Joe Panetta, president and CEO of BIOCOM, discusses an emerging model of M&As in which human and IP assets are valued and biotech brings expertise to Big Pharma as venture capitalist funding dwindles and patent cliffs loom large.

Pharm Exec: Can you tell me about how small biotech and specialty companies have started switching from relying on venture capitalist (VC) funds to M&As, and when that shift came about?

Joe Panetta: I wouldn’t say they’re switching from relying on VC. I think the fact is that VC investment has taken on a different approach than it had traditionally; so we’re seeing a different, let’s say more conservative, shorter-term VC investment model. That’s combined with the fact that we’ve seen for a couple of years now that VC firms have been much more engaged in investing in their current portfolio companies, and there’s been less of an appetite for investment in new companies than there was five years ago.

Part of that is the fact that we’ve got economic challenges; part of it is the fact that we have a tremendously challenging environment at FDA; and part of it is the fact that we have uncertainty from a political standpoint. So those kinds of things have created a much more conservative approach to VC investing than we’ve seen in the past, and that’s had an impact in terms of the ability of our companies to be able to raise the kind of funding that they still need to raise to move their products through the pipeline.

What that means is that companies need to turn toward alternative sources of funding beyond VC. VC is also taking a much shorter timeframe perspective in terms of the investments that they’re making now. But that leads us to the need that large pharma companies see for innovative technology to fill their pipelines; the ability of biotech companies to attract large biotech and large pharma partners much more successfully than they have in the past; and the dynamic that we’re beginning to see—biotech companies becoming much more focused on management of the products that they’re developing, and on partnering to gain the expertise that is needed to move through development and clinical testing and commercialization.

So that creates the opportunity for companies to focus on innovation and to team up and partner with the experts on product development, commercialization, and manufacturing. And that’s where pharma comes in and plays an enormous role. Obviously pharma’s pipelines have become more depleted in terms of new innovative products over time, so there’s a greater appetite from the pharma side to engage in real partnerships with biotech companies. It’s not outright acquisition; rather, what I’m hearing more and more from a number of different pharma companies, is that the partnering model is more attractive than the outright acquisition model. And if the outright acquisition takes place, then the ability to allow a biotech company to continue to function as a satellite entity is much more attractive than simply acquiring the assets and letting the people go.

PE: What has changed in the industry or the economy that has larger pharma realizing that partnerships where both organizations work together on a level playing field may be more valuable than the straight acquisition model?

JP: There isn’t so much of an appetite any more in biotech, from the investor side or even from the management side, for creating fully integrated future large biotech companies that look like pharmaceutical companies. That used to be much more the direction that the companies were headed in, and for the most part that model has gone by the wayside. Now there’s a more virtual model, a leaner model, and that makes it much more attractive for partnering. The larger partner doesn’t have to worry about what to do with an entity that is duplicating—or at least attempting to duplicate—what they already have the ability to do.

The other thing that’s changing is the fact that we’re seeing generics come on the scene. Now there’s a future road map for biosimilars that is being developed. We see that way forward, and larger companies are beginning to plan for the world of biosimilars. Also, Big Pharma is beginning to plan more for the world of generics and of patents expiring, and I think they’re beginning to realize that they need to go into fast forward to begin to fill the pipeline, and to develop more innovative products. That’s not coming out of the merger of pharmaceutical companies. Those mergers are actually resulting in the large pharma companies having to deal with duplicate organizations and integrating existing products together, so that isn’t providing for innovation.

PE: So the mergers with smaller or more specialized biotech companies are where you believe the more specialized knowledge can come from?

JP: Absolutely—the more specialized knowledge, and the ability to do early-stage research and development much more nimbly and more quickly, resulting in more candidate products that can be developed through partnerships.

PE: How is this working so far as an economic strategy? Is this helping to bridge the financial gap that’s left from VC funding?

JP: I think it’s more than bridging the gap. Last year we did our first pharma/biotech partnering conference here in San Diego, but the relationship between large pharma and biotech has been evolving slowly over time. There was a time when the attitude on the pharma side was, ‘don’t call us, we’ll call you.’ But what we saw at out partnering conference last year and we are continuing to see now is a real appetite for equal partnership on both sides.

Everything we hear and everything we see points to a greater desire for there to be a real partnership between the two. And I think that can sustain smaller biotech companies. Pharma needs biotech as a partner, and biotech needs pharma, but pharma especially needs to continue to appreciate the value of biotech as a partner in terms of the people assets, and not just the intellectual property assets.

PE: Can you tell me more about the dynamic? How is this model of partnering different in terms of what both sides might be gaining, compared to the traditional acquisition model?

JP: The major difference is that by utilizing the resources of smaller biotech companies and by creating partnerships with various smaller biotech companies, a larger pharma can take advantage of the diversity of technologies that these small biotech companies are working in; they can take advantage of the creative environments that exist within these companies; they can harness all of that energy. Just as the biotech model is evolving away from creating a fully integrated pharmaceutical company, the pharma model is evolving away from creating these enormous R&D organizations; if we look at the performance over the last few years for the investment that’s been made, it’s pretty clear that that model isn’t as successful as it was years ago.

PE: What are some factors that result in VCs not being as willing to invest as they were in the past?

JP: I think FDA is overwhelmingly the concern right now. I don’t think a day goes by where I don’t hear or read something about how the FDA is negatively impacting the ability of the industry to be competitive in terms of developing and introducing new drugs. The climate has changed. Because of the risk-averseness at FDA, the lack of ability to accept innovation at FDA, the investor community—particularly the VC community—has been encouraging its members to obtain their approvals outside of the US, in Europe in particular. And that’s because the review process at the European Medicines Agency (EMA) is much more predictable and much more innovation-focused than the FDA is here.

If we look at what has happened with a number of drugs that have been reviewed by the FDA in the last year or two, in the obesity arena in particular and in diabetes drugs, the FDA has shown a real reluctance to approve new products and new technologies. So why invest in a process that’s unpredictable and has demonstrated that the ability to get all the way through the process to commercialization is pretty slim? That wasn’t the case years ago with FDA, especially when the Prescription Drug User Fee Act (PDUFA) came into play 15 years ago. There was a real desire on the part of the FDA to move products through the pipeline more efficiently, to take advantage of the user fees and the deadlines that were agreed upon. But now we’ve got an FDA that’s just mired in bureaucracy and risk-averseness.

Part of that is fear of making a mistake. We’ve got examples like Vioxx where, post-approval, there have been issues that have come up, and FDA is taken to task by Congress for having made a mistake. There’s a lack of understanding of the fact that there are risks associated with all products that are approved; from a media standpoint, from the Congress standpoint, from the public’s standpoint. So that all makes for a very risk-averse climate and VCs won’t invest in a process that isn’t predictable. That’s why we’re seeing a lot of VC investment moving more towards early-stage product development with an investment period of maybe three years. This way, they can be more focused on the part of the process that doesn’t involve FDA review, and can let pharma or other partners deal with the later stages of review at FDA.

I think FDA is beginning to appreciate the fact that this is an issue, and is beginning to talk more about the need to focus more on innovation. But making good on that is a long-term process, and it’s going to take years for it to happen.

PE: How do you see all of this panning out in the next five to ten years? Will M&As continue to spread, and will VCs come around if they see certain changes occurring within industry?

JP: I think pharma will continue to need to engage in M&A over the next five years. I think biotech is becoming more sophisticated in terms of its ability to rely on outside expertise and predictive tools.

Two weeks ago I talked to a VC firm that actually has an FDA expert within the firm, who now goes in and looks at all of the relationships that the biotech company might have had with the FDA before making a decision on investing. I think that’s good; I think it helps to focus in on the companies that are doing it right, and it helps to drive other companies to understand that they need to bring in the expertise to help them to create greater predictability for the investors.

But I think in the next five years, if we see an FDA that truly responds to this call that’s coming from the industry and from Congress to focus more on innovation, and we begin to see some results, then I don’t think there’s any doubt that we will see the VC community engaging in later-stage investing. But I don’t think that changes anything in terms of the need for Big Pharma to create more partnerships across the board with biotech companies. And I think we’ll continue to see that happening as there’s a need to fill pipelines and as the patents expire on products, and as we move more towards the implementation of the biosimilars legislation. VC funding and healthy, dynamic M&A deals do not have to be mutually exclusive.

Last week’s annual meeting of BIO in Chicago once again proved illustrative in showcasing the high profile that governments now plays as the biotech sector’s chief advocate. While private venture capitalists confined themselves to the margins of the meeting, the Convention hall was bursting at the seams with host country “pavilions,” each designed to highlight its status as destination partner of choice for the industry.

Missing from the slick videos, graphics and takeaway tchotskes was any real sense of the importance of pricing and reimbursement levels that can accommodate the high cost of capital, increased regulation and long development lead times that together have sharply lowered effective periods of market exclusivity for biotech. Instead, the talk was all about building more Potemkin villages around infrastructure – tax breaks, R&D allowances, funding for basic research and facilitation of academic partnerships – that do little to compensate those who risk private capital for a profitable return on the investment.

The essential steps required to promote rapid commercialization of research, where government has to pull back and basically let the market work for itself, just didn’t seem to be part of the conversation. It’s another sign that the “public utility” model may well be the most realistic scenario driving the industry’s future; ironically, its the most innovative research segment – biotech – that seems to be leading the way.

One example of this disconnect between advocacy of “front end” support for innovation and neglect of the “back end,” where products face an increasingly skeptical phalanx of payers, was the appearance of Sir Michael Rawlins in a series of impromptu exchanges at BIO hosted by the UK Department of Business, Innovation and Skills. Rawlins heads the National Institute for Health and Clinical Excellence [NICE], which reviews medicines for evidence of cost-effectiveness prior to listing on the NHS,. NICE is criticized in some quarters of industry for holding back access to medicines on grounds that their clinical value is insufficient when weighted against strict metrics of affordability.

Rawlins made a number of useful points in suggesting where governments are heading in this puzzling, increasingly disconnected game to “promote” biotech:

• What’s wrong with good evidence to help politicians decide where to commit scarce public funds for health? Rawlins noted flatly that results of the UK election will not compromise the mandate of NICE in critically appraising medicines for listing in line with the priorities and resources of the NHS – all three major parties support the organization’s role “without hesitation.”
• NICE has broadened its roots as a leader in the politics of public health. Rawlins himself is chairing a bipartisan government commission to review the entire UK regulatory climate for medicines, with recommendations due by the end of the year. By default, NICE is thus likely to survive this critical review unscathed.
• Austerity will help promote the NICE reputation by deflecting criticism away from politicians in making unpopular resource choices. Rawlins believes that drastic cuts in public spending to restore the fiscal balance in the UK will actually enhance the value of metrics-driven tools to ensure decisions are made fairly and on the basis of independent evidence. Hence NICE is actually likely to grow in political stature as a consequence of the urgent need to curb public spending.
• Can you “define” innovation? NICE believes it can. A new priority for NICE in 2010 is identifying areas to “disinvest,” including recommending the removal of some medicines from NHS reimbursement. However, Rawlins is no fan of the big pharma “headroom for innovation” argument – new molecules will still have to prove their merit as “value drivers,” regardless of whether such disinvestment frees up funds for alternative use.
• NICE work carries significant implications beyond the UK. As the financial crisis spreads to more countries, reliance on appropriate evidence to ration health care will increase, and NICE is determined to sell its model to anyone who is interested. Rawlins said NICE has created an international consulting unit with a five person staff. It is working closely with a number of multilateral agencies – including the World Bank and the Inter American Development Bank [IADB] – as well as the UK Department for International Development [DFID] to promote health technology assessment tools in emerging middle-income markets. The focus is on helping countries decide what to spend on medicines through therapeutic targets and clinical guidelines, rather than individual product appraisals. Nevertheless, it’s a trend that will affect biotech fortunes for good or bad in markets that are slated to account for much of the growth in global pharmaceutical spending over the next 10 years.

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Coats is referring to the pressure that cash-strapped biotechs are feeling to sell out and says he gets no less than five calls a day from small companies desperate for suitors. “The VC guys are saying you better get another revenue stream or control the costs, because the money is just not coming in,” he says.

It’s an interesting vantage point for Eisai, which unlike some Big Pharma competitors doesn’t have to go through the massive reorganization and downsizing.

Part of that has to do with the more careful business planning on behalf of the Japanese companies, according to Elizabeth Evans, a senior specialty sales rep with Eisai. “The culture is different,” she said. “It’s the worst thing to fire someone, so they think very much about the long-term before making the hire.”

Coats notes that 21 percent of the company’s revenue now comes from specialty drugs—with more promising therapeutics on the way out of its new MGI Pharma acquisition. But Eisai has just 1,000 specialty reps. “Because we haven’t taken on the infrastructure, we don’t have to go through the pain that a lot of the other companies have,” he said.

Rather, the pharma company of the future will be built through partnerships instead of a lot of heavy M&A. “M&A and all the work you have to do on integration is a big distraction,” said Coats. “Look at Merck. There was a lot of pressure to do a merger. But they held the line until there were drugs coming out of the pipeline.”

Coats also notes that Jeff Kindler has made some right moves in this direction for Pfizer; he’s willing to take the hit now by holding out on a lot of the M&A that will just build up infrastructure and make the patent cliff steeper for as long as possible. Instead, the company is seeding projects throughout the rest of the industry that will bring it revenue streams in the future.