Here's part 2:
Biotech Beach. Last of two parts.
A bitter pill | Without products to sell, San Diego biotechs rely heavily on
funding from big companies for survival. But are they selling their future?
Thomas Kupper
STAFF WRITER
09-Mar-1998 Monday
After a decade of work, occasional frustration and finally the triumph of
Food and Drug Administration approval, San Diego's Idec Pharmaceuticals was
ready to launch its first drug in December.
And a company 500 miles away was preparing to collect most of the profits.
In need of cash two years earlier, Idec had turned to the larger Bay Area
biotech Genentech, which paid for much of the remaining development of the
lymphoma drug Rituxan in return for what analysts expect to be a majority
of the profits. Genentech also handles some of the manufacturing and takes
a big role in marketing the drug.
The symbiotic relationship represents an increasingly common arrangement
for biotechs, one in which companies share financial risks among themselves
but also share the profits from any drugs they develop.
In some cases, biotechs are shunning drug development entirely and sticking
with niches in early-stage research.
It's a trend that could make it more difficult for San Diego's adolescent
biotech community to fulfill its promise as an engine of the local economy
in the 21st century, let alone to catch up to the industry's leaders in
Silicon Valley and on the East Coast.
You can't become the next Amgen, the world's largest biotech, if half your
profits or more are going to collaborators in New Jersey or Switzerland.
Instead of taking one or two drugs to get there, as it did for Thousand
Oaks-based Amgen, these companies could require repeat successes before
they're in a position to launch products on their own.
While not impossible, the degree of difficulty is illustrated by the fact
that San Diego biotechs so far have gotten only two drugs approved,
including Idec's.
"Successfully done," Idec chief executive William Rastetter said, "you keep
the next series of products for yourselves" -- if there is another series
of products.
The difference between San Diego's companies and heavy hitters like Amgen
and Genentech is largely that the San Diego companies are younger and that
the industry has changed over time. In the 1970s and early '80s, investors
in search of huge returns were willing to pay much of the cost of building
a large-scale biotech company.
But as it became clear that success in biotech is far from a sure bet, Wall
Street looked for ways to reduce the risk of such investments.
Since peaking in early 1992, biotech shares have fallen out of favor, and
the difficulty of raising money through stock sales only intensified after
the industry got whacked in last fall's market collapse. Just last week,
Idec withdrew a planned stock offering, blaming weak market conditions.
Instead of the early model of the "fully-integrated" biotech company, many
investors now favor the "virtual" company, one that enlists other companies
to help in the drug development process and thus spread the costs and risk.
Additionally, big pharmaceutical companies have grown hungrier for new
drugs and thus willing to invest heavily in biotech. In recent years, big
pharmaceutical companies, many of them overseas, have poured billions into
the U.S. biotech industry and occasionally acquired sizable ownership
stakes in biotech companies.
Investments triple
Biotechs nationwide collected $5.9 billion in such funding in 1997, almost
triple the previous year, according to the San Francisco merchant bank
Burrill & Co.
In fact, such deals have become almost prerequisites to doing business in
biotech, because Wall Street won't finance companies that don't have
benefactors in "big pharma."
"Biotech investors want to see surrogates, for validation, and corporate
partners who are willing to invest are the surrogates," said chief
executive Stanley Crooke of Carlsbad-based Isis Pharmaceuticals.
Nearly all of San Diego's roughly three-dozen publicly traded biotechs rely
in one way or another on partnership deals with pharmaceutical companies.
Such deals contributed more than half the local industry's revenue in 1996,
according to a survey of the industry by Ernst & Young.
Agouron Pharmaceuticals, whose AIDS drug Viracept was the first San Diego
biotech drug to win government approval, similarly shares the profits from
that drug with partner Japan Tobacco.
Isis has a deal with CIBA Vision for fomivirsen, a drug for AIDS-related
blindness. That one calls for up to $20 million in funding but gives CIBA
Vision nearly half the profits.
And Amylin Pharmaceuticals, a company that is working on a new diabetes
drug, was splitting the costs with Johnson & Johnson until the larger
company backed out of the deal last week.
J&J had put $91 million into the project through the end of 1996.
Compared with biotech clusters elsewhere, the difference is stark. More
mature biotech clusters generate more revenue from product sales and thus
are less reliant on partnerships, according to the Ernst & Young survey.
Bay Area biotechs, including power hitters Genentech and Chiron, generated
70 percent of their revenue from product sales in 1996, while in New
England the figure was 64 percent.
In San Diego, it was 44 percent.
Among the country's top research clusters, only North Carolina, where
biotechs are concentrated in the Raleigh-area Research Triangle, generated
a lower proportion of its revenues from products.
Partners for long?
The question is whether the local companies will mature to the point that
they outgrow the partnerships, as the industry's heavyweights have, or if
they will merely become research franchises, with much smaller profits.
At Idec, executives signed on to the deal with Genentech -- a biotech
powerhouse that had grown big enough to take such deals -- in March 1995, a
time when Idec needed cash to keep the Rituxan development moving forward.
With Idec stock at less than $4 at the time of the deal -- one-tenth what
it sells for today -- the company would have had to give up a huge stake to
raise the money on Wall Street.
Instead, it gave Genentech rights to co-market Rituxan and to take more
than half the profits from the drug. In return, Genentech would pay Idec up
to $57 million, of which Idec collected $31 million by the end of 1996.
Part of the idea was to win access to manufacturing capability to
supplement what it could build on its own in La Jolla. And Idec also
planned to build a sales force gradually.
"It's clear that with our access to capital as a young company, we could
not put into place a manufacturing facility that's needed to address a
worldwide market," said Idec chief Rastetter.
Indeed, success through partnerships would not be unprecedented. One of the
top biotechs, Biogen, started with a strategy of licensing its drugs and
now has annual sales of over $250 million and a market capitalization of
over $2.5 billion.
But more than a quarter of those sales come from the Massachusetts-based
company's newest product, a multiple sclerosis drug it launched in 1996 and
now markets itself.
The lure of partnerships remains strong. In recent years, a new type of
biotech has emerged that in many cases relies entirely on such deals.
These "toolbox" biotechs sell services or information to other drug
companies and make money without ever producing a product in the
traditional sense.
One fast starter
For example, the 1997 rookie of the year in San Diego biotech was Aurora
Biosciences, which went public and already has achieved a market
capitalization that puts it among the top 10 local biotechs, despite having
no plans to develop its own drugs.
The company is building the Ferrari of drug-screening systems -- one that
Aurora says will be 50 times faster than anything now in use.
"Royalties on any one deal are not going to get stockholders the kind of
returns that Amgen gets," said chief executive Timothy Rink, referring to
the world's largest biotech. "But we have the potential to do tens or even
hundreds of projects."
But some have started to question this model, arguing that while there's
less risk, it also takes more successes to sustain profits.
The San Diego gene-hunting firm Sequana Therapeutics, best known for its
discovery of an asthma gene, sold out to the Bay Area biotech Arris
recently, partly for that reason.
An illustration of how partnership deals can water down the payoff from a
drug is Agouron, which splits the profits for its AIDS drug Viracept with
partner Japan Tobacco, which helped with development costs.
In the most recent quarter, Agouron sold $91.8 million worth of Viracept,
with a gross profit margin of almost 60 percent. But under the terms of the
deal with Japan Tobacco, Agouron passed along $15.4 million to its partner.
After administrative costs and research on other projects, that left net
income of $4.9 million for Agouron.
Meanwhile, Japan Tobacco had received $28.8 million in royalties through
the end of last year -- a quick return on the company's contribution of $30
million plus an undisclosed share of the Viracept development costs. Those
royalties will continue indefinitely.
And Agouron's deal was a relatively favorable one for a biotech. The
company was able to give away a smaller share of the profits because it is
marketing the drug in the United States itself.
Chief executive Peter Johnson said the company prefers to avoid partnership
deals if possible partly because a larger company often wouldn't share a
biotech's degree of commitment to a project.
"We recognized the frailties of dependence on corporate partners at an
early point," Agouron's Johnson said.
In extreme cases, larger companies have simply bought large stakes in
biotech companies -- in a sense making them research franchises. Many
partnership deals involve part ownership for the larger company.
Selling large stakes
Genentech and Chiron, the two top biotechs in the Bay Area, both sold large
stakes to Swiss pharmaceutical companies. Roche owns 66 percent of
Genentech, and Novartis owns 46 percent of Chiron.
Several of San Diego's top biotechs are also partly owned by major
pharmaceutical companies. Novartis holds 9 percent of Isis, for example,
and Johnson & Johnson owns 11 percent of Amylin.
Nonetheless, some believe a biotech powerhouse could still emerge from San
Diego, though possibly in much different form than today's industry powers.
Some executives say success could come through a merger or combination of
several companies. An example is the Arris-Sequana deal, which was designed
to create a "gene-to-drug" company, one that offers the potential to both
launch big-revenue drugs and continue breakthrough genetic research.
Likewise, traditional drug-development biotechs say large-scale success
could come through the evolution of new business models. Eventually, many
of these companies hope to switch to the other side of the deals, as
Genentech did in its deal for Rituxan with Idec.
In fact, Idec completed such a deal this year, acquiring the rights to an
antibody from the Seattle biotech Cytokine Networks.
"By the time you're a dozen years old, you start building partnerships the
other way," said Rastetter, Idec's chairman.
More common for now in San Diego, however, are deals like the one the local
biotech Vical has with Merck & Co. for Vical's vaccine technology. The
companies think the work could have applications in dozens of diseases.
Alain Schreiber, Vical's chief executive, said there's no way a small
company like Vical could pull off the extensive testing necessary for such
vaccines -- let alone market them worldwide.
So the company's alternative was to turn over the development to Merck in
exchange for royalties that analysts estimate at slightly less than 10
percent.
That could still be a huge payoff if new vaccines for diseases such as
influenza or AIDS emerge, Schreiber said. But Merck would be the one taking
a bigger share of the cash to the bank.
"There is no question," Schreiber said. "If you have the financial means,
you reap about 10 times the benefit if you do it yourself."
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How biotecs are financed
Partnership deals with larger companies make up a growing proportion of
biotech financing. But such deals usually also require biotechs to give
away a piece of their future profits.
1996 % of total 1997 % of total
Stock offerings $4,231 57.8% $3,714 31.7
Private investment 537 7.3 1,297 11.1
Venture capital 449 6.1 609 5.2
Other 103 1.4 213 1.8
Partnering 2,004 27.4 5,892 50.3 (upfront payments
and equity
investments)
TOTAL 7,324 11,725
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Big brothers
With a few exceptions, San Diego's biotechs depend on larger companies to
help finance their top projects. Here are a few of the deals:
Advanced Tissue Sciences Dermagraft (skin replacement)
Smith & Nephew holds half the commercial rights
Agouron Pharmaceuticals Viracept (AIDS drug)
Japan Tobacco receives share of profits
Idec Pharmaceuticals Rituxan (Lymphoma drug)
Genentech holds co-marketing rights and a share of profits
Isis Pharmaceuticals Fomivirsen (Drug for AIDS-related blindness)
Ciba Vision (Novartis) holds worldwide distribution rights
Ligand Pharmaceuticals Targretin (Diabetes drug)
Eli Lilly & Co. developing the drug |
