Jazz Pharmaceuticals: The Concept Bet, at a Whole New Level

The press around the size of Jazz Pharmaceuticals' $250 million private financing has obscured the whole point: the company and the financing represent a fundamentally different business model for biopharmaceutical investing and companies: betting on product concepts--not products and not technology.

If you only read the press—of which there was plenty--about Jazz Pharmaceuticals Inc. 's $250 million private financing, [See Deal] all you'd probably have learned is that it was the biggest series B round ever and that the deal represented the debut of Kohlberg Kravis Roberts & Co.—best known for mega-LBOs--into the very unleveraged world of biopharmaceuticals.

And you would have missed the whole point. Jazz represents a fundamentally different business model for biopharmaceutical investing and companies: betting on product concepts—not products and not technology. It is in fact a redefinition of discovery along a Jumpstart model, where the discovery is the therapeutic idea and the tools for its creation are some combination of existing compound and existing formulation/delivery systems.

Or another way of describing the start-up: Jazz is an opportunity to re-do Alza Corp. —the alma mater of the group's top managers—keeping what worked well and dispensing with what worked less well.

What worked well: the product concept—the notion of defining the product characteristics that would satisfy an unmet need, then scouring the pharmacopeia for a compound with a known safety and efficacy profile, and pairing it with an existing delivery technology that addresses the compound's shortcomings in meeting the product concept. Once it is all put together, the product is put through an inexpensive bridging study to establish its bona fides and if it passes that test, it can go on to relatively low-risk pivotal trials.

Take Alza's extended release oxybutynin (Ditropan XL), the incontinence treatment. Says Sam Saks, MD, Alza's former group VP, clinical, regulatory & commercial, then company group chairman after its $13.1 billion acquisition by Johnson & Johnson [See Deal], "We started with a well-characterized delivery system, Oros. We added a drug that had been on the market for years: oxybutynin. So what was the chance that the FDA would say no? Not zero—but not high, either. And then what was the chance we'd fail commercially? Higher than the regulatory risk, but we'd already gone a long way by showing in a single, inexpensive, early experiment that the drug reduced the incidence of dry mouth"—the key problem the product concept addressed.

Jazz's strategy is quite simply to take the product-concept model and free it from the paradoxically restraining bonds of profitability and internal technology. At Alza, investors never wanted to trade-off earnings in order to spend money on internal R&D for Alza's self-developed products. Alza more or less handled the problem through its off-balance sheet, special-purpose funding corporations—but such financing vehicles are virtually impossible to set up today. And the money they provide, by many accounts, is more expensive even than equity.

But if the profitability problem is well known to many biotech CEOs (see "Enzon: The Perils of Profitability," IN VIVO, April 2004 ), the notion of technological constraint is hardly intuitive. Drug R&D always begins with a proprietary compound or, at least, a proprietary formulation or delivery technology that can be used on many products.

But for Sam Saks, Jazz's CEO, there are few drug delivery technologies which really lend themselves to multiple blockbuster uses. "People with a technology are looking for what the technology can do; people with compounds are looking for the same thing—whether the compound is perfectly suited for the use or not." At Alza, says its former EVP and COO, and now Jazz executive chairman Bruce Cozadd, "we had to maximize particular technology investments,"—that is, find uses for the technologies Alza had developed. Adds Saks: "Every company talks about meeting unmet need but if you start with a particular NCE or technology base you'll be pulled in that direction. That's how we got products like scrotal Testaderm"—the famously unsuccessful testosterone patch. "Our goal at Jazz is really to be market focused."

That market will be in neurology and psychiatry, which has a history, Cozadd and Saks say, both of using modified versions of existing compounds for new indications or of seeing different specialties use the same formulation for different diseases. Saks cites Alza's own fentanyl patch (Duragesic) for pain; the compound was originally used as an anesthetic. GlaxoSmithKline PLC 's bupropion (Wellbutrin) for depression was reformulated into Zyban, for smoking cessation. Divalproex (Depakote) is prescribed for epilepsy by neurologists and for biopolar disorder by psychiatrists.

The downside of Jazz's approach will be its need for collaborators. Thus, Jazz's technology licensers will take part of the revenue stream—a cost they hope to off-set with greater revenues thanks to their freedom to choose more important products.

The collaboration requirement will also force Jazz to create a core competency in partnering—an area in which Alza, says Saks, did not shine.

On the other hand, there's plenty of technology available because the business remains a buyer's market. Drug delivery dealmaking has increased over the past 10 years but not really over the past four (see Exhibit 1) and deal valuations still dramatically lag those of other biotech deals (see Exhibit 2). "Companies are ready and willing to partner," says Saks, "without taking a huge piece of the gross margin."

To kickstart the process, Jazz will in-license marketed or market-ready products in its neurology/psychiatry niche. Cozadd figures the company can earn a decent return on those products, with the returns rising as they bring on additional drugs. They also want their commercial operations smoothed out by the time their own self-developed products are ready for launch. And finally, they see a commercial presence as increasing their attractiveness as an in-licenser--for marketed products, certainly, but also for development candidates. Competing for compounds with existing specialty pharmaceutical companies like Shire Pharmaceuticals Group PLC , Cephalon Inc. and King Pharmaceuticals Inc. , Jazz will need to match their commercial capabilities even as it thinks its development skills will give it significant partnering advantages.

All this in-licensing and clinical work is expensive—the reason Jazz executives wanted to raise as much money as they did. "Each product will cost us a minimum of $50-70 million to get it to market," says Cozadd, so the company will need several times that amount to avoid dependence on a single lead drug.

That kind of money put Jazz well out of the range of venture capital. Its original VC investors, Prospect Venture Partners and Versant Ventures, put money into the series B but will now own a relatively small share of the whole while newcomer KKR will dominate the investor group. The issue clearly concerns VCs we've spoken with, in part because, long-range, companies like Jazz may set a pattern for the highest quality start-ups: huge investments in R&D focused companies whose returns are less risky and shorter-term than the traditional VC-funded biopharma. Only a handful of VCs today have the funds to compete in a world now dominated by private equity funds like KKR, The Blackstone Group and The Carlyle Group, all of whom have shown increasing interest in the pharmaceutical business.

Indeed, KKR had never previously gone into drug-company investing because the returns, says Cozadd, looked too risky and took too long to realize. "But our approach to product development puts our timelines in the range of 4-5 years, not 10-12; we spend in the millions of dollars, not the hundreds of millions; and—as we did with the Ditropan dry mouth test--we do the critical experiments early, killing those projects that don't work and putting our bets on those that are more likely to."

Jazz also raises another concern for VCs—that their bets on drug delivery, an increasingly popular area of investment, are riskier than they originally figured. At the April 1-2 Start-Up Symposium in Boston, Alan Frazier, founder and managing partner of Frazier Healthcare and Technology Ventures, described his conversation with Sam Saks as "almost chilling when he told us that you'd get maybe one or two products, maximum, from a single drug delivery technology."

Of course, Jazz brings a new kind of investment risk, particularly given the amounts of money involved. This is the largest venture bet ever on a team. The company has few if any assets—certainly none that it's advertising—beyond the concept and the managers. And if VC today is increasingly all about management, and less and less about the products or technologies they begin with, Jazz takes that concept to a whole new level. There's plenty of materials available to build houses, its advocates argue: what's needed are architects with the right ideas for the right locations.