Pharm Exec's 2014 Dealmakers Outlook

Start Early, Stay Late

Experts from big Pharma and biotech dissect the road ahead for M&As, licensing, and partnerships.

Roundtable Participants

Igor Bilinsky, SVP, Corporate Development, Vical Pharmaceuticals

Mike Broxson, Head Global Licensing, Takeda Pharmaceuticals

Christophe Degois, VP, Business Development, Geron Corporation

Doug Fisher, Partner, InterWest Partners

Josh Grass, SVP, Business and Corporate Development, BioMarin

Curt Herberts, Senior Director, Corporate Development & Strategy, Sangamo Biosciences

Ravi Kiron, Entrepreneur in Residence, SRI International

Jason Levin, Chief Business Officer, Sorbent Therapeutics

Gail Maderis, President, BayBio

Kimberly Manhard, Co-Founder and SVP, Ardea Biosciences

Neel Patel, Director, Campbell Alliance

Jim Schaeffer, Executive Director, Business Development, Merck & Co.

Dr. Jay Tung, Chief Research Officer, Myelin Repair Foundation

Samuel Wu, Managing Director, MedImmune Ventures

After fading to dreary summer stock for the past few years, dealmaking is today back to center stage, but with the major roles reversed—small biotech, yesterday's understudy, now gets top billing, while big Pharma has to work harder for its close-up. As the pacing around the urge to merge picks up, Pharm Exec brought partner Campbell Alliance and a select group of West Coast dealmakers to a Sonoma raceway for a test performance on what lies ahead for asset licensing and M&A activity in 2014. The following is excerpts from a full morning of discussion—and despite all the high-octane rhetoric around deals, the key differentiator of success hasn't much changed. It's still that hard—and honestly wrought–evidence of value to payers and patients.

— William Looney, Editor-in-Chief

PE: Campbell Alliance has conducted its Survey of Dealmaker Intentions for six years, one of the most volatile periods in memory. Three of Pharm Exec's top 20 sales leaders—Wyeth, Schering-Plough and Genentech—have disappeared, along with major realignments in the generics and mid-size biotech sectors. What has been distinctive about the past 12 months and how is this weighing on the current business calculations of pharma companies and the host of new partners emerging in this space?

Neel Patel, Campbell Alliance: Our annual survey, which was conducted early in the first quarter this year, is focused on director-level and above executives engaged in key corporate functions, including executive management and business development. There is a slight bias in the survey toward those who are engaged in out-licensing activities, mainly reflecting the fact that right now there are more companies selling assets than buying. Our geographic scope is primarily the US along with a strong sample from Europe. Companies are a mix of public and private, and range in sales from the billion dollar plus big Pharma players to some micro-cap biotechs with revenue below $5 million. In essence, our data is broadly representative of the dealmaking field, which bolsters our ability to accurately gauge forward-looking sentiment.

As far as expectations for activity over the next 12 months are concerned, there is a solid if nuanced convergence around expectations for an increase in the overall volume of deals. Significantly, both out-licensors and in-licensors expect more deals at the early preclinical stage and carrying forward to Phase II clinical trials. At Phase III, there are tempered expectations for deals versus early stage assets. For fully marketed assets, both groups are largely aligned, this time in anticipation that the number of deals will decline. The expectations on marketed assets represent a reversal in sentiment from our last survey, when respondents were expecting an increase in deals. Driving this is the growing confidence among biotech firms in being able to commercialize independently—conditions are more conducive to making that final sprint to the finish line, without any push from big Pharma.

Out-licensors and in-licensors expect more deals at the early preclinical stage and carrying forward to Phase II clinical trials.

Therapeutic drivers

Christophe Degois, Geron: Might it also be due to the perception that there are fewer good deals at the later Phase III stage?

Patel: That has been the prevailing view in our Survey for the past two years. But there is a healthy contrarian view among some buyers that a few real gems are still out there waiting to be discovered. What is determinative is value. Most buyers believe that if an asset can provide real evidence of value, it deserves a premium price. It is emblematic of the "de-risking" sentiment that is driving valuations today in the life sciences.

PE: Which therapeutic areas are attracting the most interest among dealmakers this year?

Patel: There is relatively little change—oncology assets are by far the top draw; this has been the case since we began the Survey. Both buyers and sellers are committed to signing deals in oncology, which is to be expected, as this is where the science is trending, too. We haven't cut the numbers in detail, but one thing I expect to see is a rise over the years in both out-licensing and in-licensing deals that cover earlier stage, pre-commercial assets. Competitive interest in oncology means that mid- to late-stage deals are harder to find; you have to move earlier to find an asset worth licensing.

What is interesting this year is the therapeutic category we call "Other." Interest is scaling up in this category, which includes mainly orphan drug assets for a growing list of rare diseases. "Other" also includes ophthalmology drugs, which is a favorite for the high pricing flexibility these give to investors. Overall, virtually every company we surveyed—from the biotech start-up to the big Pharma top 10—now includes orphan drugs as part of its business development and licensing strategy. Another intriguing finding is the continuing interest in cardiovascular and metabolic diseases, despite the intense competition and high costs of the large-scale outcomes trials now being required by registration authorities and payers.

Samuel Wu, MedImmune Ventures: Is the willingness to move earlier to license or acquire oncology assets due to the greater confidence that investors have in the underlying science?

Patel: Yes. Significant progress has been made over the past 10 years in understanding the biology behind tumor formation and metastasis. Diagnostic instruments have advanced considerably. As a result, treatments being developed are more targeted, resulting in a practical progression of survival rates for many individual cancers. Cancer itself is seen increasingly as a collection of rare diseases, which is advantageous to drug developers because it helps concentrate resources.

Financing trends

Igor Bilinsky, Vical: The greater availability of capital is reshaping the overall strategy of developing an asset. Companies now have more financing options than just relying on out-licensing or an outright acquisition deal, particularly if they have more than one asset to play with. For example, we may be seeing more companies looking to sell some assets earlier in the development pipeline in order to self-finance commercialization of the best of the lot, rather than the formerly common strategy of "selling the first born."

Jason Levin, Sorbent Therapeutics: Capital markets have a big impact on deal strategy because you have additional options to consider. If you are a small company like mine, the strategy is to go first – and get it done fast. If I can raise the capital, I will use it to keep pushing the company forward to generate more value as well as to help fund an expanded, complementary portfolio. Or if someone outside steps up and puts a valuation on the table that my shareholders are willing to take, then I can do that too. Today, the capital markets are open enough that I can do a financing deal much faster than negotiating to sell the asset to someone else.

Doug Fisher, InterWest Partners: The key objective for a seller in exploring any option today is to maximize the value of its most important asset. I would rather have one strong lead asset than a portfolio of runner-ups. Prior to the capital crunch than began around 2007, it was acceptable to fold all the less interesting candidates into a deal, as part of a platform approach. Since then, the dominant perception is that it is folly to waste money developing assets that big Pharma doesn't want. Even among companies that claim to have multiple assets in play, the focus is still on that proverbial "asset A."

Structuring the deal

Patel: Over the last two years, our Survey has seen a significant increase in structured asset transactions built around contingent value rights, leveraged through a "earn out" clause. The "earn out" is a useful way of establishing a contingent value for an asset, which is attractive to companies that want to quantify their risk exposure by tying payment to a goal or an event that has to happen. If you believe we will continue to see a buoyant capital market, then it will be interesting if the availability of funds trumps the necessity for sellers to negotiate these "earn outs."

Fisher: I don't think future growth in funding through the private capital markets can be assumed. At any rate, what really drives a transaction is not capital but the level of competition for the asset. If this is lacking, the buyer can do whatever he likes. Alternatively, when there are multiple bidders, there is no end to the creative things you can do to seal a deal. On balance, when you can get a competitive bidding situation going, then the likelihood is the seller won't have to settle for a structured transaction.

Bilinsky: Contingent value rights (CVRs) are typically driven by the differing opinions of the buyer and the seller about the value of the asset. Buyers will often have a more conservative view of the prospects for an asset's market success, while the seller tends to see a higher potential. CVRs are a tool to bridge the gap. Based on what is happening in the capital markets, sellers are becoming ever more confident and optimistic, while buyers in big Pharma cannot always match that. To find that elusive common ground, you have to opt for a structured transaction that can end up being quite complicated.

Levin: It is a tricky process. The deal can include provision for issuing a separate class of securities that are tradable in their own right, which often creates a big drag on the issuing company's own stock. The big Pharma players can afford to take the hit, but the toll on smaller companies can be considerable.

Curt Herberts, Sangamo: CVRs are one of the most useful tools to set terms around a defined event that is expected to occur in the relatively near future. When you are able to identify the specific event and establish the success metrics, then there is less operating risk because you can also set expectations. Otherwise, a CVR ends up being very hard to structure.

Patel: The number and quality of assets available to transact has a strong bearing on the final structure of a deal. What is interesting in our Survey this year is the soaring level of demand for preclinical and early-stage assets in oncology. This is a reversal of previous years, when there was enough supply to meet the demand; now what is available has shrunk, resulting in a much higher level of competition among buyers. Another striking development is the level of interest in products with orphan designations. Everyone wants a stake in this area, to the point where asset sellers are re-classifying products as orphans as opposed to other therapeutic categories.

Levin: One card that is increasingly hard to play is that of the contrarian investor—going against the grain. The reason is the long lead times that still confront any drug developer interested in the ultimate goal of market authorization. Big Pharma remains the biggest buyer, with the deepest pockets, yet we see much more turmoil in the way they manage their pipeline portfolio and therapeutic franchises.

Patel: This is true. We see a clear pattern here: a promising compound fails in Phase III and all of a sudden management decides to exit that entire therapeutic area. Every asset in that zone is declared persona non grata, even though the company might have spent many millions in acquiring the assets and even entire companies, seeking a position of leadership. And we are not even considering the churn in management ranks, where there is an innate tendency for newcomers to do the opposite of what their predecessors did.

Market pressures

Bilinsky: Another continuing trend is the growing attention by licensors on whether an asset can command an attractive reimbursement rate from payers, which will ultimately determine whether your investment is going to be successful or not.

PE: These comments indicate uncertainty about who will be driving the financing for the next generation of biopharmaceutical innovations. No one has cited the involvement of public and philanthropic science. Can this alternative stream fill the gap left by private sources of financing?

Gail Maderis, BayBio: These sources are absolutely critical, but they represent a drop in the bucket against what is needed. The expectation is that industry should take the lead in developing breakthroughs for medical conditions where there are few or no treatments. Our reputation suffers when we are perceived as not making the effort because of a narrow financial calculation.

Herberts: Some new sources of early-stage capital are arising as a consequence of strategic commitments made by organized disease groups to develop a specific drug for their patient community. Many of these now come in the form of venture philanthropy. It is not occurring on a large scale that will change the norm for funding drug development, but in a few instances it is bearing fruit, especially when you can drive expedited development in a small patient population.

Wu: But this is not getting at the critical issue, which is where the money is going to come from for work at the preclinical phase. The pathway to commercialization starts here; if financing is scarce, you never get to the next step.

Maderis: There are signs of progress. Just in the last three years, the Bay Area has seen Pfizer, Bayer, J&J, and Merck establish centers of innovation that are designed to incentivize start-up work around promising new areas of science—all at the early-stage and proof-of-concept level.

Jim Schaeffer, Merck & Co.: Merck was among the first pharmaceutical companies to locate a business development group with scientific evaluation capabilities on the West Coast. The objective was to have feet on the ground and to hunt for promising new ideas that might complement what we are doing already or represent something entirely new but is still synergistic to our R&D model. Thirty years ago, all of the action focused on small molecule chemistry which required legions of medicinal chemists. Today, the ability of small companies to compete with larger firms has been enhanced by the availability of commercially accessible chemical collections, increased high throughput screening capabilities, and CROs, in addition to an increased focus on biological therapeutics that do not require large numbers of employees. Consequently, the larger companies are paying more attention to their smaller competitors and now view them as potential partners.

Ravi Kiron, SRI International: The investment in this work is not large, but the payout can be significant. It is all about innovating and then jump-starting a great research idea. J&J was among the first to try it, and I recall we were making bets with as little as $50,000 per grant. The concept is a good one. It has positive consequences for the six billion people outside our mature pharma markets for which the conventional R&D model, based on hundreds of millions of dollars invested per compound, is not sustainable.

Maderis: The areas where deals are being financed—where the private sector demand is—are focused on specialty oncology medicines and orphan diseases. There is less going on in the major chronic diseases areas like diabetes and senile dementia that account for most health spending. This is why major public and philanthropy initiatives can have an impact.

Dr. Jay Tung, Myelin Repair Foundation: Someone clearly has to be addressing the long-term questions that relate to our understanding of the fundamental biologic roots of disease. The Foundation is deeply invested in translating academic research into something that can be applied commercially. We apply a strict standard of rigor to the translation in order to give private investors the confidence they require to take a project forward. The Foundation is non-profit but ultimately our work is dependent on someone finding a way to realize a return on the money invested. It's a way to de-risk some of the costs of starting up in areas of science that have been neglected by the mainstream private R&D model. Clearly, we see big differences in the cultures of academia and big Pharma. For example, in academia the aim of any research is to get it published—there is a single hurdle, called peer review. In contrast, drug companies want to see that research replicated hundreds of times to test, ratify, and reaffirm the faith in their up-front investments. The cultural divide is pronounced; if anything, it is growing wider.

Patel: Nevertheless, options for small companies with good assets to go it alone are improving. They are holding on to these longer than in prior years. We are now being asked to help licensors develop their portfolio strategy, which was rare just two years ago. Biotechs see the potential of remaining independent, with multiple assets that can be developed without necessarily selling out to big Pharma. We are also seeing a more nuanced approach to the footprint companies make in each therapeutic area; there is a lot more "slicing and dicing" of assets, geared to obtaining a very focused market profile that buyers can understand.

PE: Having viewed the Campbell Survey presentation, is there a takeaway message that is missing or needs to be embellished?

Mike Broxson, Takeda Pharmaceuticals: The indicators suggest that the second half of this year is going to be better for buyers. This is evidenced by the fact that there is more capital available and is being put to productive use. I'd also emphasize including more input to the Survey from Japanese companies.

Levin: Valuations are sufficiently robust that more holders of assets will be ready to transact. The message is on balance very positive for deals in our sector.

PE: Looking at the current news cycle, I see three important trends affecting the transaction environment. The first is the three-way distribution of selected assets between Novartis, GSK, and Lilly designed to strengthen each other's position in different franchise therapies. This friendly exchange between avowed competitors was a "no go" only a few years ago. The second is the arrival of hedge funds as a driver of M&A in a sector these speculators find to be undervalued. Valeant's bid for Allergan, with support from investor activist Bill Ackman, is an example here. And, finally, we are seeing a change in payer perspectives, with key PBMs like Express Scripts seeking to create a grassroots coalition to beat down prices of top-selling, highcost drugs. Taken together, where are these developments taking us? Is there a connection between the three?

Degois: What binds these trends is the primacy of demonstrating long-term value. This work has to be initiated very early in the development of any new asset, with the focus on shaping how that asset is going to be priced and reimbursed several years down the road. It is not an easy task. It requires significant resource commitments, which creates additional burdens for smaller companies like my own. It is interesting that a significant push to provide value is now coming from payers here in the US. Arguably, the pressure is as intense as in Europe, which has controlled prices for years.

Kimberly Manhard, Ardea Biosciences: One positive is that it is easier to obtain a breakthrough designation from the FDA, which is one demonstrable means to prove value.

Herberts: The practical matter is that you no longer have a choice to do it. Potential buyers of your asset expect to have some type of payer/market access assessment even for early-stage preclinical assets. Even if payer discussions are conducted on a high-level conceptual TPP basis, they lay the foundation for both parties to assess the potential commercial value, and thereby the financial value, of the asset. When a small company has these analyses already completed, it creates the credibility that can seal the partnership and lead to a strategic investment. Despite the many potential errors in underlying assumptions, this payer assessment can work to create a common foundation upon which to consummate a transaction.

Grass: The value model itself has to keep pace with the science. The movement toward personalized medicine can make the calculations much harder because pharmacoeconomic data is less meaningful in very small patient populations, especially those with no current therapeutic options.

Maderis: One trend we have not discussed is industry consolidation. Presently, many biotech companies are finding it easier to tap the capital markets and commercialize assets on their own instead of having to rely on partnerships and licensing with big Pharma. But I expect this is temporary; the markets are cyclical. Consolidation is going to make the entire transaction field more challenging, particularly for the smaller players who need to partner, as buyers' leverage increases as the number of potential buyers declines.

PE: So are the big players getting too big? Is it important for R&D organizations to maintain the flexibility required to act fast, seal the deal, and preserve the intimacy that builds trust and keeps partners in line? Is there anything big Pharma can do to mitigate the negative link between size, organizational inertia, and management uncertainty?

Grass: You cannot assume that because an organization is large it is inept and remote. As long as the process between partners is clear, and the objectives are understood, then the chances of a junior partner being surprised are limited. When you get bad news, it's usually because of the simple fact that someone was not communicating. This can happen regardless of the size of the organization.

Kiron: It also depends on what you are selling: for example, is it an asset or a platform technology? With the latter, you usually don't get an automatic "in-or-out" decision. It can take time to conduct all the scientific evaluations. Then there are the commercial and market access discussions around an asset. You can finally get it all done and suddenly the big Pharma partner will say a decision has been taken to exit that particular therapy area. But I would say from experience that this happens rarely and the adverse impact is accentuated by a simple failure to communicate. If a company has strong interest in an asset, it comes across right away; you find out very quickly who the decision makers are. This, in turn, speeds the process. The longer it takes to come to agreement, the bigger the risks.

Maderis: There is so much out of your control. Continuity over the life of a deal is very rare. Changes are to be expected, especially as other M&A activity shapes the external therapeutic landscape beneath your feet. It is hard to take uncertainty and risk out of the deal-making equation.

PE: Is the need for due diligence becoming more of a drag on speed and timing to execute a deal?

Levin: Due diligence represents a challenge to the seller side because of the higher resource commitments needed to assure buyers worried about hidden risks. The big companies want to see everything and then this has to be evaluated at multiple decision points. A smaller company interested in buying can move quickly, without having to do things like presenting due diligence evidence directly to a distant Board.

PE: Is parsing the IP angle still important?

Manhard: IP protection is our company's biggest category of spend in dealmaking. It is vital to keep track of the changing boundaries of exclusivity in areas like data protection and biosimilars.

Broxon: There are lots of potential PTO problems in any company's portfolio; some issues can be pending for a decade or more. There are varying shades of exposure, and if you don't adequately establish the risk up front it can emerge as a deal killer. You need experts to probe all the patent claims. They should have the experience necessary to pose the right questions.

PE: Jay, as a representative of a non-profit professional disease organization, what suggestions do you have on how the biopharmaceutical industry can be a more effective partner in advancing the search for cures?

Tung: The challenge is that each party has different motivations that are based on decades of learned behavior. Companies are reluctant to make early investments in anything that involves speculation against the prevailing grain—but this is often where true innovation begins. At the same time, most non-profits lack the resources and expertise to move these promising ideas into commercial development. What the Foundation has done to address this is to bring this expertise into our staff so we can facilitate the packaging of highly relevant data that takes some of the mystery out of speculative bets. Our data contributions work in the language that big R&D organizations understand; it reduces the number of steps in the preclinical research phase, saving time and money, which in our industry is classified as risk.

To create a permanent infrastructure to drive this concept, we established a translational medicine center with a research agenda specifically geared to myelin repair as a treatment pathway for MS. What we'd like most from industry is more partnering on projects in this area, such as building a consortium of companies to develop new biomarkers that make MS diagnosis more predictable and help narrow and personalize treatments. These biomarkers would boost the clinical credibility of additional investments to find ways to clinically induce repair of myelin rather than the traditional approach, focused entirely on immune response.

Building the business development function

PE: Is it safe to assume from our discussion thus far that business development—dealmaking—is now a key strategic function for both big Pharma and biotech? What are some of the key internal issues that must be confronted in helping those of you active in this area maximize your contribution to the organization? Where is the best home for business development—in the R&D organization or in the commercial operation?

Schaeffer: Most pharma companies have integrated licensing and business development activities within the R&D organization. The reason is simple: the most critical component in any licensing evaluation is the scientific assessment. Decisions concerning licensing or acquiring a specific asset will be predicated on this review.

Grass: Business development is a strategic activity and, hence, it should report directly into the CEO. This is the best way to minimize the tendency to overweight the scientific or the commercial view in deals, which happens when you have business development located exclusively in either function. Ideally, you want business development to exist independently of the prejudices and preconceptions that collect when you are located in one area. Organizing business development so that it is independent and directly accountable to the CEO ensures a more balanced view on transactions.

Levin: It's a moot question for smaller companies. Here, business development nearly always reports in to the CEO.

Kiron: It is also important to think in terms of distinguishing your functional corporate/business position as being based on the development stage of an asset. It can be more effective where one team works around assets in preclinical to Phase I, while a separate licensing group handles everything from Phase II onward. You are then able to create that mix between fully understanding the science behind an asset as well as being able to take it forward from a more global, networked orientation that zero's in on market potential.

Maderis: Another key question is to evaluate where in-house corporate venture capital groups fit into the business development picture. We are seeing these internal groups take on a more prominent role; some are fully embedded in the business development function, whereas in the past they operated on the margin—as a separate unit that tended to invest in experimental, speculative things.

Kiron: I'd assess their position within the organization on the basis of this question: can you manage an offbalance sheet activity and still have an impact on strategy?

The next wave

PE: What will be the major drivers of the dealmaking environment in three years' time? Are there commercial or policy changes in store that might deflect some of the up-front risk in arranging new deals? Or is the climate likely to become even more challenging for those seeking the best assets?

Degois: The search for attractive opportunities at the preclinical stage is going to accelerate. This is reflective of the exciting state of science right now, with more innovations to come as we begin to digest the progress in our understanding of the biologic origins of disease. Big Pharma buyers know they have to cash in on this science at the beginning if they want to seize the competitive advantage around all the emerging platforms. This in turn carries implications for the value debate we are experiencing right now, because if there is no Phase II or III evidence to incorporate, buyers will have no choice but to be more flexible on terms.

Schaeffer: Much of the innovation will still be coming from many smaller biotech companies, which is good for competition. You will likely see the bigger biotechs picking up more assets from the smaller ones. And big Pharma will need to be faster on its feet; deals won't simply fall in their lap.

Bilinksy: We will see higher asset valuations—licensors are better capitalized now and do not have the same pressures to sell just for financial reasons. And there will be more biotech to biotech deals. Many lead programs will inevitably fail in development in the next one to two years, and biotechs will need to deploy the capital that they raised from public markets to fill their pipelines by in-licensing from other biotechs.

Maderis: What concerns me is the continued efficiency of the system that has fueled so much medical innovation over the past decades. The steep decline in public funding of basic research is troubling and not easy to replace, even with the onset of increased independent philanthropic activity. Big Pharma players are outsourcing more of their R&D and overall R&D investment by the industry is falling. Big Pharma wants to do more deals, but will there be enough inventory of good assets? Where is the financing for the innovative start-ups going to come from? It is a long-term process to raise the productivity of the industry's research pipeline. It is inefficient to rely on hope that another cycle in which valuations go through the roof will end up turning that pipeline back on.

Fisher: One cloud I see on the horizon is a drying up in the capital markets, similar to what happened five years ago. If the past is precedent, then you will see many more structured deals, along with a more powerful big Pharma contingent coming to the negotiating table in better shape, especially with the patent cliff behind them.

Wu: I, too, see more deals among smaller companies. Sustainable sources of financing is thus going to be important in preserving the momentum of what is likely to be a new and changing series of niche markets.

Kiron: Another trend affecting deals in the near future is the desire of big Pharma to shed older assets. We will see more dealmaking activity involving off-patent compounds, many of which are no longer being reimbursed, but have real potential as repurposed products with an extended protection of patent life and subsequent product revenues, or in other ancillary portfolio settings.

Fisher: One fact remains constant— the best assets will get funded!

William Looney is Pharmaceutical Executive's Editor-in-Chief. He can be reached at wlooney@advanstar.com.