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San Francisco Business Times
From the September 5, 2005 print edition
Inventing a new bio model
Exelixis' financial prowess matches its scientific skills
Daniel S. Levine
In a glass room on the ground floor of a building behind the executive offices of Exelixis, a yellow robotic arm spins with precision.
The arm grabs trays, filling grids of tiny wells with minute amounts of compounds in search of ones that might show activity against a disease.
The robot does this 600,000 to 1 million times a day, screening a library of more than 4 million chemical compounds for evidence of activity against a target disease. It's a methodical approach, like carefully taking a haystack apart straw by straw to find a needle.
In a year's time, the South San Francisco-based company will screen its library of compounds -- large enough to rival those of major pharmaceutical companies -- against about 30 targets. The process will identify a handful of compounds of interest, about three of which will make it into the clinic.
Founded in 1994 as a genetics company working on the fruit fly and other model systems, Exelixis has married its early strength in performing high-throughput genetics with high-throughput chemical screening to become an emerging drug development powerhouse.
Its methodology is a reflection of Exelixis CEO George Scangos' willingness to break with conventional thinking. For example, Scangos didn't believe other genetics companies' pursuit of a single animal model for disease made sense. So he built a virtual zoo of creatures to find genes that underlie specific diseases. And while most pharmaceutical companies consider libraries of a few hundred thousand compounds adequate for drug discovery, Scangos set out to build one 10 times larger, believing that even slightly different compounds can generate signficantly different results.
Exelixis' creativity and willingness to challenge convention on the scientific side is matched on the financial side. It needs to be: Exelixis' ambition is to become one of the top five biotechnology companies and it knows it will have to spend heavily to get there.
Though the company is not averse to conventional financings -- it recently completed a $50 million secondary offering -- the capital markets are just one source of financing and not necessarily the preferred one.
"Most biotechs take a look at how much cash they have and the board takes a look at how long that should last and prioritizes," said Scangos. "We look at what kind of company we want to be. We don't let our money drive our goals. We let our goals drive our company."
The cost of being productive
Exelixis has already built a drug discovery engine of enviable productivity. The company filed with regulators to begin clinical trials on three compounds last year, will file for a total of three this year and roughly three more next year. By the end of 2005, the company expects to have eight compounds either in the clinic or ready to begin clinical trials. When all of the drugs' indications are considered, Exelixis could be conducting twice as many clinical trials simultaneously.
"It is interesting stuff," said John McCamant, editor of the Medical Technology Stock Letter of Exelixis' approach, "but it does cost a lot of money."
The company expects to spend $180 million to $185 million this year and will spend roughly $200 million a year for the next five years. Its willingness to spend has not always been appreciated by Wall Street, which keeps a careful eye on burn rates of biotechnology companies and a jaundiced one on ambitions of companies like Exelixis to become top biotech firms.
"We have big goals and a big vision to become one of the leading biotechs," said the company's chief financial officer, Frank Karbe. "You can't save your way to becoming the next Genentech."
Being creative
From the start, Exelixis has been both opportunistic and willing to seek financing in atypical places. In fact, its first round of funding didn't come from conventional venture investors, but another biotechnology company and an investment bank not known for doing early-stage financings.
It's not that Exelixis likes to shop for unusual deals. But it has been good at recognizing opportunity when it presents itself. For instance, at the end of 2001, the company struck a deal to purchase Genomica Corp. in a stock swap. The maker of software for research seemed destined for failure because of the limited market it faced. What it had going for it, though, was $110 million in cash. It approached Exelixis, which acquired the company, kept the cash and shortly after sold off the software.
"You've got to have the creativity on the financing side or you are going to shut down the research side," Scangos said.
So in 2004, when the company needed a new CFO, Scangos recruited Karbe.
An investment banker at Goldman Sachs, Karbe was about six months away from becoming a managing director, but was lured by the potential of Exelixis.
His investment banking background provides a different perspective than that of a typical biotech CFO, who might choose to conserve cash by focusing financial resources on a company's lead compounds.
"My job is not to slap people on the fingers and say, 'You spend too much money,' " he said.
Karbe talks about the financial strategy of Exelixis as having four pillars -- and the capital markets represent just one of them.
During the second quarter of this year, Exelixis raised more than $180 million through its various deal-making maneuvers, none of them involving a venture investor or the stock market.
Old becomes new
The activity included convincing partner GlaxoSmithKline to accelerate a $30 million milestone payment. GSK had put Exelixis on the map in 2002 with an alliance worth up to $480 million. But Exelixis' threatened to become a victim of its own success.
Because the company was identifying and advancing compounds faster than it or GSK had expected, Exelixis was running out of money to pursue them all.
Karbe told the pharma giant it needed more money to fund the development project or it would have to hit the brakes on some of the projects.
GSK not only accelerated the milestone payment, but it also allowed Exelixis to raise outside money against compounds covered in their agreement. GSK has the right to select up to three compounds from 12 programs now in development, but must decide to exercise its option when a compound is early in a mid-stage clinical trial.
Getting GSK to accelerate its milestone solved the immediate problem, but it left the challenge of raising money against compounds GSK had an option to claim as its own without creating significant dilution for shareholders.
Part of the solution Exelixis hit upon came in June through an agreement with Symphony Capital Partners, a New York private equity fund. A subsidiary, Symphony Evolution Inc., will provide up to $80 million to Exelixis to conduct clinical trials for the three compounds. Exelixis has licensed the drugs to Symphony, but retains exclusive rights to them through a purchase option. Symphony will have the right to purchase up to 1.5 million shares of Exelixis' stock for $8.90 each, but the arrangement provides financing for mid-stage clinical trials without significant dilution, and off-loads the risk of the compounds.
If the clinical trials are successful, Exelixis can buy back the compounds for a compounded annual rate of return of 25 percent to Symphony. If the compounds fail in the trials, the company hasn't spent money on funding them and has no obligation to buy them back. Exelixis expects to use the same mechanism to finance the clinical trials of other compounds as they advance through their pipeline.
"We think these are attractive compounds with multiple shots on goal. The markets are so huge, there'll be a strong incentive to buy us out," said Mark Kessel, Symphony's managing director. "We're one of the reasons they are hopefully able to turn out a lot of compounds."
Many tools in the box
Two other deals Exelixis made during the second quarter illustrate other prongs of its financing strategy.
On the same day that Exelixis announced the Symphony deal, it also unveiled an agreement with the Swiss pharmaceutical Helsinn Healthcare S.A., which obtained a worldwide license for Exelixis' late-stage candidate to treat bile duct tumors.
The deal gave Exelixis $4 million in cash and milestones up to $21 million. Perhaps more importantly, the agreement calls for Helsinn to assume the cost of the clinical trials under way in 50 centers in North America and Europe. That frees Exelixis to use its financial resources to develop compounds in early- and mid-stage trials. Exelixis has the right to reacquire the North American rights to the drug.
Exelixis has also been able to capitalize on assets it is not able to make full value of on its own. Though the company has built strength in developing small-molecule drugs, it does not have the resources to develop monoclonal antibodies.
It has, however, identified targets for cancer and other diseases on the cell surface that would be attractive targets for monoclonal antibodies. Rather than let the intellectual property languish, the company in June announced a collaboration with Genentech that gives Exelixis $16 million in up-front payments.
"At the end of the day, we will need a lot of money over the next few years," said Karbe. "It won't be just one answer."
The plight of pharmaceuticals
To keep raising the money it needs, though, Exelixis has to continue to deliver. Wall Street and others will be watching closely to see what happens with drug candidates in mid-stage clinical trials. One independent biotechnology analyst said it will be a test to see if Exelixis is just throwing stuff against the wall to see what sticks.
"We're going to see how productive these guys are in the next year or year and a half," said the analyst, who did not want to be identified. "That's why some people sit on the sidelines with stuff like this. If some of these things start to work, then people are going to get quite excited.
Scangos said the benefit of being able to produce a rich pipeline is that it gives the company the luxury to kill compounds in development that many other biotechnology companies might have to push through because they've bet the business on their success.
"It's not just more shots on goal. We can make better decisions," he said. "We have the luxury to scrap something with results that are less than stellar."
But that doesn't leave the company without concern. Its chairman, Stelios Papadopoulos, said there's no doubt Exelixis has been successful at approaching drug discovery from a sophisticated and analytic point of view that he said is neither unusual nor debatable.
But the reality of the business is that there is a high rate of failure in drug discovery. Even the most successful pharmaceutical companies and biotechs will have plenty of compounds that fail to make it from the clinic into the market.
It's not just enough to have a hit rate of two compounds out of 10, Papadopoulos pointed out. It matters that some hits come before the misses. If the early compounds are successful, there will be adequate enthusiasm to raise whatever money the company needs. But if success comes deep in the pipeline after many failures, weathering the storm will be much more challenging.
"There's no question whether the work we are doing is right. It is right. But drug discovery is expensive," said Papadopoulos. "I'm worried if a good drug is going to be the first or second or third in the pipeline or number seven or number 10 or number 12. That's the plight of the pharmaceutical sector. That is why companies go through troughs and peaks of yield and success -- even the best of them."
Daniel S. Levine covers biotechnology for the San Francisco Business Times. |
