Evotec Goes Wholesale

VC firm Oxford Bioscience's deal with Evotec gives its portfolio companies discounted access to the German biotech's screening and chemistry services—but with no obligation.

Nothing is better at bringing out creative deal making than a prolonged bear market. Venture capital firm Oxford Bioscience Partners' three-year agreement with Germany's screening and assay-development firm Evotec AG is one recent example. Oxford thinks it has found a way to help some of its portfolio companies save money and time, while accelerating their drug discovery programs.

VC firms are taking an increasingly active role in helping their companies' management, occasionally through encouraging intra-portfolio mergers—as German-US firm Techno Venture Management (TVM) did last June with VitaResc Biotech AG and Curacyte AG , or, as some VCs are reporting, through talking to each other about potential inter-portfolio tie-ups [See Deal].

The ideal merger often puts together a biology-based business with a chemistry expert: the former needs compounds, the latter targets, assays and pathway understanding. But mergers, when not simply a way of quietly burying investment failures, are enormously distracting—small companies, by and large, don't like to do them. On the other hand, for a biology-based company, hiring the requisite number of chemists and screeners is no easy matter, either. Both kinds of scientists are in high demand and expensive. And few companies are willing to take on additional infrastructure with the financial markets so tightly closed. As an alternative, start-ups turn to chemistry service businesses like Albany Molecular Research Inc. , Array BioPharma Inc. , Discovery Partners International Inc. , or Evotec. But their prices are hardly cheap, particularly given the amount of business these small companies can individually provide.

But Oxford's arrangement pools its portfolio companies' buying power, providing them discounted access to Evotec's drug discovery and development services in chemistry and screening. The first customer, Boston-based Elixir Pharmaceuticals Inc. , has already signed up; but Elixir's CEO Ed Cannon, PhD had already initiated talks with Evotec prior to this deal.

The more companies that follow suit and buy Evotec's services within the three-year deal timeframe, the better the rate for all of them—rather like a wholesaler arrangement. Fees are "calculated on the basis of FTEs per year," explains Joern Aldag, Evotec's president and CEO. "If the number of FTEs increases above a certain threshold, all the companies within the framework will be credited," he says. Pricing works on a sliding scale, so when Oxford companies are together employing 20-30 FTEs, they pay $X each, when it increases to 30-40, their fee will be reduced to $X-n.

For Evotec, the deal provides access to a fairly large customer base (all of Oxford's portfolio companies), with recommendation by an investor; an easier, and cheaper way to gain clients than sending a sales person on a cold call. The arrangement may mean Evotec gets "customers who might otherwise have done assay development, screening or chemistry themselves," adds Aldag.

All of which is good news for Evotec, suffering, like many others, from a bear market that's forcing many of its potential and actual customers to cut back spending—and from the collapse of the Neuer Markt (see "Germany's Biotech Bust," In Vivo Europe Rx, November 2002 (Also see "Germany's Biotech Bust" - In Vivo, 1 Nov, 2002.)). The German group issued a profits warning earlier this year, and cut about 30 staff. Goldman Sachs last week described the company's balance sheet as "ugly", with just €6 million ($6 million) of net cash forecast for the end of this year constraining, in Goldman Sachs' view, the group's ability to finance its operations.

Evotec will need quite a few partners besides Elixir for this deal to make a significant difference to its revenue, profit line or cash flow, points out Goldman Sachs analyst Stephen McGarry, PhD, particularly given the customers' small size. Evotec is negotiating with "several" other Oxford companies, says Aldag. He won't divulge the size of the discount, but it was deeper than the price cuts some other chemistry outsourcers were willing to provide: a variety of Evotec's competitors apparently also talked to Oxford about the arrangement.

In any event, the price was certainly appealing to Elixir's Cannon, heading up a company which has been operating for less than a year. ‘ There's no way we could have started out [otherwise] with Big Pharma quality screening," he says. Evotec presumably intends to make up in volume terms what it may lose on margins, relative to non-Oxford deals. What's more, some relationships could stretch beyond the three-year term of the deal, potentially turning them into more lucrative partnerships.

Not all Oxford companies will likely be interested in Evotec's services, though, whatever the cost. Some, like UK nanotechnology and genomics group [Solexa Ltd.] have technologies of their own; others like Germany's vaccine company Apovia AG say Evotec's services would not be relevant to them.

What's In It for Oxford?

The deal didn't involve any payments, equity or otherwise, between Oxford and Evotec, according to the deal's protagonists. "We've already invested in the future of our portfolio companies" and this deal directly increases the chances of success among many of those firms, contends Jay Luly, PhD, entrepreneur-in-residence at Oxford, through allowing them to spend more time focused on what they're good at: generating targets. "It didn't make sense for all the companies to go traveling around [separately] looking for the right service provider, negotiating rates with them and figuring out how things work," Luly explains.

In fact, the idea for this umbrella agreement was sown when Elixir's Cannon asked Luly for some help with due diligence on service companies earlier this year. Oxford's aim is to simplify that process for its other portfolio companies and, by grouping them together, give them more clout as a customer. Elixir may not have benefited as much as others might from time-savings on due diligence and travel, but Cannon confirms that "the level of attention we got [from Evotec] increased when Jay [Luly] stepped in with the umbrella agreement."

Rob Zegelaar, partner at Atlas Ventures, describes the deal as "an interesting idea." But he, and others, question whether it could lead to conflicts of interest, limiting biotech firms' flexibility to pick whatever choice of screening partner they want. "At the end of the day, management have to decide what deals they want to do, primarily concentrating not on cost but on quality," says Zegelaar. Adds another VC: "Just because Oxford feels that Evotec is the best [for providing screening services] doesn't mean that it's necessarily the best for all of their portfolio companies."

Oxford's biotechs won't have to choose Evotec's services, however. "We're not mandating our companies" to sign up with Evotec or with any other service provider, insists Luly. But the advantage, particularly for younger companies, of having access to one fully vetted service provider, complete with deal structure, and with the already discounted price declining still further the more Oxford companies sign up, will likely influence management decisions nevertheless.

Evotec certainly has the track record to justify the Oxford group purchasing deal. It has ongoing screening deals with GlaxoSmithKline PLC , Pfizer Inc. [See Deal] and Novartis AG [See Deal]. The company also offers assay development, hit profiling, library design, lead optimization, ADMET testing and development chemistry, and has combinatorial library and hit structure determination deals with Merck & Co. Inc. [See Deal], Amgen Inc. and Biogen

Aldag doesn't think the deal will affect its signing up other potential partners outside Oxford's portfolio. He's confident the group can satisfy demand on the short term through shifting staff internally—for example, moving development chemists over to medicinal chemistry, which has been less badly hit by the downturn. "Last year we hired 100 chemists," Aldag points out, adding that the cuts announced in October were in the instrumentation group rather than in the drug discovery arena.

Nor, he claims, will this arrangement reduce flexibility on the structure of individual deals. "Oxford is offering an umbrella contract, with rules for certain generic aspects of each contract," explains Aldag. Beyond that, Evotec will adapt each deal according to the required work plan. "We offer what the customer wants," he concludes. And the lines of responsibility will be clear: Oxford affiliates pay Evotec directly, and the German firm is, likewise, directly responsible to the clients for its services.

The Answer For Evotec?

Yet however well Evotec satisfies its customers, and however many customers it signs up, service deals aren't going to make the German firm a lot of money long-term. Indeed, one risk Evotec runs is that new and existing non-Oxford customers will find out the level of the Oxford discounts and then use them as leverage to ratchet down prices for their own arrangements.

As such there's still speculation as to Evotec's future in its current form (see "Evotec: Putting Its Money on Services," START-UP, December 2000 (Also see "Evotec: Putting Its Money on Services" - Scrip, 1 Dec, 2000.)). "A change of business model is needed," declares one analyst, even though he likes the deal. Another VC's first reaction to the announcement was to ask whether there is a change-of-control provision, should Evotec be acquired. If there is such a clause—the parties involved won't say—Evotec's acquisition valuation could suffer since it won't be able to assure a buyer that it can bring its clients and their business along.

But in the meantime, other VCs will be exploring the Oxford innovation. TVM partner Helmut Schühsler says that in principle he's interested. Atlas' Zegelaar says he's not. Discounts, he says, are common in this environment: "it's not as if buyers [of services] don't have any leverage."

But in the midst of a biotech drought of indeterminable duration, companies need all the leverage they can find. VCs must continue to seek ways to help their portfolio companies conserve cash while progressing on their milestones. The Oxford deal clearly deserves study.

--by Melanie Senior

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