Restructuring for Success: Shifting Biotech Strategies

During a panel discussion at Elsevier Business Intelligence’s Therapeutic Area Partnerships conference in Boston in December 2011, experienced investors and biotech executives drew lessons from difficult restructurings and successful transitions.

At a January 2012 Goldman Sachs CEO conference, Merck & Co. Inc. CEO Ken Frazier, noting his company’s poor investor return in 2011 relative to its peers, acknowledged the company’s shortcomings for the year. But then he implored his investor audience that while they were free and right to judge Merck on its successes and failures, they should also judge the company on how it responded – clinically, strategically, structurally – in the face of ill fortune. “The company showed a significant amount of adaptability and resilience in the face of that … and it was a positive year in terms of what got done,” said Frazier.

His is an argument that isn’t just the defensive posturing of a large company executive. In biotech, where failure and restructuring are practically a way of life, it’s gospel for some investors. And it has led to the adage that smart investors bet on management rather than on technology or products, or technology or products alone. Companies must find ways to prepare for change, and incentivize employees to embrace the kinds of change that are necessary for long-term success. Early-stage discovery firms get revamped into in-licenser development plays. Technologies and drugs tend to fail, or at least need retooling. Clinical strategies get refined or abandoned. Few start-up biotechs succeed along their initial paths. Instead of betting on the path, why not bet on the guide?

At EBI’s Therapeutic Area Partnerships on December 1, Jan Wolpert of Wolpert Associates chaired a panel that comprised Alan Crane, the former Millennium, Momenta and Cerulean executive and general partner at Polaris Venture Partners; Ansbert Gadicke, MD, managing director at MPM Capital; Campbell Murray, MD, managing director of the Novartis Venture Funds; and Adelene Perkins, president and CEO of Infinity Pharmaceuticals Inc.

The group focused on the frequent need in biotech for dramatic strategic shifts – with members each describing examples from his or her own portfolios or experience. Their conversation has been edited and condensed.

Jan Wolpert: This panel is called “Restructuring Biopharma.” Even in the context of that name, I think that is perhaps a bit misleading. For purposes of this panel discussion, we’d like to define the idea of a restructuring as a very growth-oriented, strategic sort of initiative. I want you for the next hour to think transformation, strategic repositioning, as opposed to cost reduction, recapitalization and Chapter 11 filings, because we’re not going to talk about that. We’re not experts in that area.

To start things off, I’d like to start with Ansbert, and ask everyone to discuss their favorite one or two situations that they were instrumentally involved in either as an investor or a CEO or key executive or board member where this concept of a strategic repositioning, in other words, a significant change in direction, was a key element of success. Ansbert?

Ansbert Gadicke: Thank you. I’ll give two examples, which as you’ll hear, are very, very different, because I think it’s important to understand that there is not a cookie cutter solution that works for companies.

One that certainly had a highly successful outcome very recently is Pharmasset [Pharmasset Inc.], which is in the process of being acquired [by Gilead Sciences Inc. for $10.4 billion] at a pretty good valuation.[See Deal] But if we go back a few years at Pharmasset, this company as well as nearly all of the companies in our industry that are ultimately successful, went through sort of more difficult times as well. And the restructuring or repositioning of the company that I want to mention was actually quite difficult and significant.

The company had originally been built in Atlanta by a scientific team without much general management. It was really focused at the time on late-stage compounds for HIV and hepatitis B and C. And those compounds I would say were pretty much in the me-too category. We, for a number of reasons, at some point decided to really change direction entirely and to focus the company on the sort of highly innovative compounds that would make a major difference and to potentially provide a home run for the company and its investors.

As a means of doing that restructuring, we moved the company from Atlanta to Princeton, NJ. We brought new management in, which in most cases, as you may imagine, is not necessarily very easy, and really focused the company on its early stage pipeline. And ultimately, obviously, that was highly successful in that the company now has excellent Phase II results and got acquired basically at the beginning of Phase III based on this very early pipeline that we focused on a few years ago.

The other example I would like to use is a company called Radius [Radius Health Inc.]. Here, the success hasn’t happened yet. But I think it looks good at this point. The company started with a highly innovative, very-early-stage program coming out of academia. And we decided after a while that the program was probably not as promising as we had hoped for. And we took the opposite approach [than was done at Pharmasset] and really focused the company on later-stage compounds. We were successful in licensing a clinical compound; we also changed management in the company, restructured, recapitalized the company, etc. And to fast-forward to today, that company is now in Phase III with a top compound in osteoporosis. We have raised about $200 million for the company to actually be able to execute on a Phase III. And the company is in the process of going public through a reverse merger. [See Deal] So, that company hasn’t had the ultimate success in respect to an exit, but I think so far it’s a successful repositioning of a very-early-stage company to one that’s in Phase III with a major compound.

Campbell Murray: We have an antiviral company, Alios [Alios BioPharma Inc.], that’s following in Pharmasset’s footsteps now. But originally, when we funded it, it was targeting broad antiviral targets outside of just hepatitis C. We created the company from scratch as a spin-out based on a few technologies. The lead program, which I won’t go into detail on today, may have been salvaged, but right at the outset we were unable to reproduce any of the academic data that came out of a very prestigious center in the Midwest. Absolutely none of it. It was literally the second or third board meeting after a very high-profile, $32 million financing. [See Deal]

So we faced the situation of having this incredible team of virologists and not having a lot from what we started with. And within the space of a year, this team actually assembled three viable programs, one of which is a protected nucleotide analog program, so following in the footsteps of Pharmasset.

About two or three months ago, a deal was announced with Vertex [Vertex Pharmaceuticals Inc.] literally just under two years from the inception of this program, which was more than $1.5 billion in biodollars for two compounds from Alios with $60 million up front, $35 million in near-term milestones. [See Deal] There were additional dollars not publicly disclosed yet. We thought we got a great deal, but then Pharmasset got bought on Phase II data for $11 billion.

So, it shows it’s a mistake when you’re taking all the risk in early-stage venture capital to simply chip for the green and try and do an incrementally better product, because at the end of the day, pharma doesn’t really care. And it’s going to be very difficult for business development purposes to monetize the significant investment, which even if it’s a fast-follow me-too product, it’s still going to be $30 million or $40 million before you’re at Phase II and pharma’s prepared to move.

So, if you’re going to take all that risk, you need to know that your company is trying to solve a major problem and will make a difference to the way doctors treat patients. The converse is you come in very late and you do Phase III investments with much lower [clinical] risk. There have been firms that have specialized in that. But a lot of them in the last six months have pulled out of health care investing, because they’ve discovered that the FDA is capricious at times. And, simply, when a product is not delivering a huge benefit over existing therapies, the FDA is making it much harder to progress that product through the clinical pipeline.

“If you’re investing in early-stage technologies, which are trying to solve intractable problems that are really important to society, that’s great. But before you put your foot down on the accelerator, it’s better I think to start small and to experiment and keep costs to a minimum until you get significant chemical leads that you then have something tangible to invest into and grow forward.” – Campbell Murray

Another example is an antibiotic company called BioRelix [BioRelix Inc.] We co-seeded it with CHL Medical Partners out of Yale University based on insights around riboswitches, which are RNA modulating elements in bacteria. The idea was we could copy natural ligands and make completely novel classes of antibiotics for bacteria. The company is now doing well, but the first couple of years were very hard. We did have to significantly change the team and investment allocation, because what we discovered, if you look at most of the approved antibiotics other than linezolid, they’re generally very complex structures that leading chemists are still trying to replicate with technologies like diversity-oriented screening. But it proved to be much harder than we had anticipated and would take more time and more money and access to good natural product libraries.

The lesson for me from that was if you’re investing in early-stage technologies, which are trying to solve intractable problems that are really important to society, that’s great. But before you put your foot down on the accelerator, it’s better I think to start small and to experiment and keep costs to a minimum until you get significant chemical leads that you then have something tangible to invest into and grow forward.

Alan Crane: I’ll start out with [what] I think might be a non-obvious example. Millennium Pharmaceuticals [now Takeda Oncology], which people think of as flying high through the whole genomics revolution and then acquiring products and ultimately being acquired for $9 billion by Takeda [Takeda Pharmaceutical Co. Ltd.] [See Deal] But the reality is, there was a very important strategic repositioning that occurred around 1999. In the midst of this genomics bubble, the mentality was targets and genes and, by the way, the Internet and all that. That was the value creator. And it wasn’t about products. At one point we were sitting on an $18 billion market cap without a single drug in clinical trials. We really looked closely at our business model and all these major collaborations we had with Pharma. It was actually difficult to see how we were going to build sustainable value if people didn’t keep assigning extraordinary value to early-stage technology, and we went through a rigorous process of looking at the whole industry and saying, “What can we bring into the company?” A lot of other genomics companies that had very high market caps didn’t end up focusing in that way, and they, in essence, ended up either going out of existence or seeing significant reduction in value.

“At one point we were sitting on an $18 billion market cap without a single drug in clinical trials. We really looked closely at our business model and all these major collaborations we had with Pharma. It was actually difficult to see how we were going to build sustainable value if people didn’t keep assigning extraordinary value to early-stage technology.” – Alan Crane

At the end of the day, we acquired LeukoSite which had Velcade in it, which is now a multibillion-dollar drug and was a driver of the acquisition. [See Deal] But we also acquired a bunch of other products along the way and really were able to develop a significant pipeline and set of capabilities. So many folks just thought it was crazy that we were shifting from this genomics foundation. But we could see that these technologies, even though we had done these major deals, were really becoming proliferate. Everyone was becoming skilled at practicing genomics technologies. It's really critical to always think about how’s the environment changing, how’s the competitive landscape changing, how is what you have going to be valued in the future?

[Another] company I was involved in was Cerulean [Cerulean Pharma Inc.], which is now in its first pivotal clinical trial. You license in academic technology and sometimes you can’t repeat the findings. I mean, in this case, it was a Nature paper with a very elegant nanoparticle formulation that showed amazing results. We were able to reproduce it, but we weren’t able to industrialize it and scale it. It was a very complex formulation.

Even as we were developing this complex formulation, we said, “Why don’t we think about even simpler solutions that involve part of what we’re doing in this complex formulation?” And that really became our internal effort.

We also said, “Can we find another platform that we can add to what we've developed?” We found a small company out on the West Coast, Calando Pharmaceuticals [Arrowhead Pharmaceuticals Inc.’s Calando Pharmaceuticals Inc.], that had been started out of Cal Tech by Mark Davis, who’s one of the giants. It’s become our second platform. [See Deal] We licensed a product and it was very important to us to license the platform as well. And now we have a very broad pipeline. And, again, a first product that’s in its first pivotal study. In Phase IIa, it showed really the best results anyone has ever shown in terms of survival for non-small cell lung cancer. If we hadn’t made those key strategic decisions early on, it really could’ve gone out of business. The essence of building a biotech company is not just about executing. The essence of doing it the right way is thinking about these issues constantly and constantly being paranoid about what might happen in the future.

JW: To what extent do transactions become a significant part of that toolkit as you go through the strategic thought process?

Adelene Perkins: I think strategic transactions are a very important part of our toolkit that we use all the time. One of the key programs in our pipeline right now is an in-licensed PI3-kinase program. It came from Intellikine [Intellikine Inc.]. [See Deal] Our team doesn't have any “not invented here” [attitude]. You look at someone’s program and you like it and you love it just as much as anything of your own.

Jan Wolpert: Ansbert, as a board member, what are the elements that drive you to discuss the topic of a significant change?

AG: You often see companies run right to the cliff, and at the last moment they think about restructuring or a change in direction. And it’s far too late. I think you should always have in mind what the strategic alternatives are rather than to wait until everything falls apart. The longer you wait, the more difficult it is to bring it up and to scale your ideas for management. It's probably obvious but you definitely have to do these restructurings while you still have significant cash, because to recapitalize a company when it looks like the lead program isn’t going anywhere, as we’ve all experienced, is incredibly difficult.

JW: Alan, your example of Millennium was this feeling that, wow, maybe we’re working on borrowed time. I guess it was Mark Levin at the time driving everyone: Think hard. There’s something not right here. It’s too good. Was there that sense of urgency?

AC: It actually started with a small M&A group in my corporate development group. A new analyst we had hired had a fresh outlook. And he said there’s all this hype and excitement, but what’s the reality? And we brought that to the board. It wasn’t obvious at the time. We ended up having a series of discussions about fundamentally changing the business model, because our business model had been to leverage small dollars into these big relationships and then let Pharma spend the money on moving the drugs forward. And then, we would reap the benefits. So, it was controversial at times. …

When you’re sitting there on a board … if the management team is just sort of executing and just blind to what else could happen, you know you’re in trouble then. You want executives who are constantly thinking about and are taking a hard, honest look at the company and saying, “What could go wrong?” What are the real issues associated with my product, with my technology? What am I going to do if something blows up? What’s my backup plan? You constantly need to be thinking that way, because the nature of this industry is most things don’t work.

And [we need] teams that think that way and are always thinking about optionality and risk mitigation. Fundamentally, in our business, in venture capital, we bet on teams. I always say I’ll take a great team and a mediocre technology before I’ll take a great technology and a mediocre team, because you often end up with a different technology and a different product. But great teams really think about those issues constantly. Executing on a product is, okay, it’s hard and everything. But that’s not that difficult. But building a company in the context of all the risk and in the context of all the issues that you can have and constantly thinking about these issues, that’s what makes the difference. And so, you know it early on when your team isn’t thinking about those things.

JW: I'm also thinking of the age-old dilemma of the CSO. Do I want a highly diversified pipeline? Or do I want a pipeline that attempts to double down on programs that are particularly compelling?

CM: It’s happening across the venture industry now. We were privy to an analysis that showed that in the last five years, single product companies have on average generated higher exits in biopharmaceuticals than platform companies with products. There may be a bias in that, though, because often people will spin out. And we’re doing it right now with a couple of our companies. When it looks like you’re getting M&A interest, you spin out the other asset so that you just create a nice, simple structure.

Some firms' new model is just to invest in a single asset. They want to have a couple of people manage that single asset. And they’re prepared to accept that 80% of these single assets are going to fail. They offer their entrepreneurs job security, because their argument is that often when entrepreneurs are locked in a company, they want to protect their jobs, their livelihoods; their families depend on them and so they'll continue to push programs through that maybe if they were ruthless, they themselves would kill. So some of the venture firms are trying to create a nice, safe work environment within their family of portfolio projects. And they’re trying to separate each project individually. I guess that’s one way to address the central issue.

“I think if a program doesn’t go well, you want to cut it as soon as possible. And too many companies really try to move programs along until it becomes completely unavoidable to stop them. So, I think it’s important to establish a culture in these companies that management knows it gets rewarded for doing the right thing rather than being rewarded to move things along.” – Ansbert Gadicke

JW: What are your thoughts about an appropriate set of incentives, in the context of a significant strategic change, to bring everyone along and feel motivated to grow in the same direction?

AG: When I think about incentives, I typically don’t focus on bonus but on stock options. From my perspective, it’s really critical that we reward management for doing the right thing versus just sort of moving programs to the next stage. And I think that’s not necessarily always done in the industry. I think if a program doesn’t go well, you want to cut it as soon as possible. And too many companies really try to move programs along until it becomes completely unavoidable to stop them. So, I think it’s important to establish a culture in these companies that management knows it gets rewarded for doing the right thing rather than being rewarded to move things along.

AP: It's really important for an organization to have a clear set of goals. They can be to build for the long term, but [you still ask] what do we need to get done this year that’s building to the long term. We have two buckets. Near-term value creation is clinical trial data. There is a small group of people in the organization responsible for that. A lot of the people are involved in the things that are foundations for success: early discovery, operational excellence. And yet, we’re very clear that from a compensation perspective, 70% is based on the value driving clinical trial results. Our head of discovery at one point said, “Is that going to send the wrong signal to our discovery team, that they can do wonderful things and it only contributes 30% toward our goal?” And I said, “No, because we all have to have clarity that that is what drives value. And the foundational things, if they aren’t important, they wouldn’t be there. We just need to be clear that they are not going to be driving our value in this year. They’re for longer term.” Understanding it is the most important thing.

JW: To what extent does the macroeconomy flavor how you manage things short to medium term?

CM: I think it’s what everyone’s been saying, only the paranoid survive. So if you’re raising capital, I’d try and close soon. I’m trying. It’s very hard out there at the moment. With our portfolio companies and some new deals we’re working on, it’s very tough to get other investors to want to commit at the Series A stage with companies. Always have more capital than maybe I’d be comfortable with in boom times. We're trying to make sure no one has money in money market accounts. Don’t worry about getting a return on your money; just worry about getting a return of your money. Take no risk at all with the dollars you have as a biotech. And don’t nickel and dime investors when you’re fundraising. Just bring the money in now.

AC: Every day, someone’s exiting a life science venture capital business. We all have smaller funds than we did. We don’t know if some of our syndicate members are going to be able to continue investing in the company. So, it just puts even more emphasis on being really nimble and saying, “Okay, the funding might not be easy.”

CM: We used to hope that if we got human proof-of-concept and a really innovative mechanism that promised the potential for great patient benefit, it would be taken off our hands. Generally, we’d plan on maybe a Phase IIb contingency for reserve allocation. But we really were counting on Phase Ib/IIa exits. And we routinely now plan for Phase III-ready programs, and we’re even starting now to think that maybe [for] the occasional program we have to find an orphan indication and find a way to support those companies. At least anticipate the worst that we’ll have to fund it through to an NDA. And that just wasn’t the way we thought even two and a half, three years ago.

There are still great exits, fantastic exits. Pharmasset is breathtaking. And Plexxikon [Plexxikon Inc.] before that [through its acquisition by Daiichi Sankyo Co. Ltd.]. [See Deal] But there used to be this odd phenomenon in M&A where Phase I acquisitions were actually more highly valued than Phase II. And then they picked up again for Phase III. It was because Pharma was competing intensely for the great Phase I assets. It's become very linear now: Phase I, Phase II, Phase III. Large pharmas have become almost uniformly more focused on the fact that only 18% of Phase II compounds eventually reach commercialization stage now. So, they still see Phase II as a relatively risky stage, and they're much more likely to offer reasonable terms if you take it further.