Biogen Idec: A Sign of Biotech's Maturation

As separate companies, Biogen and Idec could not support their products and at the same time leverage the value of the associated large-molecule development infrastructure to create robust pipelines, balance risk, and thus help assure their future growth. By merging, they will be able to exploit their combined capabilities in large-molecule process development and manufacturing, which will give them both the means to reap the full rewards of organic growth and also the capability and capacity to partner with smaller companies in need of their kind of development expertise. While both companies face pipeline risk, Idec's Rituxan appears certain to continue to propel that firm's growth, justifying its higher P/E. Biogen's growth is slower and less certain. Should it further decline, it will be to the detriment of Idec's investors, who will have to wait at least 5-6 years to see the partnering model develop and the pipeline deepen.

A Biogen-Idec merger resolves many of their individual growth issues. Smaller biotechs also benefit by having another major large-molecule licensee to turn to—a rare and in-demand resource.

By Mark L. Ratner

• As separate companies, Biogen and Idec could not simultaneously support commercialization of their products and at the same time leverage the value of the associated large-molecule development infrastructure to create robust pipelines, balance risk, and thus help assure their future growth.

• By merging, they will be able to exploit their combined capabilities in large-molecule process development and manufacturing, which will give them both the means to reap the full rewards of organic growth and also the capability and capacity to partner across multiple disease areas with smaller companies in need of their kind of development expertise.

• Combining the companies also allows each company to expand into areas in which the other has already built development capabilities. Biogen was having trouble breaking into oncology, where it could leverage its immunomodulation-based R&D, and Idec could not pursue all of the indications for its clinical products.

• But while both companies face pipeline risk, Idec's Rituxan--one of the true success stories in biotech R&D--appears certain to continue to propel that firm's growth, justifying its higher P/E. Biogen's growth is slower, and much less certain. Should Biogen's growth further decline, it will be to the detriment of Idec's investors, who will have to wait at least 5-6 years to see the partnering model develop and the pipeline deepen.

In 2000, just under 11% of revenues from the top 100-selling drugs and roughly 6% of revenues from the top 500 drugs came from large molecules, according to data from Easton Associates. With the subsequent approvals of Abbott Laboratories Inc. 's adalimumab (Humira), Biogen Inc. 's alefacept (Amevive), omalizumab (Xolair, from the triumverate of Genentech Inc. , Novartis AG, and Tanox Inc. ), GlaxoSmithKline PLC 's tositumomab (Bexxar), and the anticipated approvals this year of Genentech's Phase III compounds bevacizumab (Avastin) and efalizumab (Raptiva) and ImClone Systems Inc. /Bristol-Myers Squibb Co. 's cetuximab (Erbitux), large molecules are among the fastest-growing drugs in the industry. They comprise perhaps an even greater percentage of important pipeline projects.

But unlike the market for small-molecule licensing candidates, there are relatively few development partners for protein-based drugs, particularly within Big Pharma, which has been loath to install the requisite bioprocessing expertise and manufacturing capacity needed to make them partners of choice for biomolecules. Amgen Inc. and Genentech certainly have those capabilities, but very few other companies do. Even the next tier of biotechs—Genzyme Corp. , Biogen, Chiron Corp. , and Idec Pharmaceuticals Corp. among them—while they have the skill sets and capabilities, don't have the cash flow to allow them to pay significant up-front fees and milestones without hurting earnings badly enough for investors to notice. They've got their hands full just getting out the best and brightest of their own large-molecule product candidates.

The opportunity driving the merger of Biogen and Idec [See Deal] is to create another significantly advantaged large-molecule in-licenser, one that can share in the economic privileges of this world. Indeed, despite the misgivings with which investors have greeted this deal, it is good news both for Idec and Biogen, each of which faced significant challenges, and for smaller biotechs, which now have another major customer for their wares.

Like many public, profitable biotech companies, Biogen and Idec could not simultaneously support commercialization of their products—which drives the near-term earnings on which their value is based--and at the same time leverage the value of the associated large-molecule development infrastructure to create robust pipelines and thus help assure their future value growth. Despite each having a blockbuster product and a formidable knowledge base in their respective disease areas, neither firm could significantly reduce its risk profile going forward. Nor were they generating enough cash to invest in R&D to fully support their existing pipelines.

To address similar resource constraints, many top-tier biotechs have sold out to a larger company: witness Immunex Corp. 's purchase by Amgen [See Deal], Johnson & Johnson 's acquisition of Centocor Inc. [See Deal], Wyeth 's step-wise purchase of Genetics Institute in the mid-'90s [See Deal], and even Ciba-Geigy's buying just under half the stock of Chiron [See Deal].

Biogen and Idec, however, are pursuing a different path. They are attempting to develop a larger business base, and so balance portfolio risk, without sacrificing their essential cultures—a concern that Idec management, in particular, has consistently raised in the past in response to questions about strategic alternatives. And they can do this, management believes, by exploiting their combined capabilities in large-molecule process development and manufacturing, which will give them both the means to reap the full rewards of organic growth and also the capability and capacity to partner across multiple disease areas with smaller companies in need of their kind of development expertise. (See Exhibit 1.)

Selling the Transaction

The two companies, with nearly identical market caps, are combining in a merger of equals. The deal, expected to close in late 2003 or 2004, is a stock-for-stock exchange, with Biogen shareholders receiving 1.15 Idec shares for each share of Biogen stock: after the exchange, Idec shareholders will control 50.5% of the new firm--indeed, the transaction had to be structured so that Idec becomes the majority owner, to avoid triggering a change in control provision in its long-standing collaboration and co-promotion deal with Genentech on the oncology drug, rituximab (Rituxan) [See Deal]. Were Idec to become the minority shareholder of Biogen Idec, Genentech could have ended the collaboration and insisted that one company buy out the other's interest, possibly in a Dutch auction—a risk Biogen Idec didn't want to take even if it were to emerge as the high bidder.

Wall Street doesn't generally like mergers of equals and its response to this deal was predictably cool. If either company were to be taken out, some investors reasoned, the deal should have granted the selling shareholders at least some premium to the present stock price. Instead, the merger seemed to signal to a number of analysts just how ugly the future looked for these companies—for Biogen in particular.

While Idec remains a growth story driven by Rituxan--in the most recent quarter, the drug's sales grew 28% over the same period last year, to $328 million from $257 million--the situation for Biogen is very different. It has sizable profits, but competition for interferon beta-1a (Avonex), its multiple sclerosis drug, from Serono SA 's version of the protein, Rebif, has sliced into its market share.

Although Biogen says that the growing MS market will more than offset any loss of market share to Rebif (second-quarter Avonex revenues increased 12% over the prior year, and management is maintaining an 8-10% growth rate for the year) some analysts suggested that its acceptance of an offer at virtually no premium to its current stock price signals earnings disappointments ahead. Banc of America Securities LLC's Mike King, for one, told investors that "Idec is essentially buying a no-growth company whose main product is experiencing decelerating sales growth, and follow-on products are facing market competition (Amevive) or Phase III trial risk and diluted economics (Antegren)."

King's comments were borne out in July with the release of Biogen's second-quarter numbers. Amevive, approved in February, is one of several entries in the psoriasis market. Not only has the Amevive launch been slow, prompting Biogen to reduce its 2003 estimates from $85 million to $50-70 million, the drug must compete with existing RA drugs including Amgen's etanercept (Enbrel) (which may also soon have a psoriasis label), and presumably Raptiva, now pending FDA review. And disappointing Phase III data on natalizumab (Antegren) in Crohn's disease, released the same day as the 2Q earnings, means that drug may not be approved until data in an MS indication mature. Antegren revenues therefore may not kick in until the end of 2006.

But Biogen Idec is not being created to bolster Biogen's current franchises. Rather, it is intended to allow each company to expand into areas in which the other has already built capabilities.

"We don't feel we've been resource-constrained in sales and marketing in MS," notes Biogen EVP, finance and CFO Peter Kellogg, adding that in addition to Avonex the firm has also invested in an MS program around Antegren. "Our competitiveness in MS or psoriasis was not a rationale for the merger. It had more to do with how we were going to build the company to be a significant player in the last half of the decade." Indeed, management argues for taking the long view of the transaction, pointing out that the deal reduces or defers capital expenses each firm had already planned, avoids duplicative build-out in manufacturing, QA/QC, and SG&A, and thus will improve return on assets over what each firm could accomplish on its own.

"I don't think the Street is focused on the right thing," explains Idec CEO Bill Rastetter, PhD, who will become executive chairman of the merged entity. "The perspective is way too short term--they want to see us ride out Rituxan, but you can't build a global powerhouse by riding out a product."

And some analysts did take the long view. Dennis Harp of Deutsche Bank Securities declared that "the combined entity will be in a stronger position to make future product acquisitions and to become a partner of choice for other biotech companies." Elise Wang of Smith Barney Citigroup agreed. "The combined company," she reported, "with greater critical mass, should provide more leverage as a partner of choice for new compounds versus each as a stand-alone company."

On the conference call discussing the merger, Jim Mullen, Biogen's CEO, who will also be CEO of the combined firm, emphasized that both Idec and Biogen have pieces the other has been working hard to build. Biogen has the European commercial infrastructure and large-scale bioprocess capability it can apply to in-licensing, while Idec has a presence in oncology and a pipeline of cancer and autoimmune compounds it would have been hard-pressed to fully develop on its own. (See Exhibit 2.)

"The merger accelerates the strategic plan of both companies, at less cost," Mullen explained, enabling Biogen Idec to eliminate some of the time and cost of building out infrastructure, which in turn will improve cash flow and asset utilization. Putting the two companies together will shave more than $500 million in business costs by 2007: an estimated $300 million in operating expenses, over $175 million savings in capital expenditures, and over $50 million in treasury and tax benefits. After 2007, the companies estimate a combined savings of $120 million per year from these synergies. Some of those savings will flow to the bottom line, Rastetter points out, and some will go toward licensing.

In the short term, management believes Biogen Idec can also satisfy the Street by delivering 20% cash EPS growth. Longer term, they contend, the merger gives Biogen Idec flexibility to pursue both organic growth and partnering opportunities. And with over $550 million invested in R&D, Biogen Idec would become the third-largest biotech firm in R&D spending and also market cap, behind Amgen and Genentech.

As independent companies, beyond supporting their late-stage products, they would be much less able to invest in their pipelines. "Having more dollars makes it easier to balance portfolio risk across early- and later-stage products," Peter Kellogg suggests. At their current size and revenues, both firms were sometimes "off-balance" in this respect, he says. Biogen, for example, was having trouble breaking into oncology—a frustrating product area, he points out, requiring many shots on goal, but also one where it could leverage its immunomodulation-based R&D. For its part, Idec could not pursue all of the indications for its clinical products: for example, according to Rastetter, Idec would have been hard pressed to fund Phase III studies of Idec-152 in allergic asthma. "We couldn't get the company to where we want to be in 2010," he acknowledges.

One way to broaden what they could do on a stand-alone basis was to collaborate, and in January 2003 Biogen and Idec did initiate a product alliance in oncology [See Deal]. Idec was similarly taking the collaborative route, to leverage into autoimmunity: witness its June 2003 deal with Genentech to develop anti-CD20 antibodies (of which Rituxan is one) for chronic B cell diseases, including autoimmune disorders [See Deal].

The Recent Past as Prelude

The Biogen/Idec collaboration discussions were the starting point for considering a merger. "We knew we wanted to complete the [negotiations on the] product collaboration before considering whether a broader relationship made sense," Kellogg recounts. "The discussions stemmed from the same step-wise logic: the difference was in scope." Although Kellogg stops one step short of saying the collaboration was a prelude to the merger, according to the merger document filed with the SEC, Idec's Bill Rastetter had asked Merrill Lynch & Co. Inc., the company's financial advisor, to review additional strategic alternatives with Biogen before finalizing the product collaboration. Rastetter and Biogen's Jim Mullen also had direct discussions on the subject before initiating the alliance.

Once the two research groups began interacting, the chemistry and the fit between them became apparent, Kellogg says: in particular, Idec's clinical expertise, including designing Phase III trials in oncology, would help Biogen, which in turn had experience in designing discovery programs that was of interest to Idec. More broadly, Biogen has invested in core enterprise systems and technology that Idec can adopt, and has a cost-center system it can use as it commercializes ibritumomab tiuxetan (Zevalin). Indeed, Idec can learn from Biogen in the same way as it applied to the launch of Zevalin the lessons it learned from Genentech during the commercialization of Rituxan. (See "Launching Zevalin," IN VIVO, May 2002 (Also see "Launching Zevalin" - In Vivo, 1 May, 2002.).)

The combined firm will also be able to shift resources currently committed to supporting enabling technologies. For example, after the merger, Biogen will be able to eventually move some Antegren production to a facility Idec's already building, deferring a planned $175 million capital outlay for a plant in Denmark (it would have needed a back-up manufacturing source in any event) and giving Idec a product and an established process for that plant's managers to work with, sooner. Conversely, Biogen's existing production capacity will allow Idec to close its Toreana plant, and pour the resulting $25 million savings in operating expenses into value-added R&D—either discovery research or clinical development. "That's $25 million out of a total of [Idec's current] $125 million total R&D spend. On that basis alone we've increased R&D productivity by 20%," Rastetter notes. And because both companies are in a growth mode, there won't be a rationalization of R&D. "We have to structure discovery to not be duplicative," says Peter Kellogg, "but there's not nearly as much overlap as there is complement."

With the merger and associated cost savings, "we can quadruple our [combined] R&D investment overnight and make more intelligent choices," Rastetter says, and better balance pipeline risk. The transaction "avoids the fits and starts of organic growth," he told analysts, which the companies would have had to go through separately.

Indeed, a major rationale for the merger is that by leveraging their respective commercial and manufacturing infrastructures and enhancing capital efficiency, a larger Biogen Idec will have the flexibility to think strategically about growth via a combination of internal R&D and partnering. Combining their large-molecule development expertise and manufacturing capacity gives them a rare and in-demand capability to move large molecules into the clinic, and elevates the company to a new plane as a partner of choice for companies with targets or early-stage compounds.

Although many Pharmas have positioned themselves as partners of choice to the biotech industry, barely a handful have the development and manufacturing capabilities and capacity needed to support the commercialization of large molecules. (See "Who's Got Game in Antibody Development?" IN VIVO, June 2003 (Also see "Who's Got Game in Antibody Development?" - In Vivo, 1 Jun, 2003.).) And with the exception of Genentech, even those biotechs most noted for their focus on large-molecule development, from MedImmune Inc. to Human Genome Sciences Inc. , don't have the revenue base or the scale and breadth of infrastructure to go beyond supporting their own pipelines. As stand-alone companies, the same was true of Biogen and Idec.

The companies each needed to find a way to drive more R&D investment to stay competitive, Rastetter acknowledged to analysts in the conference call. With a larger investment in R&D, both as a percentage of sales and in absolute dollar terms, "we can be more competitive with up-fronts" and milestones, he says. Plus, Biogen's commercial reach in Europe gives the new firm better access there.

A Venture Adventure

"Our in-licensing strategy will be biologics focused," Rastetter explains, to leverage the combined company's infrastructure, and will focus on building Biogen Idec's product portfolio in their existing therapeutic areas: oncology, neurology, and dermatology. He foresees the potential to make opportunistic product acquisitions from companies with a molecule, but without the ability to make it, fund it, or develop a manufacturing cell line, for that matter. Biogen Idec will also "take a more patient approach" to adding to its pipeline via discovery-stage deals that may, he says, ultimately have a higher yield than late-stage in-licensing.

"We're going to adopt a venture strategy," he adds, "putting some VC money to work in companies with a vision of the role of biologics in diseases, then add value to that investment through our biologics capabilities," in effect playing the role of incubator. In-licensing preclinical or early-phase compounds is even dicier in the large-molecule arena than for small molecules since drug sponsors must invest more, earlier, in processing than for new chemical entities—capabilities Biogen Idec can more easily offer licensors together than could either firm on its own. If bioprocess changes are not planned early in clinical development, they could lead to regulatory snags or outright failure. Difficulties could stem from purification issues (which may not become apparent until Phase III), an inability to scale up a pilot process, or not having in place essential operating procedures, including quality assurance and quality control.

By balancing their portfolios across diseases and stages of development, both elements of the plan—opportunistic product licensing and discovery dealmaking—should help lower Biogen Idec's risk profile. By 2010, Biogen Idec expects half its pipeline to come from organic development and half from the outside, spread between preclinical, Phase I, and late-stage products. But the balance, Rastetter adds, is impossible to know, now.

Is there a downside to the combination? The deal is "a little far out for the Street," admits Peter Kellogg. "People understand the strategic rationale, but as with any M&A, there's a certain amount of ‘Show me' mentality. Investors will be watching to see the synergies and the performance as well as whether we can establish the partnering and build the pipeline." The risk is much greater for Idec's shareholders. Both companies face pipeline risk, but Rituxan--one of the true successes in biotech R&D--appears certain to continue to propel Idec's growth, justifying its higher P/E. Biogen's growth is slower, and much less certain. Should Biogen's growth rate decline further, it will be to the detriment of Idec's investors, who will have to wait at least 5-6 years to see the partnering model develop and the pipeline deepen.

Moreover, each company's stock has declined roughly 12% since the merger was announced. A further decline would increase the chance of a larger company stepping in and breaking up the combination, now that they've seen that both companies are willing to consider M&A. Novartis, with a presence in Boston and little in the way of large-molecule development, could seek out Biogen. Or Genentech could consider making a play for Idec to get the rest of Rituxan, as Pfizer Inc. did with Warner-Lambert Co. after that company tried to merge with Wyeth [See Deal], [See Deal].

While that's been suggested, neither transaction is likely. Genentech doesn't have any history of acquisitions and, focused as intensely as it is on partnering, probably wouldn't like its reputation sullied by taking over its most important collaborator. Nor is a hostile attempt from another Big Pharma probable. Even at somewhat depressed prices, Idec and Biogen—with P/E multiples of 38 and 29 respectively--are both expensive relative to the major drug firms, most of whose multiples languish in the teens and low 20's.

Plus, Pfizer was able to finance its bid for Warner-Lambert in part on the back of its rights to Warner's major drug, atorvastatin (Lipitor), which it was co-promoting. Without full rights to that asset, no other counter-bidder could have beaten the price Pfizer was offering. Only Genentech is in a comparable position—with Idec—and, as noted, probably won't want to play the takeover game.

Certainly a bid for the combined company could eventually make strategic sense for a larger firm: Big Pharma's pipelines increasingly depend on a pool of ever more expensive small-molecule drugs. To get access to large molecules, they'll need to buy large-molecule development capacity. Meanwhile, Biogen Idec will be taking advantage of this unique and possibly disappearing opportunity—creating an in-licensing machine in a still relatively uncompetitive area.