Article courtesy of bob zagorin from the SQNA thread:
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Emerging Drug Discovery Technologies
>>Part I: High-Throughput Screening (HTS) Systems -
Tools for the Next Wave of Drug Discovery
August 28, 1997
by Paul E. Kelly
Introduction
Screening, as the term is used in the drug discovery process, refers simply to the testing of large numbers of candidate drugs to identify which of them have potential pharmacologic activity. The drive to develop and implement high-throughput screening (HTS) procedures derives from three interrelated forces:
Combinatorial chemistry and genomics have combined to expand exponentially the demand for screening and are expected to continue to do so for the foreseeable future. We anticipate that high-throughput screening technologies will become essential tools for drug discovery companies to keep pace with continually escalating screening demand.
Genomics, functional genomics, and signal transduction research often uncover potential drug development targets that require extensive further investigation, or validation, before they can be used in drug discovery. Tens of thousands of such targets should emerge over the next half decade. The current validation process can consume two to four years. Several new screening technologies have been developed that promise to accelerate target validation and hence to circumvent this looming bottleneck in drug discovery.
In parallel, new and emerging molecular genetic technologies promise to uncover the fundamental pathophysiologic processes of many human diseases, thereby enabling the development of an entirely new generation of pharmaceuticals precisely targeted to disease mechanisms and potentially both safer and more effective than many of the drugs that are now available. Pharmaceutical companies that falter in the race to develop molecular medicines risk becoming obsolete early in the next century. High-throughput screening technologies will, in our view, become essential tools for translating new disease targets into novel pharmaceuticals. We anticipate, therefore, that competitive forces within the pharmaceutical industry will lead to the rapid acceptance and implementation of high-throughput screening technologies.
In our view, the best of the emerging high-throughput screening technologies have the potential to become enabling in and of themselves, and therefore to command for the companies that are developing them a significant portion of the earnings potential of 21st century pharmaceuticals.
We divide high-throughput screening into two sectors: (i) HTS hardware, which comprises developers of dedicated HTS workstations and companies devising laboratory chips, miniaturized reaction vessels constructed with silicon chip technology, and (ii) novel screening technologies, unique assays or approaches to screening that either open up new avenues of drug discovery or convert hitherto laborious screens to high-throughput formats.in
Model Business Plans
There are three operating models that are open to HTS companies:
1) The sale of products and/or services to generate near-term income. Most biotechnology companies have no capability to generate real earnings unless and until the drugs that they are developing reach the marketplace. The ability to decouple revenues from the drug development and regulatory review process is one of the most attractive features of HTS companies and makes them much more akin to high-technology than biotechnology.
2) Engage in collaborative arrangements to develop HTS technology, to discover novel targets, or to develop new drugs while maintaining cash burn at reasonable rates. Given that it can cost several hundred million to get a drug onto the market and that the riskiness of drug development largely precludes biotechnology companies from raising that much money in the public markets, collaborative R&D has become the norm in the industry.
A number of HTS companies have engaged partners to help them develop their HTS technologies, generally in return for a limited period of exclusivity once a product has been realized. Many of the HTS companies described in this report seek or have established collaborations in target and/or drug discovery. These arrangements are feasible when the HTS company brings a unique technology or capability into a collaboration. When the collaborator is a pharmaceutical company, it typically covers most or all of the R&D costs of the joint projects, makes milestone payments that increase in size as jointly developed drugs work through the development and regulatory process, and normally agrees to some form of shared marketing rights or royalty payments on drugs that successfully reach commercialization. R&D payments usually do not bring a company near the break-even point, and only late-stage milestone payments are normally sizable enough to push a company into the black, and usually then only temporarily.
The typical biotechnology company has only a limited technology base and a handful of drugs, if that, in development, so the opportunity for collaboration is also limited in extent. A trait that HTS and combinatorial chemistry companies share is that they generally have a much greater capacity for collaboration than a conventional biotechnology company. They have the potential, therefore, to generate larger portfolios of developmental drugs than the typical biotechnology company, to be exposed to lesser overall development risk because of that larger drug portfolio, and ultimately to receive greater royalty income.
3) Conduct in-house target and/or drug discovery. A few HTS companies endeavor to fund their own drug and/or target discovery programs. Most such projects, should they prove promising, are likely ultimately to be partnered simply because of the high costs of drug discovery and development. The income potential from product sales and services, however, could enable a few companies to fund discovery programs to a greater extent than the typical biotechnology company could afford.
One of the more attractive features of most HTS companies is that they can engage in all three modes of operation to create a melding of high-technology and biotechnology-like business models. The best business plans, in our view, are aimed at producing attractive near-term income somewhat like high technology while they preserve the potential for typical biotechnology-like returns over the longer term, potentially with much lesser development risk than is the norm in biotechnology.
Investment Considerations
In our view, there are several key variables to consider in making an investment decision in an HTS company:
1) The Business Model To what degree can the company incorporate the near-term earnings potential of a high-technology firm while preserving the longer-term potential returns typical of a biotechnology company? The most attractive business models, in our view, combine significant and near-term earnings potential from product and/or service sales with the risks and rewards of drug discovery. On the latter point, the average royalty rate, any co-marketing agreements, and the ultimate size of the drug candidate portfolio to be developed are the critical valuation parameters. The number of corporate collaborators and the total amount of collaborative R&D revenue can be rough proxies for the size of the drug development portfolio that a company will develop. The market appears to use collaborative R&D revenue as a valuation parameter: Public drug discovery companies such as genomics and combinatorial chemistry firms tend to trade on average at about a 20 multiple to collaborative R&D revenue.
For companies ultimately dependent on new drugs to reach profitability, another key question is whether or not the business model allows for a decade or so of cash burn without excessive dilution. A second key consideration is the quality of a company's corporate partners, specifically, the partners' track records in moving drugs through the clinic and on to the market.
2) Is the Company's Technology Enabling? Enabling HTS technology either opens up new avenues of target identification, target validation, or lead optimization, or it permits such an increase in throughput that it confers a competitive advantage on those companies that utilize it. Throughput can be accelerated simply by increasing the number of assays that can be conducted per unit time, and it can be significantly improved by reducing or eliminating the time now spent on assay development. The royalty structures and milestone payments that an HTS company can negotiate will depend, in large measure, on the degree to which prospective partners consider its technology to be enabling.
3) What are the Barriers to Entry? Another way to ask the question is, "What will prevent a company's products - hardware, assays, or research services - from becoming commoditized?" Barriers in the form of patents and trade secrets may limit competition in the laboratory chip arena, they may delay it for some period of time with the novel screening technologies but there are almost always multiple approaches to assays, and they should be of even lesser importance to companies developing evolutionary HTS hardware because of the difficulty in making a truly fundamental and commercially important breakthrough in the design or engineering of laboratory equipment.
4) Is the Revenue Opportunity Sustainable? Or, in other words, what is the longevity of the technology? With multiple potential solutions to most assay problems, novel assay technologies are likely to have only a limited window of time in which they represent the only or the best approach to a particular aspect of drug discovery - they ultimately will become commodities. Companies with such technologies then either have to use their window of opportunity to stockpile items of potentially enduring value, such as drug leads or novel drug targets, or commit themselves to a continuing effort of technological refinement so that they always define the technological envelope.
Manufacturers of evolutionary HTS hardware face the same principal business challenge that computer makers, for example, face, namely to compete always on performance and price.
5) How Large is the Market Opportunity? The baseline near-term market opportunity for HTS companies is the better portion of the $5.6 billion we expect to be spent by drug discovery companies this year for screening and routine toxicology testing. Some companies can expand this opportunity through applications of their technologies to other aspects of the drug discovery and development process, namely in target identification, target validation, and lead compound optimization. Laboratory chips have applications outside of drug discovery and development, including in diagnostics, environmental testing, drug delivery, and consumer uses.
Longer term, the greatest revenue opportunity lay in capturing some of the commercial value of drugs discovered with the aid of HTS technologies. The greater the portfolio of candidate drugs that an HTS company can construct, or to put it differently, the greater the number of partners or projects that a company can pursue, the greater the potential return. There is additional value in the in-house discovery and validation of novel targets and drug leads.
6) What will Sustain Share Price? The HTS companies with real near-term product and/or service revenue opportunities have the potential to forge attractive valuations on earnings while waiting the decade or so necessary for any payoff from new drugs reaching the marketplace. Companies without real near-term revenue opportunities except R&D support (which normally does not completely cover a company's burn rate) will have to have a continuing series of meaningful events - new collaborations over the near term, for instance, and ultimately Phase II or later-stage clinical trial data - in order to sustain share price until revenues from new drugs start to flow in.
The above is a short excerpt of "Emerging Drug Discovery Technologies". If you would like a complete copy of Paul Kelly's recent report, please contact your VBW&Co. account executive.
Paul Kelly joined Volpe Brown Whelan & Company in 1997, covering Biotechnology/Drug Discovery industry. Paul previously worked as an Analyst with UBS Securities where he followed biotechnology firms for three years. Before that, Paul worked as an Analyst for Mabon Securities. Paul received his M.B.A. from University of Rochester. << |
