Shire: Remodeling Specialty Pharma

As biotech and Big Pharma invade spec pharma's traditional in-licensing ground, Shire's challenge is to bring investors along with its necessary strategic evolution. They've succeeded so far. Other spec pharma firms should take note of how.

By Melanie Senior

Matt Emmens, CEO of Shire Pharmaceuticals Group PLC , described last year's acquisition of Transkaryotic Therapies Inc. (TKT) as a "transforming transaction" during his talk at Windhover Information's Pharmaceutical Strategic Outlook (PSO) conference in New York in March 2006. And it was transformative: the $1.6 billion cash deal brought the specialty pharma firm, hitherto strictly focused on "search and development," an earlier-stage biologics pipeline and platform and the means to both discover and develop its own new drugs. [See Deal]

Yet Emmens insists that Shire's strategy hasn't changed. It's still focused on developing and selling drugs for specialist markets, which is where TKT's products and pipeline are targeted. It still seeks products with lower-than-average risk, a key attribute of TKT's enzyme replacement therapies. And it will continue in-licensing.

What's changing is the definition and boundaries of specialty pharma, the term usually used to describe in-licensing-focused groups, with no discovery or early stage development, that develop and sell the smaller drugs that Big Pharma has shunned. These days, specialty pharma no longer have that strategy to themselves. Big Pharma is forced by declining R&D productivity to look beyond the traditional mass-market blockbuster, and biotechs are compelled by investors to supplement their own pipelines with ready-made near-to-market drugs. (See Exhibit 1.)

This competition is forcing specialty pharma to move to the edges of their comfort zone and, just as significantly, to move outside the comfort zone of their investors, who choose specialty pharma over biotech precisely to achieve the kind of returns available from a lower-risk, earnings-driven company as opposed to a high-risk, high-reward biotech. In Shire's case, this move takes it into earlier-stage development and a world of preclinical compounds.

Thus Emmens' challenge—and the challenge of other specialty pharma CEOs—is to manage investors' expectations as he adapts to changing circumstances. Continued, uninterrupted profitability growth is impossible as the company invests in new product sources; yet assuming that it will find what it needs "ready-baked" is reckless.

When Emmens blew the company's entire cash pile on the TKT acquisition last March, many investors got the jitters; some walked; headlines hurt. Most observers thought Shire had overpaid: there weren't even any synergies or cost savings. As TKT's later-stage products start to reach the market, however, and as its mid-stage projects progress, investors and analysts have started to admire the TKT deal. And given the generic threat to Shire's leading attention deficit hyperactivity disorder (ADHD) amphetamine/dextroamphetamine drug (Adderall XR), which comprises more than half its $1.3 billion of sales, many admit they'd rather Shire had TKT's assets than not.

Shire has taken the strategic risk of buying a biotech firm, and it has not only survived, but thrived. Its shares have risen by more than 60% since the TKT deal. For a specialty pharma firm to reap such a reward despite moving so apparently far from its original business model is probably unique. Valeant Pharmaceuticals International (formerly ICN Pharmaceuticals), for instance, tried to step up its R&D activities several years ago, but its pipeline progress left investors unimpressed. The share price suffered throughout 2004 and 2005; only when the group announced recently that it was cutting back R&D and returning to specialty pharma did the stock recover slightly. Shire itself was brutally punished when it tried a similar strategy four years earlier, buying Canada's BioChem Pharma. [See Deal] Thus, it is difficult to overstate the importance of the model that Shire provides for the specialty pharma world, and, by extension, for the commercial-stage and near-to-market biotechs that will likewise have to satisfy shareholder expectations for earnings growth while backfilling a pipeline.

Tackling TKT

On the face of it, Shire's acquisition of TKT shouldn't have attracted so much criticism. TKT came with two approved drugs, agalsidase (Replagal) for Fabry's disease and epoietin delta (Dynepo) for anemia, plus a handful of near-to-market projects. These products would help Shire reduce its dependence on Adderall XR, a product whose overwhelming success has created follow-on problems of its own, not the least of which is the threat of generics. Shire has been building and buying ramparts around Adderall XR, for example, licensing-in NRP 104, an amphetamine pro-drug, from New River Pharmaceuticals Inc. and two once-daily patches from Noven Pharmaceuticals Inc. It has also advanced its own SPD 503 into Phase III to procure a stake in the non-stimulant market, and SPD 465, a longer-acting Adderall XR. [See Deal][See Deal][See Deal] (See Exhibit 2.)

But it wasn't—and still isn't—clear how successfully Shire could switch sufficient patients onto these alternatives once Adderall XR went generic. So with its large cash pile, Shire had to do something. But paying $1.6 billion in cash for TKT wasn't the something investors wanted; at least, they didn't think so back then. Notwithstanding its marketed drugs, TKT was a loss-making biotech, focused on protein drugs (with which Shire had no experience). Its CEO didn't want to sell, just as some of Shire's investors didn't want to buy. Emmens was criticized for overpaying for an asset which appeared to sit oddly alongside his stated low-risk "search and development" strategy. (See "Shire/TKT: The Price of Diversification," IN VIVO, May 2005 (Also see "Shire/TKT: The Price of Diversification" - In Vivo, 1 May, 2005.) and "Shire: Proving the Specialty Model," IN VIVO, April 2005 (Also see "Shire: Proving the Specialty Model" - In Vivo, 1 Apr, 2005.).)

After all, this was the strategy on which Emmens promised to focus when he joined Shire in March 2003, in reaction to his predecessor's ill-fated attempt to broaden out beyond development-stage products into earlier R&D. Shire's previous CEO, Rolf Stahel, paid richly—albeit with highly valued paper—for BioChem, on the basis that Shire needed to secure a supply of homegrown products. (See "Shire Shifts Upstream," IN VIVO, March 2001 (Also see "Shire Shifts Upstream" - In Vivo, 1 Mar, 2001.).) The deal ended Stahel's reign. Most of the assets, apart from a valuable royalty stream, have since been sold off.

Investors feared Emmens was doing another BioChem, sacrificing the earnings-driven mantra that attracts them to spec pharma for a riskier, costlier, biotech-like proposition. Some, such as Britannic Asset Management, revolted, declaring this a "bad deal, which is at total odds with the declared strategy of the management." Negative press headlines followed. (See Exhibit 3.) Shares fell 10% in the fortnight following the TKT deal announcement, just as they had after the BioChem deal. "The TKT deal marked something of a U-turn on R&D," notes Robin Campbell, PhD, an analyst at Jefferies International.

Adapting to the New Spec Pharma World

Shire had no choice, however, but to seek product sources beyond its traditional hunting ground. The boundaries of specialty pharma are shifting, in part because those of biotech and Big Pharma are, too. These categories are less distinguishable because firms within each of them are all looking to in-license niche drugs: biotech is buying in products to supplement their R&D and to keep investors happy, Big Pharma are being forced into specialist fields as primary care blockbusters run dry.

That's squeezing specialty pharma in the middle, forcing it to think more cleverly, and radically, about where and how it finds new growth sources. Like Shire, other specialty pharma have chosen the upstream R&D route, too: Cephalon Inc. last year resurrected some of the research on which the company was founded to create a cancer pipeline, though it surrounded its own assets with marketed or near-to-market oncology candidates from Salmedix, which it acquired, and from Cell Therapeutics Inc. [See Deal][See Deal] (See "Cephalon: Can Spec Pharma Do R&D?" IN VIVO, December 2005 (Also see "Cephalon: Can Spec Pharma do R&D?" - In Vivo, 1 Dec, 2005.).) Meanwhile, Forest Laboratories Inc. , too, has brought discovery-stage assets on board, signing a deal last year with Hungary's Gedeon Richter Ltd. that included, alongside a Phase II compound for neuropathic pain, a series of preclinical CNS candidates. [See Deal] The year before, it committed to a discovery-stage deal with ChemoCentryx Inc. to uncover small molecules in the autoimmune and anti-inflammatory areas. [See Deal] Forest desperately needs to build a franchise behind antidepressant escitalopram (Lexapro), which is facing generic competition but which currently accounts for more than half of Forest's sales.

Moving upstream in R&D isn't the only way spec pharmas can expand their profits. Smaller companies can also expand their market horizons—growing by moving from specialist markets, for example, onto the edges of primary care. Additional risk, certainly—but perhaps lower risk than the scientific uncertainties of R&D. Thus pain-focused Endo Pharmaceuticals Holdings Inc. felt it couldn't afford an aggressive move into R&D without denting earnings and frightening off investors. "We had to do something different in order to compete," president and CEO Peter Lankau told the audience at PSO. "So we're dipping our toe into primary care, in a specialty fashion," he added, going for Big Pharma's products but not their patients. Thus Endo hopes to capture part of the massive triptan market with frovatriptan (Frova) by promoting the drug's effectiveness in menstrually associated migraine. (See "Endo: Accessing Primary Care Through Specialist Marketing," IN VIVO, December 2004 (Also see "Endo: Accessing Primary Care through Specialist Marketing" - In Vivo, 1 Dec, 2004.).)

Managing a Gradual Transition

The shifting sands of the biopharma landscape may be obvious to specialty pharma CEOs, and so might the appropriate strategic moves. But CEOs need to bring their investors along, too--investors who are fearful of change and of any earnings drop-off. That means adopting a gradualist approach, along the lines of Endo's toe-dipping, rather than announcing any radical change of tack.

Indeed, companies that have tried to shift strategies more suddenly, in one fell swoop, have usually failed. For example, profitable but pipeline-poor spec pharma Enzon Pharmaceuticals Inc. tried to build a road back to R&D, attempting to merge with the unprofitable but research-rich NPS Pharmaceuticals Inc. [See Deal] Enzon's value-oriented shareholder base revolted, as did NPS's shareholders, who were willing to accept the risk of blockbuster product development in return for potentially substantial rewards, which they certainly didn't want to share with Enzon. The deal fell off the rails—Enzon remains, three years later, pretty much the same company it was before its attempted transformation, albeit with new management.

In contrast, Shire's management has provided, in the year post-TKT, one of the best recent examples of how to successfully manage investors' expectations during times of change. First lesson: don't make the change look too obvious. Hence Emmens' insistence that TKT represents not a U-turn but rather a logical expansion of the company's revenue-base and therapeutic-area focus. "Our strategy has not changed," he told IN VIVO. The company is still focusing on lower-than-average risk, specialist products. TKT's products serve narrowly defined, often orphan markets. And TKT (re-named Shire Human Genetic Therapies ) is mostly about development, claims Emmens, adding that Shire has just two people doing research. "I wouldn't say this is a significant step into research."

It's a step into research nevertheless: TKT has given Shire a gene activation technology for reproducing naturally occurring enzymes; it has given it preclinical compounds, NMEs. The point is that it's low-risk research. The problem with research "as you usually think about it is that the attrition rate is so large," says Eliseo Salinas, MD, CSO, and EVP Global R&D at Shire. "That's why we used to say we didn't do discovery, and it's also why we bought TKT" with its lower discovery risk. "They look for proteins missing in rare genetic diseases because they know the proteins work. We might buy another discovery company tomorrow—but if we did it would have to be low-risk discovery," Salinas adds.

And paradoxically perhaps, the addition of TKT's earlier-stage programs will balance out Shire's overall pipeline, allowing Emmens to fulfill his promise of reducing R&D spend, which has recently crept up to an above-average 20% of sales. But Salinas notes that this level of R&D spending is anomalous, entirely due to Shire's unbalanced pipeline—heavily weighted to the expensive, late-stage end. "In the last 12 to 18 months, we've submitted five or six drugs," says Salinas, including two TKT drugs, idursulfase (Elaprase) and Dynepo. "You were catching our pipeline at its most expensive point," he adds. But going forward, thanks largely to TKT's upstream assets, the pipeline "is far more balanced—we've got projects at preclinical, Phase I, II, and III, so we don't have the same spending needs," Salinas continues.

Balancing out the Shire pipeline will create a wider mandate for in-licensing, too. TKT brings not only its own new programs in rare genetic diseases, but it also brings the expertise that will allow Shire to broaden its traditional in-licensing activities in terms of therapeutic area, stage of development, and risk. "We'll be in-licensing across the spectrum—not all late-stage drugs, and not all the same kind of low-risk products which for us were improved versions of existing drugs," says Salinas. Shire's more diversified in-licensing program will comprise going after early-stage products, which are cheaper than late-stage ones, and also, "some higher-risk—though not high risk—projects, which are also cheaper than low-risk," Salinas adds.

And although Shire's high R&D spend might have caused some discomfort among investors, it has also helped the company keep the front-end product news-flow going throughout the TKT aftermath, including, critically, news-flow around TKT's own later-stage products. This is the second lesson from Shire's experience.

Elaprase was filed in November 2005 with the FDA for Hunter's syndrome, silencing concerns as to the quality of pivotal data for this drug, unknown prior to the acquisition. A month later, the product was filed in Europe. Meanwhile, Shire's own pipeline was progressing, with the December filings of ulcerative colitis treatment mesalazine (Mesavance), based on an extended-release delivery technology, and of NRP 104. And it continued to keep its older products alive, with a prolonged-release formulation of Alzheimer's drug galantamine (Reminyl XL), which was approved in the UK and Ireland, and higher-dose approval for lanthanum carbonate (Fosrenol), in end-stage renal disease.

Yet when Shire sold off its drug delivery business, Shire Laboratories Inc., in January 2006, it didn't make a song and dance about it. After all, drug delivery was the low-risk principle on which Shire was originally built, allowing it to create drugs including Adderall XR, and carbamazepine (Carbatrol) for epilepsy and its extended-release version Equetro. The company didn't want to be seen as backing away from the notion of lower development risk, so the sale, which led to the creation of Supernus Pharmaceuticals Inc. (a company that also describes itself as a specialty pharmaceuticals) was announced only in a Supernus press release.

Emmens presents that sale as an example of "pruning the tree," which, he adds, "is just as important as planting or buying new ones." Indeed, he sold off a number of earlier-stage assets as part of a re-focusing drive, including the early-stage vaccines R&D at BioChem, as well as programs in HIV and oncology, which fell outside the priority CNS, gastrointestinal, and renal fields.

Perception Matters

Still, the divestment of drug delivery was important symbolically, marking a shift in Shire's evolution, and in investors' perception. "We are now seen as a real pharmaceutical company," says Emmens, "not a drug delivery company that got lucky."

In other words, perception counts for a lot. It determines what you can and can't get away with. Presenting the necessary changes in a well-controlled manner while maintaining strong front-end news-flow and top-line earnings growth has allowed Shire to keep (most of) its investors on board. "If they'd been more overt [about selling the delivery business shortly after buying TKT], this might have scared investors," remarks Jefferies' Campbell.

Analysts now admire the TKT deal, describing it as a smart strategic shift, with acceptable risks. (See Exhibit 4.) And this means that Shire's management is able to introduce more R&D-style vocabulary into their analyst meetings. "They're now more comfortable admitting their interest in TKT's pipeline," says Nomura Code analyst Paul Diggle. And they're more comfortable admitting their upstream goals: to initiate three research programs and put one product into the clinic each year, starting in 2007.

Since the initial, negative reaction to TKT, Shire has seen its shares soar despite the increased R&D spend and despite the fact that the TKT deal won't be accretive until late in 2007. "Shire's management has done a fine job in transitioning the company," sums up Andrew Forman, senior analyst and managing director at WR Hambrecht & Co. in New York.

Emmens isn't taking all the credit, though: he claims that investors' attitudes are shifting, too, and not just toward Shire. "It used to be popular to give cash back to investors, but now they're encouraging us to invest," he says. And dilution isn't a no-no anymore; "we're no longer asked, so much, whether this [deal] will be dilutive." That's good news for other spec pharmas that are contemplating moves similar to Shire's. But unlike all other spec pharmas, Shire is uniquely advantaged in its investor base. It's the third-largest pharmaceutical company listed on the London Stock Exchange (the other two are AstraZeneca PLC and GlaxoSmithKline PLC ). As such, "there's a scarcity factor," notes Forman. "Many index fund managers have to own the stock," presenting somewhat lower downside risk. Most spec pharmas are much more thinly traded, with far less diverse investor bases. That's why a few disgruntled investors can kill a new spec pharma strategy—once they sell their holdings, it's obvious. That's why, as with the Enzon/NPS deal, a few investors abandoning the company can kill an important strategic initiative.

Execution Risk Remains

But even with Shire's shareholder advantages, Emmens knows he needs to get growth back on track. He's promising a return to the heady growth of yesteryear, predicting 15% growth by "late in this decade." This prospect is now possible, even probable, given that he's persuaded investors to take their eyes off the short-term profitability ball for just a second.

But to achieve that goal, Shire will have to successfully execute its plan to remain a leader in the ADHD segment after the arrival of generic Adderall XR, whenever that happens. It will also have to oversee relatively smooth launches of its next round of products and prove its mettle in marketing, as well as developing, biologics. "Many assume that Shire has had five or six successful launches, but actually the last two were failures," says Jonathan Senior, an analyst at Evolution Beeson Gregory. Fosrenol, which had already suffered long delays at the regulators, "plateau-ed out after patients switched from trial to commercial drug, and Equetro sold just $5 million in 2005," he points out. And then there was the delay to its methylphenidate transdermal system (Daytrana), which has only just received FDA approval after an already amended submission in June 2005. "Shire needs to get better at delivering," concurs Karl Keegan, an analyst at Canaccord Adams.

And although the biologic assets at TKT may be lower-than-average risk in development terms, many of them also serve much smaller markets than average—such as Hunter's syndrome or Fabry's disease. Dynepo's an exception, but it faces competition from experienced biologics marketers such as Amgen Inc. and Roche , which have more convenient follow-on versions of EPO, and from potential biosimilars. "Has Emmens traded clinical risk for commercial risk?" asks Senior.

Most importantly, Shire will have to manage the patent situation and potential generic competition for Adderall XR. Shire has covered all its ADHD bases thoroughly, though, with products lined up for all of the segments: pediatric, adult, stimulant and non-stimulant, and long-acting and even-longer-acting. It created the ADHD market, so it more likely than not will retain it, one way or another. And, besides the non-ADHD franchises Shire has already built—in renal and gastrointestinal, for instance---it now has TKT.

TKT has changed Shire, but not beyond recognition. It's sticking to its specialist focus, and it will continue in-licensing alongside investing in R&D. For now, that means small R and large D. But who knows for how long? "All companies should continually be morphing" to adapt to external conditions, Emmens told the PSO audience. Shire has shown it can manage investors' expectations through a significant transition. That has to be the most valuable skill in today's changing landscape.

Sidebar: All About Adderall XR

The Generic Threat

Barr Laboratories Inc. , Colony Pharmaceuticals Inc., Impax Laboratories Inc., and Teva Pharmaceuticals USA have all filed Paragraph IV letters, starting in 2003. Barr was first to file. Shire settled with Impax in January this year, granting the company rights to sell a generic version in the US starting no later than January 1, 2010. Impax will pay Shire sales royalties on the generic product, and it may become Shire's authorized partner should another company launch a competing generic. In other words, Impax provides a safety net for Shire in case Barr should launch a generic sooner than expected because if this happens, Shire would authorize Impax to market its own version, undercutting Barr's six-month exclusivity.

The situation with Barr is more critical, given its first-to-file status (no other generic can enter the market before Barr). Most analysts expect Shire to settle with Barr, too, allowing Shire to firmly establish NRP 104 before an Adderall XR generic is available. Emmens remains confident that his patents will hold even if no settlement is reached, though. And in any event, given legal delays, Shire's still safe until at least the end of 2007—even assuming Barr wins. So perhaps there's less incentive for Shire to concede anything to Barr. If NRP 104 is approved and launched on plan, in early 2007 in the US, Shire will have at least six months to switch its Adderall XR patients to the new drug. (Back in 2002, it took Shire just six months to convert 80% of patients from Adderall to longer-acting Adderall XR.) Shire will position NRP 104 as having less potential for abuse than Adderall XR because it's administered as an inactive pro-drug.

The Switching Threat

Uncertainties remain, though. The perception of NRP 104 as a safer alternative will depend in large part on the drug's scheduling, which won't be known until after approval. Most expect NRP 104 to receive a looser scheduling than the Schedule II Adderall XR, but wider safety concerns around ADHD drugs may scupper that. And even if it does receive Schedule III or more, some question the value of the difference given Adderall XR's established efficacy and strong track record. "Why would little Johnny switch," asks one analyst, "if he's quite happy on Adderall XR and it gets cheaper?"

There may also be a game to play with New River, to which Shire is contractually bound to make "best endeavor" promotional efforts, if Adderall XR survives beyond NRP 104's launch. Nor will Shire's margins on NRP 104 be as good as those for Adderall XR because it will owe New River 25% of profits in the two years post-launch, and 50% beyond that.