Biopharma in 2008: What a Difference an Economic Crisis Makes

Even before the financial meltdown, 2008 was a remodeling year for the biopharmaceutical world. Many pharma companies, more reliant on the product candidates and technologies of the biotech world than ever, were pinned down by excess infrastructure and lagging productivity. But when the world’s cash dried up, so, too, did biotech’s leverage over those downtrodden in-licensers and acquirers. We highlight some top trends from a difficult year that may shape industry in 2009 and beyond.

By FDC-Windhover’s Biopharma Team

Two thousand and eight will be remembered as a year of transformation. The twin forces of political and financial change indelibly marked the second half of the year and will have significant bearing on the future of the biotechnology and pharmaceutical industries for years to come.

But change was coming to the biopharmaceutical industry before President Obama’s November victory put momentum into health care reform and before the financial world imploded under the weight of credit default swapping and hubris. Early in 2008, even industry heavyweights were forced to acknowledge the three-headed monster of patent expiries, poor R&D productivity, and excess infrastructure, and to begin the difficult task of remodeling. Extreme Makeover: Big Pharma Edition.

Those industry behemoths spent 2008 looking for ways to hedge risks of all sorts—development risks, commercial risks, business model risks. Several of our top trends reflect this drive. For biotech firms, 2008 was a year of sourcing and stretching capital: absent investor interest in small-cap public and yet-to-be-public biotech partnering remained paramount. Innovative deal structures emerged and undervalued asset monetization gained momentum.

Regulatory risk remained high in 2008, as FDA wielded newfound FDAAA-granted powers. And with health care reform high on the agenda of the incoming Obama Administration some of industry’s bugbears are about to surface: direct negotiation of Medicare prices, drug re-importation, and a pathway for follow-on biologics may all be in the cards. Investors, particularly venture capitalists, aware of the increased regulatory and reimbursement burdens facing therapeutics, placed what bets they could afford accordingly (and did a fair amount of bargain hunting among market-clobbered public firms as well). Next-generation biologics and specialist therapeutics for unmet medical needs continued to receive the lion’s share of private investments.

Hedging Big Pharma Development Risk

It's not just cash-poor biotech firms that need the occasional helping hand to finance their drug development efforts. Even for the likes of Eli Lilly & Co. (and, say, Bristol-Myers Squibb Co., which has blazed this particular trail among larger companies), hedging pre-market risk is part of the game plan as cash becomes more expensive and clinical development and regulatory affairs more uncertain. In July, Lilly announced an agreement with TPG-Axon Capital and Quintiles Transnational Holdings Inc.'s NovaQuest partnering group under which Lilly's partners will pay up to $325 million in development funding for its two lead Alzheimer's disease compounds, a gamma secretase inhibitor and an A-beta antibody, each ready to begin Phase III testing. [See Deal]

In exchange, TPG (which provides the bulk of the capital) and NovaQuest (10% of the funding and strategic development advice) will receive success-based milestone payments and mid-to-high-single-digit royalties on future sales of the two compounds. Quintiles’ CRO arm will act under a traditional fee-for-service contract. Finally, to sweeten the deal and hedge the risk shouldered by TPG and NovaQuest, those partners will also receive an additional undisclosed royalty on a third, unidentified product that Lilly has out-licensed to a third party. (See "Alzheimer’s Development Financing: Risky Therapies Call for Innovative Deals," IN VIVO, September 2008 (Also see "Alzheimer's Development Financing: Risky Therapies Call for Innovative Deals" - In Vivo, 1 Sep, 2008.).)On one hand, the deal is forward-thinking and increasingly necessary in a difficult R&D climate; with the cost of capital increasing even for the likes of Lilly and its Big Pharma brethren, the partnership allows Lilly the flexibility to take multiple shots on goal in Alzheimer's or other diseases. It's also the first publicly announced deal (we've heard rumors of deals signed but still private) in which a private equity player takes a big financing role in a Big Pharma's development program--something they've done in small and mid-sized companies (e.g., Symphony Capital’s deals with Exelixis Inc. and Lexicon Pharmaceuticals Inc.—see "Symphony’s Project Financing Model Adapts," this issue (Also see "Symphony's Project Financing Model Adapts" - In Vivo, 1 Jan, 2009.) ) but which Big Pharma has always shunned. [See Deal] [See Deal]

Further variations on this theme are almost certain to emerge in 2009: former AstraZeneca PLC CFO, now Goldman Sachs partner, Jon Symonds says he's working on putting together a pool of PE capital for developing Phase I and II Big Pharma (and maybe other) compounds, which could be pulled together. That structure, incidentally, addresses one of the big problems for PE players (and probably one of the big sticking points of the Lilly/TPG negotiations, which apparently took about a year and a half): how do you put together a market-basket of enough developable compounds to offset the awful odds facing any single one of them? The drug company wants to put as few as possible in the basket; the PE investor wants as many as it can get.

This kind of risk mitigation might lose its sheen because a lot of people who are supposed to be the experts in this kind of thing are bankrupt, unemployed--or begging the taxpayers for assistance.

Focus or Diversify

And it is an especially odd deal for Lilly, which has focused on innovative products rather than diversifying into OTCs or related business like Novartis AG or GlaxoSmithKline PLC. The logic of focusing—that investors want to diversify for themselves, rather than turn their money over to pharma management to diversify for them--seems to apply. Shouldn't, the argument goes, Lilly's investors just hedge for themselves, rather than have Lilly management do it for them? Attitudes vary toward just how much diversification is worthwhile, but--with just a few holdouts--drug companies agree that basing a business on novel small-molecule research is way too risky.

The problem with diversification is how managers good at (or at least familiar with) running one kind of business--R&D-intensive prescription drugs--do with another kind. Which is why the more conservative of the diversifiers aren’t actually getting out of the drug business per se--by going into branded generics or OTC medicine they’re still staying close, theoretically, to home. Take the most recent convert to diversification--Merck & Co. Inc.: its December announcement that it would be going into follow-on biologics edges it toward a kind of generics strategy but without the full-blown commitment to just-in-time product development, manufacturing, and rock-bottom prices that the small-molecule end of that business requires. (See "Merck’s Head-Long Leap into Follow-On Biologics," IN VIVO, December 2008 (Also see "Merck's Head-long Leap into Follow-On Biologics" - In Vivo, 1 Dec, 2008.).)

Novartis, too, certainly recognizes the managerial challenge of diversification. Among the most aggressive of the industry’s diversifiers with extensive consumer and generics businesses, it moved this year even further afield through its play for Alcon Inc. [See Deal] (See "Novartis’ New Kind of Pharma Deal," IN VIVO, April 2008 (Also see "Novartis' New Kind of Pharma Deal" - In Vivo, 1 Apr, 2008.).) Alcon’s largest and fastest growing business is in largely self-pay surgical products, which make up 45% of its total revenues. The consumer side of ophthalmology makes up another 15%--the rest is specialty eye drugs.

Novartis is trying to minimize the problems of a pharmaceutical company managing a device business in part through the structure of its deal. Novartis is merely investing in the company (starting out with a 25% stake--for $11 billion--with a plan to increase it, sometime between 2010 and 2011, to 76%, for no more than an additional $28 billion). It theoretically won’t be managing Alcon any more than Alcon is managed by its current majority owner, Nestle SA. Instead--once it owns a majority of Alcon’s shares--it will be able to consolidate Alcon’s double-digit-growth sales-and-earnings but without the executive headache of actually running the business. And with Alcon trading independently, investors should still be able to follow and profit from its progress, according it a bigger valuation than it might have received hidden inside the much larger and slower-growing overall Novartis business.

The disadvantage: with Alcon as an independently trading company, Novartis can’t do the usual cost-cutting most acquisitions allow; nor will it be able to combine marketing efforts. The closest recent comparator to the Novartis/Alcon deal is what BMS is trying to achieve in spinning off of its consumer nutritionals business, Mead Johnson Nutrition Co.. [See Deal] (See "Pharma’s Strategic Divide: Focus or Diversify," IN VIVO, September 2008 (Also see "Pharma's Strategic Divide: Focus or Diversify" - In Vivo, 1 Sep, 2008.).) Bristol, too, wants to get the benefit of non-pharma growth without having to manage it. The company figured its pharma-oriented execs couldn’t pay quality attention to the much smaller and much different nutritionals unit; and that when they did pay attention to it, these earnest auslanders probably didn’t add significant value. Investors, too, ignored the group--Big Pharma analysts, hardly experts in the area, buried the Mead results in their spreadsheets.

By spinning off just 10 to 20% of Mead, Bristol opens up the company for investor examination, frees its own managers to focus 100% of their attention on the pharma business, and focuses Mead’s execs on the competition in nutritionals, rather than the competition for corporate resources. Meanwhile, Bristol still gets to consolidate Mead's top and bottom lines.

So far, quite similar. The big difference between the two deals is that Novartis is paying for its diversification (and had it waited six months, it could have saved 50% or so on its $11 billion down payment); Bristol wants to get paid (albeit the market meltdown will presumably lower the take it had hoped for). And from an investor’s point of view, Novartis is therefore asking its shareholders to fund its attempt to do what investors might see as their job--buying stock. Since it’s leaving Alcon independent, Novartis can’t argue that its money will be adding much corporate value to the ophthalmic company. One could argue, on the other hand, that Novartis is limiting investor choices: because they could buy Alcon shares on their own, shouldn’t Novartis do something with their money that investors couldn’t (like buy pipeline)?

On the other hand, Bristol’s spin-off actually offers investors a new choice--if they prefer to unload pharma shares for stock in a nutritionals business, well, the menu of choices just got bigger (and theoretically Bristol wins either way). The real strategic equivalent: Novartis could spin off a minority of its generics business, Sandoz International GMBH, which likewise has virtually no synergies with its parent and which might profit from some independence. Or you could argue that Novartis is in fact offering investors a new set of choices. Those with a higher appetite for risk can put their money into Alcon; those who want the security of a big company, but now with a frisson of mid-size company excitement, can buy Novartis stock leavened with Alcon growth.

The End and Unlikely Re-birth of Roche/Genentech Dealmaking

As 2008 closed, the year’s biggest deal remained in flux: Roche and Genentech Inc. are presumably still haggling over the pricing details of that very large acquisition (initial value: $43.7 billion) and have been thrown a significant curve by 2008’s economic tumult. The question that surfaced in July when Roche launched its bid and that lingers: can Roche pull off the largest biotech acquisition in history—without killing the goose that has for years laid its golden eggs? [See Deal]

Without waiting for the end of the film, Infinity Pharmaceuticals Inc. is aiming to mimic the success of that deal with a ground-breaking alliance of its own. Why? Absent irrationally exuberant markets or dilution-friendly capital structures like the R&D Limited Partnerships and SWORDS of the 1980s, it’s virtually impossible to build a self-sustaining biotech without a "big brother," contends Infinity chair and CEO Steve Holtzman. Nobody is counting on irrational exuberance these days.

In November 2008, Infinity signed the latest incarnation of that legendary idea: a tie-up with the two Sackler-family–owned private companies, US-focused Purdue Pharma LP and European-focused Mundipharma International Corp. Ltd. [See Deal] (See "Infinity/Purdue: The Challenge of Reprising Roche/Genentech," this issue (Also see "Infinity/Purdue: The Challenge of Reprising Roche/Genentech" - In Vivo, 1 Jan, 2009.).)

In return for what could be nearly 38% of its stock and the vast majority--ex-US--of its pipeline, Infinity bought probably five years of freedom from worrying about Wall Street--enough money for both its discovery and clinical programs--while retaining, like Genentech, the entire US market in which to create a commercial presence.

The most advanced compound in this enterprise: Infinity’s Phase I hedgehog cell-signaling pathway inhibitor, originally developed in a deal with MedImmune LLC [See Deal], then returned following MedImmune’s acquisition [See Deal] by AstraZeneca, which was developing a competing hedgehog program. (A few weeks after it signed the Purdue/Mundipharma deal, Infinity improved its position even more by bringing back from AZ its latest-stage program, the Phase III injectable HSP-90 inhibitor IPI-504, as well as that drug’s follow-up, a Phase I oral compound, IPI-493--drugs to which Infinity now owns all rights.)

But don’t expect this deal to be much copied. The spec-pharmas Purdue and Mundipharma have no discovery programs to protect and Mundipharma has only a single cancer product in its portfolio: there should be no significant jealousies from internal R&D no desire to interfere. Indeed, the deal is specifically not a collaboration, Infinity’s president of R&D and CSO Julian Adams, PhD, points out: as Genentech has been with Roche, Infinity will remain a completely separate operation from its new affiliate.

That’s a rare situation for most companies that can afford a deal of this size (up to $75 million in equity by early 2009; another $200 to $400 million in R&D support; and a potential $72.5 to $100 million in warranty conversions). Indeed, one reason Roche is buying out Genentech is because it feels it can now do pretty much what Genentech can do--so why pay the royalties and other costs of maintaining an independent R&D and commercial infrastructure? Moreover, the Sacklers have no need to show investors regular profit growth--at Purdue and Mundipharma, they’re the only investors that matter, and they’d prefer the tax breaks from the R&D expense to a nicely upward sloping EPS line.

So who else--absent a Big Pharma's sudden and shocking conversion--could do deals like this? Other private companies (or companies that act like them)--in particular mid-sized European firms and maybe even a Japanese company or two. They’d certainly accept the regional aspects of this deal and--unlike the Big Pharmas--wouldn’t necessarily feel the urge to tell Little Sib how to do its job.

At CMS, Authority to Protect More Drug Classes

When the Medicare outpatient prescription drug benefit began just three years ago, the story was all about the glitches encountered by beneficiaries, pharmacists, governments (state and federal), and insurers as they all tried to learn together, in real time, how to make stand-alone prescription drug insurance work.

For Forest Laboratories Inc., though, there was a much bigger glitch. It happened when the Centers for Medicare & Medicaid Services told plans in 2005 that they must cover essentially all drugs in a handful of big therapeutic categories: the now famous six protected classes—anti-depressants, anti-psychotics, anti-epileptics, anti-neoplastics, immunosuppressants, and HIV therapies. The Medicare agency concluded (after hearing loud and clear from patient organizations relying on those medicines) that the need to protect access among vulnerable beneficiaries trumped the plans’ need to be able to exclude medicines in an effort to extract deeper discounts from manufacturers.

That was good news, of course, for companies with products in those classes. Except for Forest. Because the Medicare agency made one prominent exception: there was no need for plans to cover Forest’s anti-depressant brand escitalopram (Lexapro), the agency said, so long as they covered Forest’s closely related (and off-patent) citalopram (Celexa). (See "Lexapro: The First Victim of Part D?" The RPM Report, December 2005 (Also see "Lexapro: The First Victim of Part D?" - Pink Sheet, 1 Dec, 2005.).)

In essence, the federal government told plans that Lexapro is equivalent to Celexa, and so plans could meet the agency’s goal—ensuring patients have access to all options in the six critical classes—without having to cover Forest’s biggest product. That decision took Forest by surprise, to put it mildly. Forest was ultimately able to get the language addressing Lexapro removed from CMS’ policy, and it also managed to get Lexapro on most plan formularies—but at the cost of deeper discounts than it anticipated. That history explains why a seemingly insignificant clause slipped into a hard-fought compromise on Medicare funding in 2008 may turn out to be a very big deal.

When Congress "codified" the CMS policy over the summer, it sounded like a simple matter of elevating the six protected classes from an ad-hoc principle established by administrative fiat to a formal, statutory requirement. But instead of adopting CMS’ language stipulating the classes, Congress instead gave CMS the authority to define any class as protected. And it also made it much more onerous for CMS to create exceptions to those protections within classes. Call it the Forest clause.

There is nothing to stop the next CMS administrator from expanding the list to include, say, Alzheimer’s therapies as a protected class. Plenty of people wonder why—if the goal is to protect vulnerable patient populations—AD therapies weren’t on the list in the first place. And then, why not anti-diabetics? Surely we shouldn’t disrupt treatment in that class, when the consequences of uncontrolled illness can be so severe and costly. Or rheumatoid arthritis, where decisions by Part D plans have a direct affect on Part D spending. The list goes on.

Sure, there is no reason to think that the people who created the six protected classes in the first place would expand the list just because Congress says they can. After all, they invented the list and easily could have decided to add more at any time. But those people are no longer calling the shots. The next CMS administrator could, with the stroke of a pen, add to the list of protected classes--and be cheered for it by the Democratic leadership of Congress.

No wonder managed care plans are concerned. They weren’t happy about CMS’ policy in the first place, since it basically takes away their leverage to negotiate better prices on some pretty big line items. But they really aren’t happy about the potential for that list to expand, potentially ad infinitum. And, while manufacturers may feel differently, they better not gloat. That's because Medicare Part D is itself the product of one of the more unlikely deals of all time. It came about in large part because pharmaceutical manufacturers and their long-time political adversaries, the managed care sector, were able to join forces in support of a never-before-tried concept: stand-alone prescription drug insurance.

That deal helped generate enough support in Congress—just barely—to push the Part D program through in 2003. And, as the managed care industry is busily reminding Big Pharma, that program will only work if plans are able to do what politicians historically cannot: deny access to medicines if they need to to contain costs. The alternative? A program that allows broader access to medicines—but with more direct government intervention in prices. (See "Keeping the Government at Bay: Protecting Part D from the Protected Classes and Specialty Drug Pricing," The RPM Report, November 2008 (Also see "Keeping the Government at Bay: Protecting Part D from the Protected Classes and Specialty Drug Pricing" - Pink Sheet, 1 Nov, 2008.).)

The Patent Cliff Nears

In some circles, the event had its own acronym: LLOE--Lipitor Loss of Exclusivity. Now it has a date: November 30, 2011--which may be the end of the primary care era as we know it. Pfizer Inc.’s deal with Ranbaxy Laboratories Ltd. for an authorized generic version of atorvastatin gives some certainty to both sides, but what it really offers is closure. (See "Pfizer Settlement with Ranbaxy Delays Generic Lipitor Entry," The Pink Sheet, June 23, 2008 .)

In an era when product expirations--either through the lifting of exclusivity or the weight of safety problems--seem more common than product launches, this deal is an example of how Big Pharma can try to take its primary care jumbo jets in for soft landings. Pantoprazole (Protonix)’s fall to earth offered a number of lessons for generic and brand firms to learn, and Ranbaxy seems to have gotten some good practice dealmaking when it worked out a settlement on esomeprazole (Nexium) with AstraZeneca. With the lawsuit behind them, both Ranbaxy and Pfizer can focus on what’s next. For Ranbaxy, it’s resolving manufacturing problems and figuring out how to be a regional growth engine for a Big Pharma. (See "Emerging Market Mania," below.)

For Pfizer, the question is how to learn to love being a drug maker again. Chairman and CEO Jeffery Kindler may not have all the answers to that one yet, but by acknowledging the end of the Lipitor relationship, he’s moving in the right direction. Failing to recognize the seriousness of the problem helped cost the previous management team its jobs, so the decision to sign the divorce papers with the firm’s biggest product perversely takes a weight off the company.

But while the Ranbaxy settlement is a great example of what a company like Pfizer can get when it has a former general counsel as its CEO, that talent for certainty may also be emblematic of what a firm might miss out on. While other new Big Pharma CEOs have been out trying to gobble up innovative technology or swallow up successful partners, one of the principal development decisions Pfizer has made with Kindler at the helm has been to stop placing bets on cardiovascular research. (See "Pfizer to Tin Man: Drop Dead," The IN VIVO Blog, September 30, 2008.)

The Rise of Royalty and Revenue Financing

As biotech firms search around for non-dilutive sources of capital the question on many investors’ lips paraphrases an old lyric: how much for that money in the window?

In the case of Vertex Pharmaceuticals Inc.'s June 2008 sale of the royalty stream on its HIV protease inhibitors (which are marketed by GSK) to a group of undisclosed investors, the answer was $160 million. Amprenavir (Agenerase) and fosamprenavir (Lexiva) royalties totaled $34 million on sales of $242 million in 2007, but it wasn't like the market was attaching significant value to that royalty stream. Other biotechs are recognizing similar unappreciated or underappreciated revenue or royalty streams and looking to sweep up some cash while they can. (See "Royalty Flush: Why Monetizing Tomorrow’s Revenue Stream Today Could Catch On in a Big Way," IN VIVO, June 2008 (Also see "Royalty Flush: Why Monetizing Tomorrow's Revenue Stream Today Could Catch on in a Big Way" - In Vivo, 1 Jun, 2008.).)

Vertex's deal is part of its plan to dispose of non-core assets and shore up its balance sheet as it invests in its hepatitis C franchise. "Receiving a $30 million royalty in 2011 is less relevant for the company" compared with potential future product revenues, Vertex EVP and CFO Ian Smith told us back in June. "Our belief is that we should get that money on the balance sheet now, and invest it in R&D."

And there's no shortage of buyers. Beyond the specialists such as Paul Capital Healthcare and Cowen Healthcare Royalty Partners, hedge funds are getting into the game as well: TPG-Axon in April 2008 purchased half the royalty stream to CV Therapeutics Inc.’ A2A adenosine receptor agonist regadenoson (Lexiscan), the injectible stress agent, for $185 million. [See Deal] Expect to hear much more in 2009 about this brand of alternative financing. The phenomenon is by no means new--but it’s gathering steam, and it’s not just cash-desperate biotechs that might find such deals beneficial, as Vertex's $160 million demonstrates.

"We've never been busier," Paul Capital Healthcare partner Lionel Leventhal told the audience at this years' PSA meeting. "The pharmaceutical industry is a vociferous user of capital and it doesn't matter how the markets are doing--they still need capital." With equity markets down and debt a less than an ideal way for the industry to obtain the money it needs, royalties and revenue-interest financing is becoming more mainstream, he added.

FDA Flexes Newfound Muscle

At a time when regulatory challenges, reimbursement hurdles, and the general political climate are at the top of the minds’ of many biopharma executives and their investors, the fault line between industry and government has rarely been the subject of more scrutiny.

And if you are looking for a negotiated agreement involving two or more parties with profound implications for the entire biopharma sector, the relabeling of Amgen Inc.’s darbepoetin (Aranesp) and Johnson & Johnson’s competing epoetin brand Procrit more than qualifies. Among all the other labeling changes in the year of "Safety First" at the Food & Drug Administration, this stands out because it was an especially one-sided deal. The Aranesp relabeling was the first (and, so far, only) time FDA has used its new power to order sponsors to make specific labeling changes. FDA gained that with the enactment of the FDA Amendments Act in 2007. So far, the agency has invoked the mandatory labeling authority seven times, but in each of the other cases the sponsor (or sponsors) has agreed to the change. But not with Aranesp.

Talk about an important precedent.

Labeling "negotiations" have always been something of a misnomer, since—from industry’s perspective—it was never exactly a level playing field. Still, at least in theory, manufacturers wrote the label, and FDA approved it. True, when the agency wanted, it could essentially write new labeling by declining any alternative language—but only at the cost of leaving an existing label in force while "negotiations" continued.

The FDA Amendments Act changes all that, giving FDA for the first time the explicit authority to dictate labeling to a sponsor in response to a safety issue. And with Aranesp, we have the first case study of what FDA can do with that enhanced leverage. On July 30, FDA announced updated safety labeling for Aranesp to resolve concerns about potential tumor-promoting effects of the agent. The agency insisted on two specific provisions that Amgen disagreed with: one restricting use of the products to cancer patients undergoing chemotherapy where a cure is not the expected outcome; the second warning against use when hemoglobin levels are above 10. (See "Cut to the Bone: Amgen Faces Further Aranesp Decline Ahead of Denosumab," The RPM Report, November 2008 (Also see "Cut to the Bone: Amgen Faces Further Aranesp Decline Ahead of Denosumab" - Pink Sheet, 1 Nov, 2008.).)

Here are two ways to consider the impact. First, $3 million a week. That is how much Amgen estimates the new restrictions have pinched sales. And remember, this is after an already sharp reduction in the size of the brand after a restrictive coverage policy implemented by the Medicare program. Second, $30 million a week. That is how much Aranesp still generates in revenues—a number that could be much lower if FDA had demanded the withdrawal of the oncology indication altogether (or, even, withdrawal of the product itself). Before FDAAA, those might have been the only alternatives for FDA. And remember, that is the promise of the new law: FDA has much more authority to dictate who can actually use a drug, but--in theory at least--more drugs make it to market, and those that make it stay. (See "The Impact of FDAAA on Drug Approvals: Setting the Baseline," The RPM Report, October 2008 (Also see "The Impact of FDAAA On Drug Approvals: Setting the Baseline" - Pink Sheet, 1 Nov, 2008.).)

The Biotechification of Big Pharma Continues

GlaxoSmithKline was an early adopter of new, biotech-like R&D strategies designed to improve productivity at the Big Pharma giant. The CEDD experiment has now been modified with the introduction of dozens of drug performance units housed within those centers for drug development. And GSK is showing signs of turbocharging its own biotechification, to boot.

Two deals stand out this year against the backdrop of GSK’s ongoing option-based alliance structures: the pharma’s $720 million acquisition of sirtuin biology specialist Sirtris Pharmaceuticals Inc. (now run independently by CEO Christoph Westphal, MD, PhD, as "A GSK Company") and its $148 million up-front alliance with Actelion Pharmaceuticals Ltd. for the Swiss firm’s Phase III almorexant insomnia candidate. [See Deal] [See Deal]

They are impressive testaments to the biotechification of GSK; a process seemingly driven from the very top and bent on changing the Big Pharma from the inside-out.

The July Actelion deal is one of those rare (and post-crisis, even rarer) partnerships where the biotech calls the shots. And where Big Pharma is very happy for biotech to call the shots because it not only keeps risk under control but it also picks up a tip or two on the way about how to run R&D. Actelion remains fully in charge of the clinical program (unusual, not unique) and gets to further its own ends of creating a sales force by borrowing an appropriate GSK drug for a short time. (See "GSK/Actelion: Phase III Value Is in the Eye of the Beholder," IN VIVO, July 2008 (Also see "GSK/Actelion: Phase III Value Is in the Eye of the Beholder" - In Vivo, 1 Jul, 2008.).) GSK’s risk hedging here has at least something to do with almorexant’s novel mechanism of action and the increased regulatory and reimbursement hurdles for non-life-threatening drug candidates.

But Actelion’s bets are hedged, too. The Swiss group can afford that luxury, with a market cap of CHF7.1 billion ($5.9 billion) and CHF1 billion in cash. This in itself makes Actelion a beast as rare as the novel-mechanism PC pill it's touting. And it’s a company that GSK’s management apparently wants to learn a thing or two from. According to Actelion, its chief, Jean-Paul Clozel, MD, was invited to speak to GSK R&D heads while the deal was being negotiated. That's significant: GSK is acknowledging that it might need to learn a few things about how Actelion does R&D.

With Sirtris, GSK adds industry-leading expertise in an intriguing and potentially broadly applicable pathway of targets and one of biotechs leading lights in Westphal, who now in addition to running Sirtris is also at the helm of GSK’s external development division, the Center of Excellence for External Drug Discovery (CEEDD). (See "Sirtris Satisfies GSK’s M&A Appetite," IN VIVO, May 2008 (Also see "Sirtris Satisfies GSK's M&A Appetite" - In Vivo, 1 May, 2008.).) The deal echoes and essentially doubles-down on the late-2006 acquisition of biologics platform play Domantis Ltd. [See Deal] And it continues GSK’s transformation—one that has yet to prove its worth but, with an increasingly warm embrace of biotech’s strategies, will be exciting to watch.

Emerging Market Mania

With pharmaceutical sales growth in emerging markets like the so-called BRIC countries--Brazil, Russia, India, and China--well out-pacing growth in Big Pharma’s traditional western strongholds, it’s no wonder that 2008 saw a handful of interesting deals designed to strengthen their RoW positions.

Most spectacularly—both in terms of price and in terms of the bumpy ride that has followed—Daiichi Sankyo Co. Ltd. announced in June its bid for a controlling interest in Ranbaxy, which it would buy in large part from the founding Singh family. [See Deal] The bid valued the company at about $8.5 billion based on currency values at the time. Among other deals, GSK signed what it termed a "transformational" agreement with South African generics company Aspen Pharmacare Holdings Ltd. [See Deal] and followed up with the $210 million and $36.5 million acquisitions of BMS’ Egypt and Pakistan businesses, [See Deal] [See Deal] and Sanofi bought a large stake in the Eastern European generics business Zentiva BV. [See Deal]

The word on the street was that Daiichi's move, to be financed with cash and debt, was "bold and entirely out of character." But as we said then, it should not have been surprising that Daiichi was going to do something with its $6 billion cash reserves. To remain competitive with its Japanese brethren, particularly Takeda Pharmaceutical Co. Ltd. and Eisai Co. Ltd., which have been particularly acquisitive, the firm needed to ink a major transaction that would extend its reach beyond the stagnant home market, where annual government-mandated price-cuts on drugs and a slower regulatory approvals process make for a tough business climate.

What was surprising about the Daiichi/Ranbaxy deal is that Daiichi chose to invest in a company focused primarily on generics and geographically situated in an emerging market. Although India is undoubtedly an important arena, companies such as Takeda, Astellas Pharma Inc., and Eisai have focused their efforts on building a US presence, especially in oncology. But with double the portion of industry’s growth than only a few years ago, the lure of emerging markets is easy to understand. (See "For Burgeoning Emerging Markets, All Business Is Local," The Pink Sheet DAILY, December 3, 2008 (Also see "For Burgeoning Emerging Markets, All Business is Local" - Pink Sheet, 3 Dec, 2008.).)

Oncology: The New Primary Care

Takeda's $8.8 billion bid for Takeda Oncology in April and Eli Lilly’s splashy $6.5 billion takeout of ImClone Systems Inc. in October underscore another major theme at work in the industry: Big Pharma's apparently insatiable appetite for oncology products. (See "Takeda’s Global Ambition," IN VIVO, June 2008 (Also see "Takeda's Global Ambition " - In Vivo, 1 Jun, 2008.).) [See Deal] [See Deal]

The companies were far from alone: in the past six months, we've seen Pfizer restructure with an eye to a more flexible future--a move that included eliminating early-stage R&D in Big Pharma standbys such as cardiovascular and obesity, and a greater emphasis on oncology, through the creation of its oncology business unit. (See "Pfizer’s Increasingly Specialist Focus," IN VIVO, November 2008 (Also see "Pfizer's Increasingly Specialist Focus" - In Vivo, 1 Nov, 2008.).) Oncology firms continue to be the most heavily backed among start-ups as well, as venture investors race to supply pharma with the drugs they seem to desire the most. (See "The A-List: 2008’s Trend Shaping Series A Financings," START-UP, January 2009 (Also see "The A-List: 2008's Trend Shaping Series A Financings" - Scrip, 1 Jan, 2009.).) There are so few companies among the industry’s largest that don’t wish to become big players in oncology—moves that often go hand-in-hand with the biologics strategies du jour—that they can probably be counted on one hand.

Indeed, Lilly's rationale for the ImClone deal sounded a lot like the reasoning Takeda offered up for its own bid for Millennium back in April: a need to bulk up in biologics, particularly in an indication with high unmet medical need and a smoother regulatory approval path. Certainly, from a dealmaking perspective Takeda has become the new deep-pockets of the cancer world. In 2008 alone, it inked handsome—some might argue excessive--agreements with Amgen, Cell Genesys Inc., Millennium, and Alnylam Pharmaceuticals Inc. to boost its abilities in oncology. [See Deal] [See Deal] [See Deal]

For Takeda, the strategy seems to be working. After setbacks elsewhere this year, its emerging cancer franchise, with bortezomib (Velcade) as its cornerstone, is the company's lone bright spot. Recall that Takeda's two biggest money-makers, pioglitazone (Actos) and lansoprazole (Prevacid), will go generic in 2013, at which time analysts expect profits from those drugs will drop 35% and 26%, respectively. But thanks to late-stage clinical failures and missed PDUFA dates there's little beyond Velcade to make up the revenue gap.

No wonder its oncology all the time at Takeda these days. But the question remains for Takeda and for the rest of Big Pharma: how much room is there on the oncology bandwagon?

Can VCs Make the Best of the Worst of Times?

Because of the financial meltdown, straitened endowments and institutions will have less to invest in venture capital in 2009, making it one of the most difficult fund-raising environments in recent memory. Even already committed capital may be at risk; despite evidence to the contrary, rumors are spreading that certain limited partners are balking on capital calls.

And that is forcing VCs to think hard about their own portfolio investments. With no access to the public market and the M&A market stalled as pharma buyers wait for private biotech prices to decline, VCs must decide whether they are willing to fund their private companies for the foreseeable future. Already, underperforming companies are being told to retrench. "We’re telling them to reduce their burn, and if we need to reinvest there are going to be some resets," said Francesco De Rubertis, PhD, a partner in the life sciences practice of Index Ventures. And increasingly VCs are more often placing bets in therapeutic areas where end points are sharp and relatively quick, or in orphan diseases where unmet need is particularly high.

Certainly start-ups can’t turn to so-called crossover investors—funds that play along the fault line between private and public biotech companies—for capital. According to MPM BioEquities’ Kurt von Emster, private company valuations are now well north of where they should be relative to public companies. "It will take a long time for them to catch up with the housing-market-like collapse on the public side," said von Emster. Indeed, the private biotech sectors in both the US and Europe are in the midst of an inevitable shakeout, say VCs, which should result in fewer, better firms.

To see themselves through the current downturn, companies must identify ever more creative ways to ink deals and raise capital. Meanwhile, their venture investors walk the line between gallows humor and we’ve-been-here-before bravado.

But there’s an upside for those VCs with plenty of dry powder or lucky enough to have deep-pocketed LPs. Corporate venture funds, in particular, should be in clover. Novartis Option Fund, for example, joined TVM Capital and HealthCare Ventures in Anchor Therapeutics Inc.’s $19 million Series A in late 2007 [See Deal]; in December the fund followed up with a development deal with the company around an undisclosed GPCR target worth more than $200 million in downstream milestones and royalties.

Valuation-hurting public companies are attracting renewed attention from VCs. Abingworth, for instance, recently decided to add an analyst dedicated to evaluating late-stage and public opportunities despite its focus on early-stage companies and expanded its Abingworth BioVentures V fund by £84 million (to £392 million). Together with Index Ventures, which raised a €400 million growth fund in January 2008, Abingworth co-led a $40 million PIPE in next-generation antibody player Micromet Inc. earlier this fall.

Novo AS, the corporate venture arm of Novo Nordisk AS, announced in mid-December its intention to build a new team focused on growth equity that will invest upwards of $200 million per year going forward. Ulrik Spork, managing director of Novo Growth Equity, said the move was precipitated by what Novo saw as the opportunities in later-stage companies created by the financial whirlwind. Meantime, ex-Serono owner and chief Ernesto Bertarelli recently launched Ares Life Sciences, rumored to have north of €1 billion to invest.

As biotechs are forced out of business by an indifferent market and VCs are forced to make tough choices, a very different private biotech sector could emerge in a year’s time. Consolidation—and likely even contraction—will remake the landscape. Executives will come to a sort of valuation reckoning brought on by tough times. According to Steve Bunting, PhD, managing partner of the health care–focused venture outfit Abingworth, "if you’re driving at 70 miles an hour at a brick wall and someone offers you a set of brakes, you’ll probably do a deal." (See "Reacting to the Crisis: Biotech Venture Capital’s Plan B," START-UP, December 2008 (Also see "Reacting to the Crisis: Biotech Venture Capital's Plan B" - Scrip, 1 Dec, 2008.).)

It’s the Economy, Pharma

The economy hit nearly every business segment in 2008, but the pharmaceutical industry’s susceptibility was unprecedented. Historically, the industry has remained comparatively and uniquely aloof from recessions, but as the fundamentals that shape it change, it has become more economically sensitive. Consumers, because of lack of insurance or limitations to their coverage, are paying more out of pocket for their drugs, and if their finances are hurting, so, too, is their ability to pay for drugs--especially those that treat non-life-threatening or non-symptomatic chronic conditions, such as proton pump inhibitors, statins, and antidepressants.

IMS, which previously predicted an already modest 2 to 3% growth rate for the industry in the US in 2008, estimated that the economic slowdown would depress pharma sales further by 2 to 3 percentage points in 2008 and 2009. (See "Economic Forecast for Pharma: Winter Weather Advisory Ahead," IN VIVO, November 2008 (Also see "Economic Forecast for Pharma: Winter Weather Advisory Ahead" - In Vivo, 1 Nov, 2008.).) As of late 2008, IMS estimated that the US pharma market would grow 1 to 2% to $287 billion to $297 billion in 2008—the slowest growth in 30 years.

The broader credit crisis, which is fundamentally responsible for the current plight of the economy, is also having an impact on the industry’s capital structure. Big pharmaceutical companies, thanks to their fiscal prudence, have billions in cash and marketable securities to cushion any impact and, so far, have managed to avoid the worst of the crisis. Even the strongest players, however, are at the mercy of higher borrowing rates. Eli Lilly and Teva Pharmaceutical Industries Ltd. were believed to pay more for the billions they borrowed to acquire ImClone and Barr Pharmaceuticals Inc., respectively. [See Deal] Roche’s ability to pull together the $44 billion in financing it needs to complete its proposed buyout of Genentech is the subject of ongoing industry speculation, which has intensified as the lag lengthens between the offer, made last summer, and visible action. Roche insists it has the wherewithal to get the deal done, and most industry experts would agree, noting, however, that higher borrowing costs are likely to add to the price tag.

Small development-stage companies are more fragile, however, because they need to raise money to fund their R&D projects. Already slews have put themselves up for sale or are on the verge of shutting down. As of December, the number of biotechs trading at less than their cash value was up 61% since August, and 113 companies had a year or less cash on hand, according to a Rodman & Renshaw study. (See "Can Big Pharma Save Biotech Investors?" IN VIVO, November 2008 (Also see "Can Big Pharma Save Biotech Investors?" - In Vivo, 1 Nov, 2008.).)

The weak economy is changing not only consumers and financiers’ behavior, but also that of the pharmaceutical industry. Big Pharma is on the prowl for distressed properties--albeit cautiously—and for the first time in several years appears to have the upper hand in negotiations. Retail pharmacies are noting that even as their prescription drug sales slacken, they see an upswing in over-the-counter cough and cold sales—a 10% increase as of the end of the third quarter at CVS Caremark, for example. CVS Caremark executives believe that patients are going to doctors less and relying more on self-medication.

Pharmaceutical companies are adjusting their marketing approaches—although consumer economics is only one of many reasons for their changes. They’re looking at cost-effective ways to mobilize patient support, absorbing lessons learned from other, more pressured industries, as well as their own limited experiences. They’re increasingly using grassroots marketing techniques with price-sensitive messages to reach consumers and investing more in new kinds of patient communication. They’re also working to build more support for their wares from payors and politicians, which can help with insurance coverage issues. The new mind-set is here to stay—even after the economy recovers. The "E word" is likely to be an increasingly important part of pharma’s story.

SIDEBAR: An Immediate Election Impact?

Health reform advocates aren’t about to let the economic crisis get in the way of universal health coverage in the US. The victories of 2008 have set the stage for a major push on multiple fronts in 2009. (See "Prioritizing Health Care: Reform Gains Early Momentum," The RPM Report, November 2008 (Also see "Prioritizing Health Care: Reform Gains Early Momentum" - Pink Sheet, 1 Nov, 2008.).)

The personnel puzzle is beginning to take shape. The pick of former Senate Majority Leader Tom Daschle as HHS Secretary and the ascension of California Democrat Henry Waxman to chairman of the powerful Energy & Commerce Committee get the ball rolling. Senator Hillary Clinton may now be President Obama’s Secretary of State—but the team behind 1993’s failed health reform bid has returned, and without its sometimes polarizing leader. Senate Finance Committee Chairman Max Baucus has ensured himself a prominent and visible seat at the health reform table as well, with a "white paper" outlining his legislative proposals published barely a week after election day. And the movement of Congressional Budget Office director Peter Orszag to head the White House Office of Management and Budget simultaneously rewards and reins in one of the Democrats’ most outspoken thinkers on health care.

At a November health care briefing at the Engelberg Center for Health Care Reform early opinion coalesced around two key observations: pieces of the health reform puzzle will pass through legislation early in the first Obama term, while more sweeping reforms—such as universal health care—may have to wait until a second theoretical term mainly because of the ongoing economic crisis. But although some observers feel the economy will cast a long shadow on health care reform efforts, a number of lawmakers and policy experts—and the President himself—say the two are inexorably linked, and therefore, moving forward quickly is possible.

Baucus, for example, has repeatedly tied health care and the economy together in public appearances. "There is no way to solve America's economic troubles without fixing the health care system as well," Baucus said in a keynote address at the Engelberg event. "It's my top priority for the year," he said, referring to 2009.

Essentially it will be up to the new president: how much political capital is Obama willing to spend—and how early—in order to reform the system? "I was going to Montana, and my plane landed," Baucus recounted at the November Engelberg meeting. "My cell phone rang, it said 'private number' so I pushed it. I said, 'Hello.' The person on the other end said, 'Max, this is Barack.' And so we talked about health care reform and what we needed to do to get it passed."

The first six months of the next administration will tell just how serious that conversation was.