Such a Deal, Late-Phase

The cliché is that late-stage deals are necessarily expensive. Genentech is showing they don't have to be, lowering its cost of access to drugs by weighting most of its payments towards equity and milestones--and buying the drugs others pass over as too risky.

The cliché is that late-stage deals are necessarily expensive. Genentech is showing they don't have to be—if you're prepared to take some risk.

by Deborah Erickson

Late-phase licensing deals are often pricey, because Big Pharma execs would rather bid high on a sure thing than risk their jobs on an unknown quantity.

Genentech lowers its cost of access to late-stage products by weighting most of its payments towards equity and milestones.

So far, results are mixed: a win with Idec, a loss with Scios, a remains-to-be-seen with Alteon, now developing a drug to treat diabetic complications.

Genentech isn't playing white knight to downtrodden Alteon: it hopes the small-molecule pimagedine, or a version of it, will become an endocrinology blockbuster.

Most drug companies looking to in-license late-stage products assume good deals are available only to those willing and able to put down hefty amounts of cash upfront. Often, this is precisely the case when compounds that have performed well in clinical trials are essentially put up for auction by companies unable to carry them forward. Bidders line up, checkbooks out, particularly if the drug is geared to a large, established market. One classic example of this scenario involved Warner Lambert Co.'s Lipitor(atorvastatin), an HMG coA reductase inhibitor that Warner showed could powerfully reduce low-density lipoproteins and triglycerides. Pfizer Inc. , and plenty of others, figured that combination of effects added up to a clear winner. In April 1996, Pfizer paid an estimated $87 million upfront, an estimated $110 million in filing and milestone payments, and 50% of all promotional expenses in return for the right to co-promote Lipitor for ten years [See Deal].

But late-phase dealmaking doesn't have to entail tremendously big bucks, if the licensor is willing to take on risk. Genentech Inc. has demonstrated as much not just once but three times now, by in-licensing late-phase drugs for what can look like bargain prices. It targets small firms running low on cash and options, because they have experienced trouble of some kind—including trouble proving definitively that their late-phase products actually work. Genentech exchanges some millions of dollars upfront for equity, and promises a string of further cash payments repayable later in equity. If the product does do well enough to win the FDA's approval for marketing, it agrees to sell the drug aggressively, and to give the licensee a reasonable royalty and substantial milestone payments.

So far, the results of Genentech's risk-embracing late-phase dealmaking strategy are mixed. Genentech's late-stage deal with Scios Inc. for Auriculin, an atrial naturetic peptide intended to treat kidney failure, hasn't worked out so well [See Deal]. The drug's Phase III trial was shut down this past summer, for failure to show efficacy. Scios stock has been trading between $8 and $9 for the last several months—slightly higher than the market value at the time of the deal, but still below the $9.50 per share Genentech paid in its initial equity purchase.

Genentech's deal with Idec Pharmaceutical Corp. has been a roaring success. It licensed Rituxan, Idec's therapeutic monoclonal antibody against B-cell non-Hodgkin's lymphoma in March 1995, largely for equity [See Deal], and won twice: first because the drug was approved, and second, because the stock appreciated. The initial batch of preferred shares for which Genentech paid $5 million are worth over $30 million now. The jury is still out on Genentech's most recent deal with Alteon Inc. for pimagedine, a small molecule initially being developed to treat diabetic complications. Genentech agreed in December 1997 to pay Alteon $15 million upfront in a series of tranches.

The dealmaking pattern is clear, and nearly unique among major players: Genentech fills its late-stage pipeline with drugs other companies stay away from, while hedging its bets with stock. This bottom-fishing method entails greater risk, but it nets the company a wider range of marketing rights without a substantial hit to its P&L.

Genentech has gotten nearly worldwide rights in its deals, inexpensively, while most other late-phase licensors pay heavily for a much smaller piece of the marketing action. Pharmacia & Upjohn Inc. , for instance, paid Gilead Sciences Inc. a $10 million upfront licensing fee in August 1996 for ex-US rights to Vistide, a treatment for CMV retinitis in AIDS patients. When the drug won European approval in May 1997, P&U paid a $10 million cash milestone and was then allowed to buy $40 million in stock at 145% of the common price per share [See Deal].

Genentech's late-stage strategy is to some extent a product of the company's unique situation: it is two-thirds owned by Roche, which has the right to buy the company at a steadily increasing price until June 1999, at which point public investors may "put" their shares to Roche for $60 a share. If Genentech hopes to keep Roche from exercising its option (and public shareholders from selling), it needs to keep its stock price up. To do that, it needs to keep its earnings up, and also to keep its R&D expenses—currently about 50% of revenues, or better than twice the average of Big Pharma—down.

Those are different constraints than Genentech has felt the last few years, when Roche's put option essentially acted as a floor for the stock price. No matter what Genentech did, or how much it spent on R&D, investors knew the stock was going to be worth $60 in June 1999, which now is not so far away. Genentech's immediate challenge is to keep its stock over $60 and build a convincing case that it will be worth steadily more than that. So far, so good. Shares were trading at $63.75 asIN VIVO went to press in late January.

With the market's spotlight trained on its earnings, Genentech needs later-stage drugs. Its two flagship products, Activase(tissue plasminogen activator) and human growth hormone (hGH) are under considerable pressure. HGH, for instance, is now sold by three other manufacturers. Activase is competing against a raft of other treatment modalities, including Retavase, the new drug from Corange Ltd. subsidiary Boehringer Mannheim GMBH (which Roche recently bid to acquire), and the rising popularity of mechanical reperfusion instead of thrombolytic therapy. At the same time, Genentech doesn't have the capacity to develop more drugs: it has nine drugs in Phase III or registration, two in Phase II, and it doesn't want to buy the infrastructure to develop more. So Genentech has tailored its late-stage licensing deals to fit its main concerns: the company brings in late-phase drugs with the potential to boost earnings, and in effect rents from its licensors the capacities it needs to develop them. Sweeter still, much of the arrangement gets recorded on the balance sheet as an equity holding instead of an income-draining expense.

It's now clear that Genentech made a smart move by licensing Idec's therapeutic monoclonal antibody back in March 1995, when most health investors were still bitter about monoclonal antibody failures by Centocor Inc. , XomaCorp. and Syntex Inc., and concerned about national health reform to boot. Even though Idec had just published positive data from Phase II trials pitting the antibody (then called c2B8) against non-Hodgkin's B-cell lymphoma, the company's stock remained severely depressed. Idec shares—diluted the year before when 2.8 million of them were issued directly to the public at $2.75 pershare —were then trading at just $3.63.

In spite of the market's low regard for Idec (based in part on the firm's failure to commercialize its previous lead drug Specifid) Genentech decided to take a chance. It bet that the new antibody would come to market before other oncology products Genentech itself was developing in-house. For worldwide rights to the drug, excluding Japan, some other Asian territories and the Middle East, Genentech paid just $9 million upfront—$4 million as a flat licensing fee and the other $5 million as an equity investment [See Deal]. Genentech picked up 6% of the company that way, paying just $5 a share, a 37% premium over Idec's trading value at the time. It also promised Idec another $17.5 million, in a series of three payments, in exchange for equity prior to FDA approval, convertible at fair market value at that time.

Idec's antibody, trade-namedRituxan, received the FDA's final approval for marketing at the end of November 1997 and many analysts expect it to be highly successful. Merrill Lynch's Eric Hecht, for one, says the drug has the potential to rack up sales of $140 million in its first year, and $400 million annually when mature. But even before Rituxan hit the market, the Idec deal was a winner for Genentech. As news spread that Idec's Phase III trials of the antibody were indeed successful, the company's once-beleaguered stock shot up. By September 1996, months before Idec's data was officially released, the company's shares were trading near $24. Upon the announcement, they jumped to about $35 and have been trading there and higher since—$42 at press time. From the stock transaction alone, Genentech made money on this deal.

Unlike Genentech's success with Idec, the licensing agreement it signed with Scios at the start of 1995 now appears to be a failure. The firm, one of the earliest-founded biotechs, was something of a fallen angel at the time, under shareholder duress for having failed to commercialize a product, which it still has not done. But Genentech decided to license Auriculin, an atrial naturetic peptide being developed as a treatment for kidney failure, anyway. Genentech wanted this potential acute-care drug, in part because it could be sold by the same sales force detailing Activase. It had the basic appeal of a treatment for a significant unmet medical need. But mostly Genentech wanted it to pave the way for the earlier-stage products it was developing through its own research discovery program in naturetic peptides.

For full worldwide rights to Auriculin, Genentech turned over $20 million upfront for non-voting preferred shares convertible to 2.1 million shares (5.7% of the company) at $9.50 a share [See Deal]. Scios also got the right to access up to $30 million, which it did, and to repay this within eight years in cash or shares. Genentech never had to pay the $30 million milestone payment it promised if Auriculinreceived FDA's approval for kidney failure. Scios announced in the summer of 1997 that it was halting the Phase III trial of the drug for lack of efficacy.

It's too soon to predict how Genentech's most recent late-phase licensing agreement, with Alteon Inc. of Ramsey, NJ, will turn out. But if pimagedine, a small-molecule Alteon is developing to ameliorate the complications of diabetes, performs well enough in Phase III trials to get the nod from the FDA, Genentech will have once again gotten itself a good deal, without a big expense hit. And it will once again have done so by buying up the stock of a beleaguered biotech other potential licensors were afraid to touch.

Alteon's problems stemmed largely from the break-up of its previous pimagedine deal, with Hoechst Marion Roussel(HMR). The German giant acquired the drug when it bought Marion Merrill Dow (MMD) in 1995 [See Deal]. But pimagedine was already a hand-me-down by then. Alteon originally licensed the drug and related technology to Marion in 1990, just as that firm was becoming MMD. Alteon itself obtained rights to pimagedine and related technology from Rockefeller University researcher Anthony Cerami, PhD, who remains an active advisor to the company. Cerami did not discover pimagedine; the nitrogen-rich compound was found over 100 years ago, and has long been valued as a high-grade fertilizer. But Cerami filed and obtained the patents claiming pimagedine could be used to treat diabetic complications.

Alteon believes pimagedine can block formation of so-called AGEs, or advanced glycosylation endproducts, that form when glucose binds to proteins without the help of enzymes. The firm expects that inhibiting these endproducts will improve complications frequently seen in diabetics who, they reason, are prone to AGE formation because of the high levels of glucose in their blood. AGEs act like molecular glue, gumming up cells, tissues and organs and rendering them increasingly stiff and dysfunctional, Alteon scientists believe. Consequently, they think AGE build-up has a lot to do with diabetic complications such as deterioration of the kidneys, eyes and nerves. On this theory, the company is also working on other compounds that may break apart AGEs and possibly undo tissue damage that has already occurred.

The disease state pimagedine is first intended to treat is kidney dysfunction caused by renal deterioration in Type I diabetics. Because this serious diabetic complication develops and worsens slowly, any drug meant to delay the decline has to be studied over years. "The length of the clinical trials for pimagedine has haunted us," says James J. Mauzey, Alteon's CEO.

No Data Spells High Risk

The burden of conducting a lengthy trial was an issue acknowledged early on by Marion, and one reflected in the clinical-trial structure MMD and Alteon devised for pimagedine. Instead of staging separate Phase I, II and III trials, as is traditional, the partners decided to combine Phase II and III. The point of this, explains Jere E. Goyen PhD, for two years commissioner of the FDA under President Jimmy Carter and Alteon's president since 1993, was "to save time finding and enrolling patients between the different phases." With hindsight, Alteon's executives say they realize the combined trial structure that seemed clever at the time, was actually a big mistake: there would be no interim Phase II data on which to make preliminary judgments about the drug. The data gap increased the risk of the Phase III trials immeasurably.

Shortly after Hoechst acquired MMD, Mauzey asked his firm's new, bigger partner to pay for separate Phase II studies of pimagedine. Mauzey was troubled, he says, over the combined Phase II/III combination. He wanted to be able to show that the drug would have broad-spectrum effects against different pathologies of diabetes, such as end-stage renal dysfunction and dyslipidemia. HMR said no; it was looking for ways to make good on a public vow to streamline operations by cutting $800 million in expenses and 8,000 employees. Alteon went ahead with the trials anyway, on its own nickel—and in so doing, may have saved the company's bacon: these trial results were what ultimately cinched the licensing deal with Genentech.

In January of 1996, HMR informed Alteon that the small firm had survived the first cut in the post-merger re-organization. The news, though good on its face, was nonetheless unsettling. Alteon asserted that if there was even a chance it might be dropped later, it had a fiduciary responsibility to investors to begin talking to other potential partners on a "what if" basis. HMR said okay, and Alteon began what would be a series of over 50 meetings to find a new partner.

HMR announced on June 10, 1996 that it was terminating its inherited agreement with Alteon, for financial reasons only, and that the dissolution would be final in August. The small firm got back everything it had licensed away originally: not just pimagedine, but all rights to the platform AGE technology and other compounds derived from it.

"They never even looked at our data on the other compounds, though we asked them several times. To be fair, they were pretty busy with other things," asserts Jim Mauzey. He says, "I can understand why, to HMR, pimagedine seemed like a high-risk project. In mid-1996, we had fantastic animal data, but were two years from Phase III data. We had no Phase II data in hand, and our trials were burning over $20 million a year. For an acquiring company that's got to rank its priorities, you can see how the risk profile and economics would dictate their decision to drop the drug," he says.

Another Side to the Story

Although HMR cited mainly financial and strategic reasons for the split at the time, a senior executive close to the company now says other factors influenced the decision as well. Two large clinical trials, the DCCT in the US and PDS in the UK (ongoing) have clearly shown that blood glucose of about 6-7 millimoles is the main culprit for late-stage diabetic complications. However, "HMR thinks insulin itself is a risk factor too. It's a growth factor. If you're resistant to insulin, as many Type II diabetics are, you have higher levels of it in your bloodstream. That's probably contributing a good deal to the complications. Therefore [compounds that act as] insulin sensitizers make a lot of sense. If you can avoid too-high levels of insulin in the blood, you'll have a good chance to reduce side effects. That's where HMR thinks the action is in diabetes, and what makes the most sense to invest in. HMR is working on programs that eventually could overcome insulin resistance."

Even before new insulin-sensitizing drugs come to market, long-acting insulins could begin shrinking the market for pimagedine, this executive suspects. Other factors might conspire to do so as well: "Many clinical guys, marketers and researchers at HMR are convinced that if insulin delivery can really be optimized, through tight glucose control and strong compliance, the level of late-phase diabetic complications can be reduced dramatically—by about half. That possibility changes the formula for calculating the opportunity cost of developing a product like pimagedine."

This executive also emphasizes that HMR feels most comfortable backing drugs that have "a more dramatic effect than I believe they're now seeing with pimagedine." The source goes on to say: "Positive trends in the data, or even statistical significance in patient sub-groups, are not good enough. Like most big companies, HMR needs to see significant clinical improvement to feel confident about marketing a product, no matter how nice the rationale."

Optimistic, At First

Regardless of the reasons for HMR's decision to end the relationship, Alteon's executives weren't overly concerned at the news, at least not at first: the small company was on a roll. Alteon's stock was then at $16, and just a few days before, it had signed papers [quickly rescinded] for a private financing of $13 million. When the HMR call came, Alteon was two days away from going to the American Diabetic Association meeting to announce two new therapeutic programs: one based on the platform technology that had given rise to pimagedine, the other from Alteon's own labs. The firm was primed to talk about so-called AGE "breakers" intended to break apart damaging glucose-protein linkages, and possibly undo existing damage. It was also ready to speak publicly about its ALT 4000 series of glucose-lowering agents, and did so for the first time.

"We were very optimistic, actually," Mauzey says: "They'd put $55 million into us and we were getting everything back. We were in fairly late-stage what-if negotiations by that time, and told each other, ‘we'll be fine....'" He pauses, then laughs ruefully, "Well...it wasn't that easy." The drug companies that Alteon had been talking about partnering with on a what-if basis "started acting skeptical. People began calling up, asking ‘What does HMR know that I don't?'

Alteon also had more immediate problems, explains Kenneth I. Moch, SVP, finance and business development, who is also the firm's CFO: "We had 60 days to assume a massive Phase III trial," and all that entails, from management of the clinical program and the database for it, to drug manufacturing and stability issues, to planning processes for the NDA. "HMR had all the necessary infrastructure, but we sure didn't. Suddenly, we were responsible for a trial involving about 1,500 patients at 110 clinical sites. There are no comparables for a biotech company taking on the kind of burden we did."

Clearly, the prospect of shelling out $1.5 million a month to pursue the clinical trials of pimagedine intimidated many potential partners, who either couldn't do it or wouldn't do it after HMR backed out. Alteon did get some offers, Mauzey says, "but none of them were appropriate for the value we were providing. People were viewing us as a wounded duck." Still, he says, the firm persisted in believing it would find a good partner for pimagedine, even as "investors began questioning our sanity, calling up saying, ‘Hey, is this management team asleep?' When are you going to get a new partner?"

"People assumed something was wrong with Alteon when Hoechst ended the deal," says BancAmerica Robertson Stephens analyst Mark Simon. Alteon earned no public-relations points when it subsequently cancelled a Phase II trial of pimagedine in Britain, saying it could not afford to continue without its large partner's infrastructure. In fact, the move prompted The Lancetto publish an editorial, written by some of the clinicians involved with the trial, criticizing HMR for valuing money over medicine. It certainly didn't help matters any when the firm announced in December 1996, six months after the split with HMR was finalized, that some elderly patients taking high doses of pimagedine in its so-called Action II study in Type II diabetics experienced unacceptable side effects.

Waiting for Data

The end of 1996 was the low-water mark for Alteon, Jim Mauzey says, even though the stock wouldn't hit its low of $2.125 until March 1997. "At the end of '96, we still had no partner lined up, though we'd begun talking to companies in January of that year, and the trials just kept burning money." Mauzey took the necessary but painful steps: tabling some R&D projects the firm would like to have kept, and cutting Alteon's staff from 64 to 46 people. "It was bad enough losing the confidence of investors and struggling to keep it with clinicians," Mauzey recalls, "but I can't tell you how horrible it was, letting all those people go. We were small anyway, everybody knew each other, people were crying in the halls....It was just awful."

Alteon had little choice but to hunker down and wait for the results of its self-funded Phase II trials. At least it had that hope to cling to. If Alteon hadn't launched its own trials to supplement HMR's, it would still be waiting for data and very likely, a partner that would never have come in time. Alteon simply had to come up with some positive data to get a deal for pimagedine. Genentech, one of the many firms that looked at the drug after HMR dropped it, had told the company as much, straight out.

Genentech was interested in pimagedine because one of its own late-phase drug candidates had not worked out. The company had planned to follow up its second-biggest product, human growth hormone, (hGH), with another hormone, insulin-like growth factor, IGF-1. But Genentech ended up killing the product in the midst of a Phase III trial in September 1997, largely based on a revised assessment of how long it would take to get approved.

"The loss of IGF-1 left a big hole in our build-up of the metabolic disease business; pimagedine was a nice fit," says Nick Simon, Genentech's VP of business and corporate development. He explains that Genentech now sells hGH mostly to pediatric endocrinologists, but research is showing "there truly are diseases of aging that hGH will benefit," such as osteoporosis and congestive heart failure. The firm received approval to market hGH for adult growth-hormone deficiency at the end of 1997, he points out, so it is already working to establish a sales force to detail endocrinologists who treat adults. These physicians also see the kinds of diabetics that drugs like pimagedine may help.

"Once the announcement came out that Hoechst and Alteon were parting ways, we got very involved...until the complication came up in Alteon's Action II study that fall," Simon notes. It appeared that patients taking pimagedine for the first time were exhibiting flu-like symptoms that caused a higher adverse cardiovascular event rate in the older, more fragile Action II patients. This first look at the data gave Genentech pause about AGE inhibitors as a class of molecules, Simon declares. But Genentech also realized that only 8-10% of the data was in at that time; it would take another look.

"We liked the idea of how AGE inhibitors work, but I've got to tell you, we scrubbed Alteon's data more than anything we had in-licensed before. Once we had, we told them, ‘These are our three issues. If you can resolve them, we could have a deal.'" Simon declines to describe Genentech's three-point challenge to Alteon, saying the matters are now competitive issues, but he avows, "Alteon has done a great job getting the risks down."

Throughout 1997, Alteon harvested the evidence that finally convinced its new partner. Nick Simon notes, "We felt a lot more comfortable once data from 60% of the individuals in the Action I study-versus 10% was in" and reviewed by Alteon's external safety and monitoring committee. Phase II data reported in April showed that pimagedine lowered key serum lipid levels in Type II diabetics with dyslipidemia. Results from a separate Phase II study, revealed in July, showed the drug conveyed a mortality benefit in end-stage renal failure. Simon recalls, "Alteon's great preclinical data was bearing out in human studies. That gave us a stronger sense that the drug was doing what it's supposed to do."

There's still a lot of risk in pimagedine that will remain until the Phase III trial concludes in August and the data is unblinded in the fourth quarter of 1998, Simon declares: "We'll know then whether this first-generation compound sinks or swims." At the moment, he's satisfied that the drug has passed important milestones. But there's no denying the achievement took a lot out of Alteon.

By the time Genentech felt confident enough to license rights to pimagedine in December, Alteon's market capitalization had fallen from $250 million to $60 million. Worse yet, the small company had only $15 million left in the bank—nowhere near enough to complete its Phase III trials, in fact barely enough to survive another half a year. Genentech offered Alteon terms similar to those it had offered Idec and Scios, and the deal was signed [See Deal].

Genentech gave Alteon $15 million up-front cash in exchange for stock it received immediately. Paying a 10% premium, or about $6.70 a share, it thereby acquired slightly less than 5% of Alteon.

Equity as Collateral: More Chances to Win

In addition to the initial cash infusion, Genentech also committed to provide up to $48 million for US development and regulatory processes, all in exchange for preferred stock. Of this, $16 million will be provided to Alteon in return for preferred stock at the end of January 1998. The rest will be drawn down on a quarterly basis as needed. The entire $48 million will be convertible into common stock after five years, or when an NDA for pimagedine is approved, whichever comes first. Genentech will pay royalties estimated at 15-17%, on sales of pimagedine. There's been no decision on pricing yet, but Alteon executives point out that Warner set a new standard for diabetes drug pricing by pricing Rezulinat $3-4 a day, or roughly $1,000-1,500 a year.

Genentech has said it will pay an additional $50 million cash in milestones related to filing and approval for pimagedine. If a second AGE compound is developed and approved, Genentech will pay another $50 million worth of milestones, creditable to future royalties, in addition to all development costs for its licensed territories.

Alteon is highly pleased with its new deal: "We get the cash we need now, without being diluted," Ken Moch declares. At least, Alteon won't be diluted anything near like what it would have been by going through the markets, if it could even get capital that way. The higher the price of the company's stock at the time Genentech's preferred-to-common stock conversion takes place, the less of itself Alteon will have to give away. Nick Simon points out: "We'll be putting about $35 to $60 million into Alteon, and their market cap was only about that when we did the deal. Essentially, this is pre-funded equity, and that's why it's a win-win: they're getting cheap cash and we're getting a late-phase product with a lot of potential, income-neutral."

"Our licensors are using their equity as collateral," Simon points out, giving hard-luck companies one more chance to bail themselves out. Even if a particular drug licensed in late-phase fails, both Genentech and its licensors still have a chance to walk away better off. Scios may yet bear this out: under the agreement for Auriculin, it took $20 million from Genentech in exchange for non-voting stock, and also got the right to borrow up to $30 million repayable in cash or shares. Auriculinfailed, but in the years since Genentech signed that first late-stage licensing deal, Scios has inked others with American Home Products Corp. 's Wyeth-Ayerst Laboratories [See Deal]. Clearly, Scios is still being viewed by industry players as a firm with scientific assets, despite the fact that it has not yet marketed a product since its founding in 1981. Its stock is currently trading above $8, higher than it was when Genentech licensed Auriculin. There's no telling where it will be trading when payback time comes.

More Than Cash, Culture

Alteon executives insist it's more than the cash to carry on that's making them happy these days. They say they wanted a partner that would be a good cultural match, and one that would treat pimagedine as a high priority. That, Jim Mauzey exults, is exactly what Alteon has found in Genentech. Nick Simon says, "We told them we'd make this a top-tier development effort, that the drug wouldn't be just one of 70, like it was before, but more like one of ten. We said we want to make a commercial success out of this too, and we'll make it happen any way possible, not just in R&D."

BancAmerica Robertson Stephens analyst Mark Simon says Alteon has every reason to be happy: "Now they have an aggressive partner that understands the needs of a small company." He perceives an even more important boon to Alteon: "Gen-entech is a biotech; it meets with analysts, and when those analysts visit, they'll go over why they licensed Alteon's product." That exposure and endorsement can only benefit Alteon, he asserts.

"The Genentech deal answers the questions investors were having about Alteon: there is no problem with the company or its technology," asserts Simon, who now rates its stock a buy, and holds shares in the company. Beyond the Genentech partnership agreement, he says investors can take comfort in the data Alteon released from the two separate Phase II trials unblinded this past spring and summer: "The results show they've gotten around the side-effect issues that troubled them before."

"If Alteon's Phase III data on pimagedine is good, all Genentech has to do is execute on the marketing side—which they've already shown they know how to do for a first-in-class drug [tPA]—and this product could be a billion-dollar blockbuster," Simon declares. His chart-topping estimate assumes that the drug will find the broadest markets possible, not just as a treatment for overt diabetic complications, but for more generalized symptoms of aging.

To Diabetes, and Beyond

What's the worst that could happen in this admittedly risky late-phase deal? "If nothing works in this class of molecules, that would be a problem for Alteon and for us," Nick Simon asserts. But Genentech won't be crushed if pimagedine itself turns out not to have what it takes to become a robust product. "Second-generation molecules that are more potent and selective for AGEs could take care of any shortcomings pimagedine may have; and we've got worldwide rights to those, too.", he says. If the data from the current Phase III trial turns out to be so bad that Genentech decides it's not worth going forward, it will channel the remaining monies into the new version, "until the same equity investment is exhausted," at which point Genentech will pick up the tab for whatever studies remain necessary.

Simon says Genentech is not worried about the diabetes market shrinking, not even through better compliance and competition with insulin sensitizers. "You'd have to get glucose under complete control, and insulin super-tightly regulated to impact complications enough that the market would shrink. That's a pretty tall order," he declares. Besides, Genentech believes pimagedine or a next-generation version of it will be valuable well beyond the diabetic market.

If additional trials of pimagedine or other AGE inhibitors indicate the drugs are beneficial in treating end-stage complications of diabetes, Nick Simon points out, "then we can start to build a compelling case for their use...not just in a niche market like overt nephropathy related to diabetes," but in much broader complications such as cardiovascular disorders and retinopathies—which occur not only among diabetics but among the aging. If this avenue of research proves out, he notes, AGE inhibitors could begin migrating into primary-care settings and large markets. That's why, to Genentech, the potential of AGE inhibitors seemed worth the risk of doing an in-licensing deal with a small company that had come upon hard times.

"We saw the same problems others saw when HMR walked away from pimagedine," Nick Simon declares, "but instead of blowing Alteon off, we decided to work with them. When they came back and got the data we wanted, we started selling ourselves to them, too, not only on where we are now, but on where we're going to be in the future."

Genentech wants to be at the forefront of several discrete business areas: endocrinology, oncology and acute-care medicine, and deals are supplementing these efforts. The Scios/Auriculindeal, had it panned out, would have leveraged the position Genentech built for itself in acute-care medicine, through Activase. The Idec/Rituxan deal is now paving the way for the maturing progeny of Genentech's own oncology research. The recent deal with Alteon, if it succeeds, will leverage the position Genentech established a decade ago with human growth hormone and possibly help the company build a bridge from the specialized niche of endocrinology into the large and growing market of other age-related disorders.

Late-stage deals, of course, supplement the R&D efforts of plenty of drug firms. And Genentech isn't alone in using equity to get late-stage drugs. When Abbott Laboratories Inc. paid La Jolla Pharmaceutical Co. $10 million to kick-off their collaboration on La Jolla's compound LJP 394 for lupus nephritis, $4 million of that bought equity in the small company at market price [See Deal]. In that deal, as in Genentech's with Idec, the post-approval increase in the licensor's stock value probably paid for P&U's cost of the deal.

Although other drug companies buy equity in smaller firms, so far Genentech is the only major earnings-driven company to buy truly risky late-stage drugs—drugs that others aren't bidding on. By going after drugs that have advanced to late stages of development, yet remain unwanted by larger firms who've got the necessary marketing wherewithal, Genentech can use equity far more aggressively than other drug firms—equity purchases can comprise 50% and more of the value of its deals—and net itself broader rights. Knowing from experience that advanced technology goes hand in hand with risk, Genentech's risk-oriented culture allows it to structure deals most Big Pharmas won't consider. Genentech doesn't always win its bets, but when it does, it can win big.