A Recipe for Acquisition: the Esperion Strategy

Though one key ingredient is luck, exit-by-M&A can be planned, as the Esperion-Pfizer transaction shows. Focusing on a single underappreciated pathway and eschewing discovery, Esperion put together, very inexpensively and very quickly, an in-licensed portfolio of related compounds. By doing so, Esperion minimized the chances it would find itself competing against an improved follow-on should it prove the value of its mechanism of action. Likewise, once it had reached some clinical proof of principle, its strategy positioned it either for a major multi-product deal or, even more likely, an acquisition-with Pfizer's $1.3 billion takeover the eventual outcome.

Though one key ingredient is luck, exit-by-M&A can be planned. But don't look to Esperion-Pfizer as a template for lots of other deals.

By Roger Longman

• Focusing on a single underappreciated pathway and eschewing discovery, Esperion put together, very inexpensively and very quickly, an in-licensed portfolio of related compounds.

• By doing so, Esperion minimized the chances it would find itself competing against an improved follow-on should it prove the value of its mechanism of action.

• Likewise, once it had reached some clinical proof of principle, its strategy positioned it either for a major multi-product deal or, even more likely, an acquisition.

• Pfizer is aggressively using its financial might to dominate new treatment approaches, creating competitive advantage through its willingness to take expensive therapeutic risks.

Three key lessons shout from Pfizer Inc. 's $1.3 billion acquisition of Esperion Therapeutics Inc. , perhaps the year's highest-value biotech transaction, figured by stage of product development. [See Deal] (See Exhibit 1.)

First, even those companies most dedicated to small-molecule, chronic care therapeutics will pay large amounts of money for large-molecule, acute care opportunities.

Second, drug discovery isn't necessary to build a high-value, R&D-driven biotech. Esperion built its business around its belief in a totally non-proprietary mechanism of action, indeed one that had been explored for years by academic and even corporate researchers. It had simply been ignored by most of the industry, which thus allowed Esperion to in-license many of the available compounds, which turned out to be relatively plentiful and cheap.

And third, the combination of the first two allowed Esperion's investors to achieve their returns in what is comparatively a pharmaceutical eyeblink—five years. Absolute returns were stunning enough--100% for those who invested in its follow-on offering, 1400% for the average private investor. But the IRR would have pleased any venture capitalist: 68% for those in Esperion's last private round (granted they'd been smart enough to hold on), far more for earlier-stage investors.

Luck played its usual role: Esperion managed to prove—with its very first compound--the clinical utility of a mechanism in which few corporate researchers believed: reducing arterial plaque by reducing cholesterol.

But even if that first compound had failed, the company would have had enough money to finish Phase II trials on a second compound, which, had it worked, would still have generated plenty of excitement among pharmaceutical partners—and have forced them to seriously consider buying the rest of the Esperion pipeline, providing a nice exit for investors. In short, the Esperion model—minimize discovery, focus on a preclinically promising mechanism generally ignored by corporate pharma, and then beat the bushes for all available compounds related to that mechanism—has in fact suggested a recipe other start-ups can helpfully follow.

Focused Diversification

Esperion is a triumph of focused diversification—creating a set of molecules all of which help to accomplish much the same thing. The company was founded in 1998, around a Pharmacia & Upjohn compound and four scientists from the Parke-Davis research unit of Warner-Lambert. The team was led by Roger Newton, PhD, president and CEO and the co-discoverer of, and product champion for, atorvastatin (Lipitor), the world's biggest selling drug.

Following the merger which created it, P&U hired David Scheer, founder of the CT-based advisory firm Scheer & Co. Inc. to look through a number of out-licensable projects and find homes for them, says Newton. One of the molecules slated for outlicensing was an HDL-mimetic called Apolipoprotein A-1 Milano (Apo A-1M). Its discoverers, Guido Franceschini and Cesare Sirtori at the Università degli Studi di Milano, had studied a group of long-lived Italians who shared an HDL mutation that appeared to dramatically decrease LDL and any evidence of atherosclerosis. Sirtori and Franceschini made a recombinant complex of Apo A-1M, the key protein in the Italians' HDL, and a phospholipid, which together mimicked the activity of this mutant HDL.

The theory behind Apo A-1M was to encourage a process called reverse lipid transfer (RLT)—the body's way of getting rid of excess cholesterol that is collected in various tissues, most dangerously the arterial walls, where it helps to form plaque and the blockages and free-floating clots which can lead to heart attacks and strokes. HDL plays a central role in the process, carrying excess cholesterol out of the body—just as LDL delivers it to the various organs, storing the excess in various places, including arteries.

Scheer eventually found his way to Newton who had just left Parke-Davis, after a company reorganization. It was time: Parke-Davis had decided, given the roaring success of Lipitor, to stick with LDL, while he was more interested in exploring HDL regulation. By lowering LDL, even the best statins in the most optimistic studies, notes Newton, reduce morbidity and mortality by only about 35%; the major opportunity is to attack the remaining 65%. Newton's interest in HDL was driven more by hypothesis than medical fact: there was no clinical proof that raising HDL would in fact reduce LDL, let alone plaque buildup. There was, however, interesting animal data, including data from Sirtori and Franceschini.

He was, nonetheless, skeptical of the Apo A-1M opportunity: "I was a small-molecule, chronic care kind of guy," he says, but the more he investigated the preclinical logic, the more interested he became. "I began to see a real opportunity in treating people acutely," says Newton, those who had already had a heart attack, who are at the most risk of having a second event. He thus signed on to run the company that Scheer offered to help create, eventually finding funding from Oak Investment Partners, TL Ventures, and HealthCap.

Within a year, Newton had become even more certain of the opportunity. Studies by other researchers showed that injection of HDL mimetics in atherosclerotic animals could reduce plaque within three weeks by 70%. An infusion trial with a precursor protein to Apo A-1 showed increased amounts of cholesterol in the stool: the body was eliminating it. Meanwhile, says Newton, most of the statin companies dismissed the HDL preclinical and clinical studies: remodeling through RLT, they thought, simply would never work. And besides, given the opportunities in small-molecule, chronic care agents, the notion of an acute care, large-molecule business seemed paltry.

That no pharmaceutical companies seemed particularly interested in remodeling mechanisms was in fact a benefit since Esperion knew, says Newton, "that the Apo A-1M patent estate wasn't enough." His strategy was to "scour the world" for additional RLT-related compounds. In the first place, if one candidate failed, he wanted another to be ready six to nine months later. In the second, if Esperion proved the value of acute care, HDL-increasing therapies, competitors would react quickly and find perhaps better and even more advanced molecules.

As it turned out, Newton' strategy positioned it directly for the acquisition: apparently, no other plaque remodeling program is anywhere as advanced or as diverse. If companies wanted a near-term opportunity, with fall-back options, the most direct route lay through Esperion.

Licensing Up and Down the Pathway

There was a third reason behind the in-licensing strategy: Pharmacia had an option for European and Asian rights to Apo A-1M (along with a nearly worthless right of first negotiation for North America). Without the ability to out-license worldwide rights to the drug, Esperion couldn't hope to drive a high-value deal unless it was willing to take the drug all the way through Phase III. This right was not well understood by Wall Street or the press, who assumed that Pfizer had a complete, worldwide right of first refusal to Apo A-1M. That misunderstanding probably kept a lid on Esperion stock. Indeed, even after the Pfizer acquisition was announced, news media and analysts continued to confuse the crucial distinction between Pfizer's actual right of first negotiation and fictive right of first refusal.

Since in 1998, much of the biotech world was focused on discovery and discovery tools as the low-risk, quick-exit opportunity, while the cardiovascularly focused among Big Pharma were fixed on chronic indications, Esperion had a relatively free hand in mining the available opportunities—and mining them cheap. One follow-on came, indirectly, from the French pharmaceutical company Groupe Fournier, which never recognized that it had found a potential follow-on to its only major success, the lipid-lowering agent fenofibrate (trademarked Lipanthyl in France, its major market). In closing down its Heidelberg, Germany operation, Fournier was bound by German law to give the patents for its HDL mimetic, a peptide/phospholipid complex now called ETC-642, to the former employees who had invented it. Within a week of the announcement of Esperion's formation, one of these former Fournier employees, chemist Jean-Louis Dasseux, PhD, telephoned Newton and told him about the drug. Newton licensed it—for $50,000 up front--and hired Dasseux, now the company's VP of chemistry and new technologies.

A third RLT-enhancing compound—a liposome formulation called a large unilamellar vesicle (LUV) came from the University of British Columbia , via the cancer-focused Canadian start-up Inex Pharmaceuticals Corp. [See Deal] The LUVs apparently help shuttle cholesterol out of the core of the plaque build-ups. Total cost for the preclinical project: $250,000 at signing and milestones of up to $6.2 million, plus sales royalties. And finally, in February 2000 the Belgian Region Wallonne contributed the Phase I protein ProApo A-I, the precursor protein which synthesizes normal Apo A-1, for a $25,000 up-front fee. [See Deal]

Thus, within two years of its founding, Esperion had pulled together what is today its entire clinical-stage product portfolio, paying up-front $1.08 million, the vast majority, $750,000, for Apo A-1M. [See Deal] Desultory partnering discussions went nowhere and its strategy eventually evolved towards keeping its products until they had proven the therapeutic principle in a Phase II trial.

It wasn't that the world was completely ignoring HDL-increasing strategies. Pfizer, for example, was pursuing small-molecule, chronic care approaches, ending up with a compound, torcetrapib, now in Phase III as part of a combination therapy with Lipitor. Newton's old colleagues at Parke-Davis had also kept up with things, and, soon after the closing of Pfizer's acquisition of Warner, they signed a deal with Xenon Genetics Inc. to find targets based around an HDL-promoting gene. [See Deal]

Follow-On Offering Problems

But the pharmaceutical world didn't really sit up and take notice of Esperion until July 2003, when the Cleveland Clinic Foundation 's Steven Nissen, MD, announced preliminary results from a 47-patient trial showing, via the imaging technology of intravascular ultrasound (IVUS), real arterial remodeling—the patients' atherosclerosis had decreased. It wasn't yet clear by how much the arterial narrowing had decreased, but the news was enough to allow Esperion to begin a road show for a follow-on offering. With just a year's worth of cash, the company needed to fill up its coffers as it began to look for a licensing partner. "We knew that Pharmas would simply string us out," says Tim Mayleben, the company's COO and CFO, delaying negotiations until Esperion was so desperate for cash that they'd accept any deal. Another slug of cash would allow them to progress all four of their clinical candidates, a capability crucial to Esperion's follow-on strategy.

They figured they'd be able to raise about $80 million: the biotech market had come back for follow-ons; they had good clinical news; and their book was building nicely. But one week after the road show began, Mayleben received a call from Scott Sacane of Durus Capital Management, at 21% the company's biggest shareholder. Sacane told Mayleben, says Mayleben, that his fund had "inadvertently" bought more shares without letting the SEC know: he now owned 32.9% of the company.

The stock dropped 25% on the Sacane announcement. No one knew what kind of influence Sacane—up to now a model and quite passive investor—would try to wield over the company. Rumors swirled that Sacane had bought the shares on margin and that margin calls from worried investors would force him to sell stock, dramatically depressing the shares just as Esperion was trying to issue new ones. Investors were also worried that Sacane owned more shares than he was admitting to—after all, his firm owned more than 70% of Aksys Ltd.

"To their credit," says Mayleben, "Lehman [the offering's lead underwriter] didn't give up on us. And we couldn't give up either. We needed the money. Even if we had to sell shares at $14." He didn't have to go as low as that: the deal closed at $16, with the company making do with $60 million, not $80 million.

Pre-Empted Auction

The short-fall didn't matter. Nor did the company need the money for anything but shoring up its negotiating position.

On November 5th, the publication of Nissen's full data in an article in the Journal of the American Medical Association caused nearly every major drug company, says Newton, plus at least one large biotech, to show up looking for one of three kinds of deals: a single-product license, a multi-product alliance, or an acquisition. None were scared off by the Pfizer ex-North America option, says Newton, having all read the P&U/Esperion contract, unlike many of the analysts.

Nonetheless, they all recognized that a one-off licensing deal for Apo A-1M could prove dicey for all the same reasons Newton had articulated in seeking a series of in-licensed compounds: even if Apo A-1M worked for the licensee, Esperion could soon be ready to out-license the ex-Fournier peptide version, ETC-642, which would have been easier and cheaper to manufacture (one bidder on the deal noted the high cost of goods entailed with producing the protein-lipid complex). Thus, any Apo A-1M licensee could soon face competition from an improved version of the drug.

Discussions thus rapidly graduated towards multi-product alliances, the values of which easily bumped into the ceiling set by a potential acquisition. And while there were apparently still companies interested in alliances, by the time Newton signed the Pfizer deal, they'd already had several competitive acquisition contracts on the table. Pfizer had in fact been one of the last to the table but moved with intense speed—increasingly a hallmark of its dealmaking. Says Pfizer's head of global R&D, John LaMattina, PhD, "we needed rights to all of the compounds; rather than let the other products go to others, it made sense to buy all of them."

Spurring Pfizer on was the notion, says LaMattina, of a nearly complete treatment approach to lipid problems: starting patients in the hospital with an acute HDL-increasing therapy, and then continuing them on a chronic therapy, like torcetrapib/Lipitor. "We think that 80% of our business will always be small-molecule therapy," he says, "but for a company our size there are plenty of opportunities for large molecules."

The acute-to-chronic approach "is a classic strategy," says Steve Nissen, and it accords with one of the messages of another major study he published a week after his JAMA article on Apo A-1M. The REVERSAL study compared Lipitor and Bristol-Myers Squibb Co. 's pravastatin (Pravachol): neither drug reversed plaque build up in the arteries, but Lipitor, and not Pravachol, did apparently stop its progress. The messages, says Nissen, are two fold: "More statins are better," he says, "but statins are not enough. The battleground of the next five years will be to bring a drug to market that has added efficacy on top of a statin. That drug will make a boatload of money." Torcetrapib is part of the answer; acute RLT therapies are another.

But it's also important to recognize that Pfizer's preemptive bid—and it was indeed preemptive—signals the kind of power that Pfizer now believes it has. Predominant among pharmaceutical companies, Pfizer can commit, as it apparently has, to spending $800 million on its Phase III torcetrapib/Lipitor study, and $1.3 billion on Esperion, before embarking on what Nissen believes will be the enormously complex and costly trials the Esperion compounds will require. One senior executive at a Pfizer competitor, who negotiated with but did not ultimately bid on Esperion, noted that the company had put a $1.2 billion value on APO A-1M—but risk-adjusted the NPV down to about $100 million given the cost and uncertainty of the mechanism itself, a mechanism unproven by any marketed product. LaMattina himself notes that any torcetrapib/Lipitor trial will have to show reduced morbidity and mortality. "Just showing the rise in HDL isn't going to convince the FDA," he says. Likewise, Nissen points out, the Apo A-1M trial, while as positive as it could be, was hardly conclusive--it included only 47 patients.

No Big Pharma Buying Spree

Ultimately it was these risks and costs that left Pfizer alone in the field. Even the kind of licensing deal Esperion would have required for its HDL-elevating therapies—"and we would have had to take both the protein and the peptide"-- would still have meant huge risks, says the competitor's executive. "And neither we, nor apparently other drug companies, felt these trials would be affordable on top of what we are already spending money on. But Pfizer figures that they can push ahead simultaneously on all four and if even one of the products work, they'll do OK. They are so big, they are uniquely capable of playing this kind of Russian roulette."

The deal isn't closed yet. And LaMattina is right to play up the risks of the HDL venture. As with any deal Pfizer does, the Esperion acquisition raises antitrust questions, particularly given Pfizer's increasing dominance of the lipid world. On the statin side, both Pravachol and Merck & Co. Inc. 's simvastatin (Zocor) are going off patent relatively soon; Lipitor still has plenty of patent life left. Moreover, the REVERSAL study will mean that Pfizer won't face much generic erosion when those competitors do go off patent: after all, Lipitor has proven it stops plaque progression and that Pravachol doesn't. Giving patients any other statin, Pfizer's reps could argue to doctors and payers, is to give them second-class medicine. Pfizer still faces tough competition from AstraZeneca PLC 's rosuvastatin (Crestor) and the Merck/Schering-Plough Corp. ezetemibe (Zetia) and Zocor combination, but in any case the market will soon have fewer branded competitors than it does now.

Moreover, in addition to dominating the statin market, Pfizer has the most advanced small-molecule approach to raising HDL. And the Esperion acquisition will allow Pfizer to dominate acute care approaches in a single stroke. "We're pretty comfortable that the deal won't run into antitrust problems. Our attorneys think it will be OK," says Mayleben. But he admits: "The FTC will have to make its own determination."

The current FTC isn't, however, likely to make much of a fuss over Esperion. And if it doesn't, Esperion will have pulled off a neat, if not wholly unique, trick in the biotech world. Biotech acquisitions are rare and the vast majority are done more out of desperation than any real hope of seeing a significant return. High value M&A requires marketed, or at least late-stage, products. But Esperion managed to win its investors a 55% premium to its already healthy stock price (it was trading around its all-time high) with its most advanced product still only in Phase II. The reason: Esperion had virtually shut out the competition by in-licensing it, just as its target mechanism of action became red hot. Esperion's strategy was made for acquisition.

Not that Big Pharma is likely to go on a biotech buying spree: Esperion-like companies, those with a set of products all built to attack the same biological pathway, are rare. Alliances are still a far cheaper way to go for the more usual one-off opportunities. And there aren't all that many acquirers willing to take on the kinds of risks Pfizer clearly is. But the fact that Pfizer had acquisition competition for the deal does mean that Esperion's acquisition recipe is repeatable, granted the target has followed it accurately.