United States: Advice of Counsel January 2000- Q&A On Tech Transfer - Were Any New Biotech Business Models Developed In 1999 That We Can Expect To Continue To See In The New Year?

Advice of Counsel Q&A On Tech Transfer

by Michael Lytton

Answer: Yes. Here is one view of new business models likely to predominate in the months ahead.

1. "Made to Order" Service Deals. As biotech platform technology tools have become commoditized and widely available to in-house R&D departments at pharmaceutical companies, biotechs are now offering service deals to pharmaceutical customers. The terms are on a pay-as-you-go basis, including a healthy profit margin. Up-front fees, milestones and royalties are notably absent from these deals, signed by companies like Albany Molecular Research Inc. and Array BioPharma Inc. One could think of these companies as chemistry CROs, providing an integrated chemistry outsourcing service for pharmaceutical companies. Their attractiveness to the chemistry department of a large pharmaceutical company is not simply cost savings; embedded in the culture of these new companies is customer service, i.e., an attempt to be the Nordstrom for pharmaceutical customers. These companies owe their existence to the explosion of leads and targets created by combinatorial chemistry, high-throughput screening, and genomics, which has overwhelmed in-house R&D departments at pharma companies. The outsourcing seems most prevalent at the lead optimization and medicinal chemistry stages of the development process. Look for more examples of this phenomenon in related fields. For example, a new Boston-area company, Cellstore Inc., was founded and recently received just under $10 million in venture funding to enable it to be the key out-sourcing provider of biological tissues and other materials, as well as accompanying genomic information, to pharmaceutical and biotechnology companies. It will be interesting to observe how amenable the biotech mindset is to the advent of these new, service-oriented companies.

2. Second-Generation Database Companies. New companies will have a tough time pursuing the Incyte Pharmaceutical Inc. model of providing relatively raw biological or chemical information to pharma companies for significant up-front fees, milestone payments, and reach-through royalties. Now that pharma companies possess much of this information in-house, they want to buy solutions rather than information. Hence the advent of new companies like Rigel Inc., which identifies its own targets and then validates them before presenting them to pharmaceutical companies, or database companies like Genaissance Pharmaceuticals Inc. or Lexicon Genetics Inc., which provide genomic databases and accompanying services to pharma companies with focused information needs. Subscriptions to these databases are typically short-term (i.e., two to three years), and are non-exclusive. The pharma company is only interested in obtaining a lead over its competitors, not exclusive access to the tool offered by the platform company. Customized services are the unique selling proposition of these data offerings, whether it is Lexicon's mice, Genaissance's clinical cohort construction, or ArQule Inc.'s custom arrays. The economics differ from the past as well. The emphasis is on annual access fees and milestone payments, with low or very modest royalties. Downstream, the pharma company can patent freely, without having to worry about royalty stacking. As the technology advances, the trend is to digitize as much as possible, replacing the early stages of the previously high-cost wet lab experiments previously undertaken by pharmaceutical companies.

3. Technology Transfer, Enabling Pharma to Buy and Make for Itself. Formerly a company selling chemical libraries to multiple pharma companies, ArQule has transformed its business model; it is now training drug firms to make compounds on their own. Its first deal of this nature was with Pfizer Inc., for which it will receive well in excess of $100 million in guaranteed payments. Accompanying the transfer of ArQule's system was a "user's manual," equipment and ArQule employees loaned to Pfizer. The system is for Pfizer's internal use only; it may not sublicense it to others. The terms are non-exclusive, enabling ArQule to do the same deal with multiple pharmaceutical and biotech companies. Although $100 million is a lot to pay, Pfizer is able to use the platform to make compounds without the need to account to ArQule for royalties on downstream products. Applying these large, guaranteed payments, ArQule can now focus its attentions on internal drug development.

4. Building to Sell. Roughly two years ago, two small companies, Advanced Inhalation Research Inc. and Genetic MicroSystems Inc., were founded to offer divergent technologies based on a common premise: their ultimate economic success would lie in building technology value, raising a very small amount of venture capital, and then selling the company so that the technology could expand and flourish within a much larger company. AIR's large-particle drug delivery technology licensed from Massachusetts Institute of Technology enabled it to do three corporate partnering deals (within the space of one year) with Glaxo Wellcome PLC, Eli Lilly & Co. and Pfizer Inc. and raise approximately $2 million in venture capital. The company was then promptly sold for in more than $100 million to Alkermes Inc., which has handily incorporated AIR's inhalation technology with its other drug delivery systems. The Genetic MicroSystems story is similar. Former executives of General Scanning Inc. and Perkin-Elmer Corp. developed innovative scanning and arraying machines for biological materials, exciting the research community and attracting the interest of each of the major gene chip companies. After an angel round of financing raised a few million dollars and commercial sales began, Affymetrix Inc. bought the firm for more than $100 million, saving Genetic MicroSystems the expense and ultimate futility of trying to build a sales force to compete with the big players in the laboratory research market. In both cases, the founders and investors drove a sensational rate of return for two years of hard work.

5. Holding onto a Share of the Upside of a Late-Stage Product. In the old days, a biotech company would license out a compound in Phase I or maybe as late as Phase II, giving up the lion's share of the upside in exchange for a modest up-front payment, development payments and milestones post launch, and a high royalty rate. While a number of these deals are still being done, CV Therapeutics Inc.'s deal with the Innovex unit of Quintiles Transnational Corp. to market its angina drug ranolazine breaks the mold (See "Cv Therapeutics Lets Innovex Do the Legwork-and Pay for Some of It, Too," IN VIVO, June 1999). CV will be launching ranolazine (now in Phase III trials) using Innovex's dedicated cardiology sales force of at least 75 people. The product launch is being funded by Quintiles, which also made a $5 million equity investment in CV. Quintiles is providing a $10 million loan for pre-launch activities, and additional funding upon FDA approval, as well as at least $19 million in free services during the first year after launch. In return, Innovex will receive roughly 33% of revenues in years 1 and 2 and decreasing to 25% in years 4 and 5. CV thus retains more of the upside than it would have been able to do in a deal with a pharma company, while allowing it to boost its top line by booking 100% of the revenues. As a bonus, CV obtains access to a fully trained sales force, as well as other marketing services available from the Quintiles organization. Indeed, it should be noted that CSOs in general are trying to become far more than rent-a-rep organizations, looking to become more important (and more profitable) outsourcing organizations by hiring full-time sales reps with training and compensation equivalent to their drug-company counterparts.

6. Skipping the High-Risk Phases of Drug Development. Start-ups are also looking to in-license approved products or very late-phase products under development. In mid-1999, King Pharmaceuticals Inc. licensed marketing rights to a $74 million antibiotic, Lorabid, from Eli Lilly, paying an upfront fee of approximately $90 million, plus sales performance milestones. Cubist Pharmaceuticals Inc. transformed itself from drug discoverer to drug developer through its license of the antibiotic daptomycin from Lilly in 1997. Daptomycin is now in Phase III and Cubist's stock price has quintupled. While these deals are innovative as a business matter, the deal structure is relatively straightforward. In return for the daptomycin license, Lilly received a license fee, milestone payments (paid in Cubist equity) and royalties. Expect more of these in-licensing deals in the future, as the hurdle rate rises for developing a successful drug within a pharmaceutical company and biotech companies search for late-stage products to market via specialty sales forces.

7. Diversifying the Risk-Reward Trade-Off. Millennium Pharmaceuticals Inc., long regarded as a genomics and target discovery company, transformed its business with the acquisition a few months ago of Leukosite Inc., a biotech with several late-stage product offerings. Throughout the biotechnology industry, companies are seeking to make themselves more attractive to institutional investors by offering a mix of early- and late-stage projects, thereby providing something for everyone in terms of expected risks and rewards. As the new year progresses, look for more M&A transactions to serve the objective of risk-reward profile adjustment.

   © Windhover Information Inc. January 2000

   Reprinted with permission