Southwell: Part III
Patents were a key element in Sepracor's long-term strategy
- and one Southwell had to include in his financial calcula-
tions. In effect, Sepracor was trying to take an established
drug sold by a major pharmaceuticals company, improve it,
patent it, then sell it successfully. Sepracor hoped that
working off an already established and tested compound
would require less research, less testing, less risk and a
lot less money.
Obviously, the major drug companies were not happy to see a
small rival piggyback off their established products. But they
faced a dilemma when Sepracor began to pick up product
patents. As unhappy as they were to share profits with
Sepracor on improved versions of their aging blockbusters,
it was better than giving up the business entirely to
generics once those drugs went off patent.
Why should Sepracor share? First, because the big companies
already had large marketing forces that had been selling the
patented drug for years. Second, they had the kind of money a
smaller company like Sepracor needed to drive development.
And third, they had the lawyers and time to entangle Sepracor
for years in patent litigation wars. All these factors played
a part in the decision to license Allegra to Marion Merrell
Dow in 1993 (Marion Merrell was acquired by Hoechst in 1995).
Marion Merrell had marketed Seldane and had a large marketing
force that knew the field. Moreover, some of its Seldane patents
-- those that related to composition of matter - covered Allegra,
despite the fact that Sepracor had won a method-of-use patent
on the purified compound. The bottom line: Years of expensive
litigation would result if some deal were not struck. Sepracor
also needed help pushing Allegra through clinical trials. So a
deal was cut: Marion Merrell would fund development and pay
Sepracor about $7.5 million in fees and (beginning in 1999,
when its Seldane composition-of-matter patent lapsed) a royalty
of 8 percent of sales. From Sepracor's standpoint it was not a
great deal, but the small, cash-strapped company had little choice.
(About the same time, in June 1993, Marion Merrell also agreed
to put up $10 million to buy 5.9 percent of Sepracor shares at
a 30 percent premium.) Sepracor's strategy was to license out
its purified drugs to the larger companies, which would market
them. The tricky part was to get the best possible deal. That
meant that Sepracor had to find the money to fund development
as long as possible. If Southwell could raise that money,
Sepracor could retain control of its products longer and drive
better licensing deals down the line.
It all hinged on raising money. Lots of money. Southwell almost
immediately faced a crisis: At its current burn rate, Sepracor
needed to raise at least $5 million to survive until the end of
1994. On the positive side, Sepracor was running its first clinical
trials on its purified version of bronchodilator albuterol,
dubbed levalbuterol, and was expecting its patent on Allegra to
be issued by year-end, news of which would presumably boost the
stock price and make raising money easier. Nonetheless, Southwell
found himself getting a lot of rejections. "I felt like Willy
Loman," he says.
And yet he found himself doing some rejecting, too. In one case,
he turned down a venture capital funding offer he considered too
dilutive. Finally, he got a more acceptable offer. The source:
a private fund of the New York-based Ziff family called the Oscar
Frank Delano Partners Fund. He had gotten an introduction to
Daniel Stern, president of Ziff Brothers Investments, from Mark
Lampert, a general partner at San Francisco-based Biotechnology
Value Fund, a private investment partnership that often invested
with the Ziffs.
The Ziffs and Biotechnology Value together ultimately anted up
$10 million, twice as much as Southwell had been seeking. The
structure consisted of convertible preferred stock with warrants
exercisable at varying rising prices, from $6.30 a share up to $20.
The stock was then trading at 4 5/8. Sources close to the Ziff
family (which declines to comment) say: "At the time, [Sepracor]
was pasted with all the negative stories on the biotech industry.
But they had a good story. [The Ziff managers] did the work, found
they had real products that were in development with real promise
and that were achievable."
Then came some good news. On January 4, 1995, the Allegra patent
was issued; Sepracor jumped 50 percent in a day, to 6, then soared
to the low 20s later that year with the release of positive data
for its levalbuterol product. Meanwhile, the company was making
progress with another new drug, (s)-oxybutynin, an improved
version of Hoechst Marion Roussel's Ditropan, which alleviates
urinary incontinence. By midyear, Southwell recalls, Sepracor
had very little cash, though the stock hovered around 20.
At the same time, the company was in the midst of another
restructuring program, which included a $4.1 million charge
taken for BioSepra, covering severance benefits for 54 terminated
employees, and the sale, at a loss, of Biopass for $1.3 million.
In May 1995 Sepracor set up yet another subsidiary, Versicor,
which used a technique called combinatory chemistry to search for
new antibiotic and antifungal compounds. Sepracor's growing
credibility enabled it to fund the unit through the private
sale of Versicor stock to institutional investors, issue Versicor
convertible preferred stock and set up an agreement by which
Sepracor would lend up to $4.7 million to Versicor through a
convertible subordinated note.
The downside of moving ahead with the development of (s)-oxybutynin
was that clinical testing would require an escalation in the burn
rate. "I told [investors and analysts]: 'Our burn rate is $30
million a year. We're raising it to $45 million,"' Southwell
recalls. He says he explained, without mincing words, "'We either
drop the new product or increase the bum rate."' In fact, by
mid-1995 Sepracor had $20 million in cash and marketable
securities and, including restructuring charges, was spending
cash at the rate of about $56 million a year.
Sepracor had to find more money. With biotech stocks beginning
to fly again, the company began a dizzying flurry of financings -
four in six months - with a variety of underwriters (see box)
that left Southwell bedraggled and a little jet-lagged. Here's
a chronology of events:
August 1, 1995. Southwell oversaw a secondary public offering
of 4 million shares of Sepracor stock (the offering diluted
shares by 20 percent). The proceeds amounted to $67 million.
September 21, 1995. He moved to catch the buoyant biotech market
by doing a secondary offering of HemaSure, for $47 million,
reducing Sepracor's ownership from 55 percent to 37 percent,
and getting it off the books (that is, no longer consolidating
HemaSure's finances). The proceeds went to fund HemaSure.
November 1, 1995. Southwell completed an unusual convertible
debenture offering through Lehman: "Here we were losing
$50 million a year and doing a convertible offering," Southwell
marvels. Investors, he figured, were willing to buy the equity
at a 30 percent premium, in exchange for preferred that was more
liquid and paid a 7 percent premium. The take: $81 million.
March 1996. Southwell was busy doing an even more complex
spin-off of a fourth new subsidiary. In this case, the
transaction involved a public stock offering on the Nasdaq
of two companies that were about to merge - but hadn't yet:
Sepracor's SepraChem division, with its technology for
creating proprietary chemical synthesis products, and U.K.
based Sterling Organics, a chemicals manufacturer that had
been originally spun off from Eastman Kodak Co. The $87 million
in proceeds from the offering paid for the acquisition of
Sterling and the formation of a new Wellesley, Massachusetts
-based entity called ChiRex. This spin-off left Sepracor with
a 32 percent stake in ChiRex and focused it further on its
core research.
By mid-1996 Southwell could finally catch his breath.
Sepracor's cash position had soared in just over 12 months
to $122 million. Although it had upped its burn rate
dramatically, it now had enough cash to last nearly two
years. Even better, Sepracor was still riding a virtuous
cycle. The money on hand allowed it to retain the rights
to potentially lucrative drugs, including levalbuterol and
its purified version of Ditropan. Despite all this, the stock
hit its 1996 low of 1044 in July. "We were relatively flush
with cash, but we still trade on major [drug development]
events. In 1996 there were not many events. And investors
like events. I was trying to tell people what to expect
in 1997," Southwell recalls.
It's April in Paris, and Southwell has jetted in to visit
the company's BioSepra division, which has just won a key
patent lawsuit and is finally breaking even. "It's still a
tiny [$30 million market cap] company," he says. "I need to
raise its visibility." A few days later he's off to London to
speak at a UBS Securities health sciences conference and meet
with investors. Then it is on to the U.S. for a road show
for a Versicor private placement. (A few weeks earlier he
oversaw ChiRex's secondary stock offering, raising an
additional $30 million and selling Sepracor's stake in
the unit.)
Southwell no longer feels like a downtrodden traveling salesman.
Doors open now. Even giant Fidelity Investments owns nearly
12 percent of Sepracor, largely through its ContraFund. And
drug research looks good. Allegra won FDA approval in July
1996 and is now on the market. Four other drugs are close to,
or actually in, phase-three testing, the last step before
applying to the FDA for a new-drug application. With its
heightened credibility, Sepracor can demand better licensing
terms and be choosier about its partners or co-marketing
arrangements. "Now that we have levalbuterol in phase-three
testing, the value of the drug is quite significant," says
Southwell. "The terms we would want and the quality of the
partner we would want for a co-promotion deal are significantly
higher." Sepracor has reportedly turned down several marketing
proposals, though it won't discuss ongoing talks.
Moreover, Sepracor is finally building its own sales force,
budgeting about $4 million annually for 40 specialized salespeople
targeted to the hospital market for its two upcoming asthma drugs.
This may sound tiny compared with the detail forces mobilized by
the drug behemoths, but Southwell contends that this marketing
strategy is feasible and, if it works, can pour 50 to 60 percent
pretax margins into the company - a considerable advance over the
Allegra royalties. With an eye to the more distant future, Sepracor
is also starting research into totally new, as opposed to purified
knockoff, drugs.
But in biotech the situation is rarely as rosy - or as gloomy -
as it seems. After all, this is a company that can boast of
raising $456 million so far - without yet generating real profits.
The Allegra royalty stream does not begin until 1999 or 2001,
depending on whether Hoechst's Seldane compositionof-matter
patent receives an extension. The four drugs close to getting
to market translate into an escalation in the burn rate, now at
$55 million a year. Last year Sepracor lost $43 million (actually
a net loss of $60 million if its contributions to subsidiaries
HemaSure and ChiRex are included). The patent outlook for the
new drugs is murky. And the stock market may falter, always bad
news for volatile biotechs. (Falling share prices mean more
difficult financings.) Southwell nonetheless contends that he
has been readying Sepracor for the day the bull market ends.
Indeed, with $130 million in cash in the till, it does have at
least two years' worth of funds. "We have the resources to
weather a really bad storm," he says.
Though Sepracor has clearly made major progress, it remains an
emerging company -- albeit a more robust one than just a few
years ago. It may continue to struggle along, get swallowed by
a giant drug company or - the rarest of cases in biotech -- reach
the promised land of self-sustaining profitability. For now,
however, Sepracor has survived, and Southwell has earned his
frequent-flier miles and his garageful of options.
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