directly into the R&D reporting structure.

Wills: I've seen organizational structures come and go over the years. I don't believe it makes a lot of difference. Where the function resides doesn't affect the mission or how business gets done. What counts are good people and supportive management.

Altomari: As a CEO, I care nothing about the structure. When we have a meeting about an asset opportunity, I simply want to have three people at the table: a business development strategist, who can explain the deal; a medical affairs person, who knows the science; and a commercial officer who can relate the asset to the overall business plan. These are the skill sets you need today to get to first base. In terms of the structure of the deal itself, the trend is to layer it in a way that spreads risks. Contingent or deferred payments and the terms for each are carefully laid out.

WL: What about new stakeholders in the partnership game?

Blumberg: Academia continues to advance as a powerful force in the business of deals. There is a palpable sense of empowerment from the universities; they are pushing very hard on the IP front and taking a major interest in leveraging their intellectual capital to generate profit. In my experience, the universities are getting harder to negotiate with. There is no level expectation in recognizing their contribution may only be a small part of the very long and expensive process to bring products to commercialization. The IP and know-how from academia is important in drug development but often represents a small piece of a very complicated value equation.

Wills: The universities are slowly learning how to deal with industry. For a long time, they insisted on terms that were entirely one-sided: take all the patent rights, refuse exclusivity in partnering, and reimburse them for 75 percent of the overhead costs. We walked away from that. Today, the approach is more level and sophisticated. Basically, they want to be treated as a small biotech partner, with upfront payments plus royalties linked to milestones. So J&J has been doing more deals with academia in the last four years than we did in the previous 10. Nevertheless, it's still a tough match because, while academia sees itself as a biotech-equivalent entity, it still lacks awareness of what it's like to actually be a biotech company.

Blumberg: Agreed. The data packages we get from many of these academic partnerships are rarely done to industry standards. It follows that keeping the principal scientific investigators in the loop and explaining to them the complicated necessities of building toward commercialization is critical to a smooth negotiation. The industry academic partnership is a win-win when both sides have balanced, informed, and reasonable expectations.

Wills: One sign of an improving relationship is that academic tech transfer offices are hiring people with background in venture, biotech, or Big Pharma. These people know from experience what is required to progress a deal. We are even seeing the major philanthropic disease foundations hire industry specialists with business development experience to increase productive use of their own money. Philanthropy venture capital is an emerging trend, as these groups want to be more involved in developing drugs that improve quality of life for their constituent patients. We also have a very interesting deal with GSK—it used to be anathema for two Big Pharma companies to work together—and a venture capital firm, Index, to stimulate early stage innovation. The aim here is not to support companies, but innovation, based on networks of collaborators from many sources, including academia.

Altomari: I advise my alma mater on this topic and one of the recommendations I make is to create an external advisory board so that the university has direct access to industry expertise from people they can trust.

WL: Are the pressures we have been discussing making it much more expensive to negotiate a deal?

Altomari: Due diligence has to be conducted more carefully, and the costs are escalating. The value proposition has to be identified and laid out much earlier. IP issues have to be vetted across a wider geographic circle. Partners want more from validation studies. By the time you get to the final negotiations, the commitments amount to big money because the bottom line is you have to try to demonstrate certainty around the asset.

Isabelle Trempe, Paladin Labs Canada: Paladin is starting to do more deals internationally. To be successful, you must invest in relationships. This is particularly true in emerging markets, where being on the ground, face to face, over a long period of pre-engagment, is a prerequisite for negotiation. Management often fails to see this as an investment, not a cost.

WL:What are the most critical factors that account for the failure to consummate a deal? What might you do in hindsight to put things back on course?

Dunn: The biggest smoking gun is the different perceptions of the buyer and seller about valuation of the asset. Much of this is not well understood and parties fail to explain their motivations as to why they are at the negotiation table in the first place. The only remedy is to require the parties—at a relatively early stage—to agree on the assumptions that will drive the valuation. It's better to know sooner rather than later if you are not playing in the same ballpark.

Altomari: You will want to do everything you can to quantify the risk involved in transfer of the asset. Structure the risk into the agreement.

Stewart: All deals today have to acknowledge the high level of uncertainty around regulatory approvals. Both parties must be on the same page here. We hear from our clients that regulatory uncertainty in Europe is killing valuations, yet parties may look no further than the FDA in assessing their approval risk exposure.

Blumberg: Matching cultures and building relationships is integral to commerce. Numbers are important but the people factor overrides all. Deals are akin to a marriage—the intent is for the relationship to be intimate and long-term. What is interesting is that negotiation alone can reveal whether the long-term match is right. If you can't agree about how to work through differences, then what happens when you really have one, post closing? The challenge of maximizing the trust factor is becoming harder now that the deal making circle is widening to include China and other emerging markets. How to get things done in these different business cultures is a puzzle.

WL: How do you see your work and the external pressures on business development changing over the next three years?

Altomari: The timeline for identifying an opportunity and negotiating a successful transaction is going to get longer. If there is some good endpoint you can identify, then there is a prospect for taking an asset quickly to auction. But this will be the exception, not the norm. Managing everyone's expectations is one reason why the process will grind on.

Another trend we will face is more "blind spots" in the community of deal makers. There will be people across the table who we know little about. Israeli, Turkish, Indian, and Chinese companies are at the stage where they will be looking at opportunities beyond their own markets. Will they want to buy my product, invest in my company, or partner with me to gain a foothold in the US? I suspect we know much less about them than they know about us. Companies must work to establish the bona fides of these emerging but still peripheral players.

Wills: The breadth and variety of transactions will continue to expand. We will not go back to a world where Big Pharma brings the best innovations forward from its own labs. Biotech and Big Pharma will find themselves joined at the hip, while the relationships with academia will continue to build. More important, the emerging growth markets of Asia present intriguing possibilities for deals, not just in products but in processes as well. Overall, there is a lot of pent-up demand. We will just have to be more creative in exploiting it.

Ryan: The financing part of the business is likely to transform as well. There will be more "boutique" firms trolling for possibilities, and a greater variety of firms will be taking smaller stakes in the transactions. The trend is a refutation of the idea that interest of the venture capital community in life sciences has waned due to tough times. Departure of the big firms is creating opportunities for those with a niche perspective.

Talley: It is going to be more difficult to be successful. You have Big Pharma partners who demand biotech take on increasing levels of risk, and payers who don't want to pay a premium for that risk. The hurdles are going to be high, but for those who can demonstrate their medicines advance the current standard of care, it remains possible to become profitable.

Stewart: Deal valuation is going to be impacted negatively by the soaring cost of clinical trials. Spending is driven by the costs and high performance of the comparator arms, which leads to the need for very large test populations. Companion diagnostics will have to be vetted as well. Do the math; someone has to pay for it.

Trempe: Public budgets for healthcare are going to be pinched. The government share of health spending is destined to rise under the US reform legislation, so the basic medical value proposition is likely to override everything else in the appraisal of an asset.