Guest Post: The Next Feeding Frenzy? VCs Rush Toward Diagnostics (!?)

Steve Dickman is the CEO of CBT Advisors. He blogs about biotech, VC and personalized medicine at Boston Biotech Watch. Interested in guest blogging for In Vivo? Drop us a line here.

There was a time not long ago when no amount of persuasion could have made most venture capitalists do a diagnostics deal. The reasons abounded: markets were too limited; margins were too low; and the number of potential acquirers too small. So imagine our surprise when the most upbeat session of this year’s c21 investor conference in late May was a panel discussion focused on – you guessed it – molecular diagnostics.

If this is not a feeding frenzy, then at least it seems to be a period of high marketability for private diagnostics companies seeking acquisition exits. Session chair Bill Kreidel of Ferghana Partners described four sell side diagnostics assignments his firm is working on for which multiple bidders had appeared.

What sells? Proprietary content, improvements in speed or sensitivity/specificity, robust datasets, and large markets. Who are the buyers? Clinical labs like Labcorp, naturally, but also instrumentation companies in the imaging business like General Electric that “see diagnostics cannibalizing some of their revenue” and are trying to capture it back, said panelist Dion Madsen of Physic Ventures.

The advent of acquirers such as GE has caused venture firms to change their tune. The three venture capitalists on the panel certainly weren’t diagnostic neophytes. Madsen, Dr. Rowan Chapman of Mohr Davidow Ventures, and Dr. William Gerber of Bay City Capital have all made numerous investments in diagnostics and personalized medicine including Tethys Bioscience and CardioDX, clinical lab companies that recently reached commercial status.

And there have been some impressive diagnostic exits driving venture interest. Switzerland-based HBM Partners, for instance, announced last September that it had earned a 21.6x multiple on its investment in Brahms, a Berlin-based diagnostics company acquired by Thermo Fisher.

But the information asymmetry that led to that deal has begun to recede now that investors have woken up to the opportunity. Still, in today’s market, where the environment is driven by cost constraints rather than spending, the locus of value is shifting earlier, toward diagnosis and away from treatment. In other words, knowing in which patients a therapy will work is as important as knowing whether it will work at all.

One common approach is for a company to walk into a VC firm and say “We are the next Genomic Health”, a Nasdaq-listed company (ticker GHDX) with OncotypeDX, a commercial breast cancer test, as if that were an appropriate role model. But Genomic Health, its stock down 25% in the last quarter, is not only not a role model, it’s a bad example, Madsen said.

“We still get companies saying they will be the next Genomic Health and we say, we don’t WANT you to be that!” emphasized Madsen. Gerber, whose fund did not invest in that biotech, added “Their first study was published in ’04 and it’s six years later and they are just about to break even!”

Circumstances have drastically changed both for IPO exits and for reimbursement in the interim. At the moment, an IPO is an unlikely dream for companies that do not have tens of millions of dollars in revenue. And reimbursement is complicated by both the murky regulatory situation and the unlikely circumstances that allowed the company to get reimbursed at unprecedented levels. “Breakeven [for Genomic Health] is predicated on a $3,000 price point,” Kreidel observed, “not something most diagnostics companies can aspire to”--except, we would argue, in oncology.

Adding to the complexity is a lack of clarity on the regulatory front. At the rate the Food and Drug Administration is moving it will be 2011 before companies offering algorithm-based tests like OncotypeDX have a clear path forward. (When will the regulations arrive? “There are as many answers to that question as there are consultants in Washington,” quipped the fourth panelist, Bruce Cohen, CEO of VitaPath Genetics.)

So VC-backed companies are working on building proprietary content strong enough to stand up to any level of regulatory scrutiny. What does content mean? (See here for a blog post explaining Madsen’s views on the subject and his criteria for what makes a “doable deal” in diagnostics.) Put simply, “content” is the unique ability to make a diagnosis or link a drug to efficacy in a particular patient in a reproducible way.

Three quick examples of the content-driven, data-intensive approach:

• VitaPath Genetics, a Mohr Davidow portfolio company developing a cheek-swab test for spina bifida risk early in prior to pregnancy. It ran a 2,100-subject study to validate its test and hopes to go commercial by 2011 on a modest $15 million.


• On-Q-Ity, a Boston-area company invested in by both Physic and Mohr Davidow is another example. To develop a commercial test to inform physicians when to treat cancer aggressively or even which chemotherapeutic agents to deploy, On-Q-Ity will require an “intensive analysis of tumor samples” and a “huge bioinformatics exercise,” he said.
  


• A third company, mentioned but left unnamed by Kreidel, has apparently achieved a remarkable level of sensitivity and specificity in predicting ovarian cancer, an area of huge unmet need where a better test would help thousands of women avoid surgery – and help insurers avoid paying for it.

So the new VC recipe goes like this: Find a potential market for which reimbursement is uncertain. Define a plan based on capturing reliable data from the vagaries of human biology. Invest VC dollars to collect the data. Crunch the numbers. Then see what you’ve got.

Hmmm. The risk profile sounds almost like …drum roll, please… therapeutics investing.

But it’s actually better – fewer dollars in, earlier clinical signals. And now, more likely exits with no need for an IPO. No wonder there are more investors than ever in this space. Some of them are likely to go home winners.– Steve Dickman

image from flickr user chamer80 used under a creative commons license

Merck/AZ Cancer Deal: Will Intra-Big Pharma Development Deals Move Beyond the Serendipitous?

Is that a mek inhibitor, sir?

Merck and AstraZeneca are expected to announce today that they're teaming up to test a combination of two early-stage oncology candidates. The companies are billing the deal as a first-of-its-kind collaboration--and fair enough: we can't think of another time two large companies have done this kind of deal with two molecules so far from the market.

The Big Pharmas will test Merck's MK-2206 and AZ's AZD6244 (a.k.a. ARRY-886, the compound was acquired from Array Biopharma in 2003) in a Phase I safety and tolerability trial. Costs will be split evenly, the program will be steered by a joint committee, and Merck is the sponsor of the trial.

The reason so few Big Pharma-Big Pharma development deals get done is that they're very tricky; control, valuation, overlap with other, non-partnered projects--these and other things present high hurdles for two large companies to come together in even basic ways. Of course there are plenty of reasons to take a stab at such deals--several of which are outlined in this February IN VIVO piece from Bain & Co. But if these alliances aren't discouraged institutionally, they're certainly not highly sought after either. In fact this deal came about not through any lets-be-friends business development outreach program at Merck or AZ, but by chance encounter.

"This was driven by two scientists meeting at an airport security checkpoint," Merck chief strategy officer and SVP worldwide licensing and external research Merv Turner told The IN VIVO Blog.

One scientist from Merck, one from AZ, they got chatting, and presumably between removing their laptops from their cases and putting their shoes back on, the special and awkward intimacy that comes from publicly surrendering all liquids and being patted down by a stranger wearing latex gloves worked its magic. WSJ's Ron Winslow has more color on the actual conversation, which apparently included that old chestnut "Are you the mek guy?"

"Of course through competitive intelligence they had some information about what each company was up to ... and they said to one another, there’s a compelling rationale for getting these molecules together," lets get the business development groups on the case, says Turner.

That airport rendezvous was in Dublin in November 2007. That it took more than 18 months to ink a deal to conduct a combination Phase I program says as much about the complexities of oncology drug development as it does the difficulties of intra-Big Pharma dealmaking.

Merck's MK-2206 is, according to Merck and AZ, the most advanced AKT inhibitor in development. AKT acts just downstream of PI3k in that important cancer cell survival pathway (the one generating all those deals lately); Phase I data on the drug were presented at this weekend's ASCO meeting. AZ's '6244 hits mitogen-activated protein kinase 1 (mek), an actor in an important parallel signaling pathway. Like the Merck compound, '6244 is further along than its competitors; the candidate has completed several Phase II monotherapy studies and its Phase II program continues apace.

A greater understanding of cancer biology, says Turner, should drive more deals like this one, where "the potential to short circuit what could otherwise be a long and combinatorial approach to finding the right pairs" of oncology therapies "becomes quite compelling."

There are over 800 molecules in development for various cancers. "We're learning more and more about the nature of tumorogenicity and the pathways involved and therefore how to select targets and populations expressing those targets ... and as we go forward into the new mechanism-driven approaches to tumor biology the rationale for combining agents which target complementary pathways becomes more clear," explains Turner.

Of course Merck is developing its own mek inhibitor and AZ its own AKT inhibitor, there are multiple targets in each pathway, and such compounds could be useful in a variety of cancers where the companies have individual ongoing programs, all which could complicate a more extensive deal.

"When we set out on this, to try to think through all the possibilities, we soon realized that the number of branches that arise if you try to construct a decision tree of all the things that might happen in development, it just becomes overwhelming," says Turner. So the companies are starting slowly, taking a step-wise approach to collaboration that need not go beyond this Phase I program.

We decided, "let's start with the easy part, work out how we'll do these experiments together in patients in Phase I, and if that succeeds, we'll go on to the next part," he says.

If the eventual goal is some sort of fixed-dose combination the companies will eventually have to jump in with two feet, perhaps partnering on multiple compounds or even entire pathways. But that need not happen at all. "The first goal could be to have each party arrive at the marketplace [independently], with a label statement that supports use of the other agent in combination," says Turner.

A small step, but a step forward, and the kind of thing that if repeated often enough could have some meaningful impact on drug development costs and speed to market, eventually advancing the standard of care in difficult diseases.

We presume this means taking another step, beyond chance encounters in airports or the DMV or even Starbucks. "If this works as advertised," sums up Turner, "we can think of it as a template for future similar deals."

GSK and Pfizer's HIV Joint Venture: Why It’s a Path Forward

Real innovation in dealmaking, like pharma R&D, is a rare commodity. As with R&D, dealmaking innovation often gets blocked by entrenched interests or misunderstanding or simple inertia. There are lots of reasons not to repeat the single most innovative and successful transaction of all time – Genentech/Roche – but none of them outweigh the spectacular opportunity that deal created.

We’re not going to say that the GlaxoSmithKline/Pfizer joint venture in HIV is, itself, comparable to Genentech/Roche. (See some short reports with some additional transaction details on the JV here and here and a more in-depth analysis here). But it could solve a set of knotty problems that by and large companies have, for whatever reason, failed to address.

First, earnings-pressured pharmas need help financing their pipelines. One option seems to be disappearing – getting investors to directly fund development (like the Lilly/TPG/Novaquest arrangement on a group of Alzheimer’s projects). Besides the market meltdown, which has taken cash away from speculative, illiquid investments, the parties’ goals were, in the dealmaker’s parlance, unaligned. Investors want to cherry pick the pieces of the pipeline they’d most like to fund, Pfizer EVP and chief strategy officer Bill Ringo told us the other day, almost as if they wanted to guarantee themselves a return (which, in the good old days, was something they could pretty much get just by investing in Pharma). The more risk they run, of course, the more upside they want (ideally, to be able to sell successes to the highest bidder) – which naturally limits the upside, and strategic value of the asset, for the pharma partner.

Here’s another problem. Most Big Pharmas want to be big and diverse enough to balance out the risks of development – but also want to be small enough to encourage biotech-ish entrepreneurialism. Various companies are trying to have their cake and eat it too by splitting into divisional enterprises (specialty pharma, or primary care, or oncology) with their own CEOs and CSOs and P&Ls. But we remain firmly Missourian about the whole idea. Will the commercial groups be able to buy research wherever they want – or remain saddled with what’s provided internally? Will research be able to sell its best fruits to the highest bidder in order to maximize their value? And for all their divisionality, how much of the corporate infrastructure – IT, manufacturing, finance – will these divisions have to absorb?

The GSK/Pfizer HIV joint venture is an interesting solution to both problems – the big/small paradox and the funding troubles. The new company is relatively small (first year projected sales: $2.4 billion); it’s got its own managers; it makes its own R&D decisions. The research stays within the parent companies and the JV pays its expenses – but if the pipeline projects don’t work out, and the JV doesn’t like what GSK and Pfizer are producing, the JV can buy their research from wherever they want. “It puts pressure and accountability onto the scientists,” GSK’s chief strategy officer David Redfern told us, echoing a favorite theme of GSK’s R&D boss, Moncef Slaoui.

Meanwhile, Pfizer doesn’t have to pay for a new worldwide commercial HIV organization on the basis of its underperforming HIV assets (maybe underperforming because it doesn’t have the commercial group it needs); GSK gets the near-term HIV pipeline it had otherwise failed to deliver. Far as we can see, no cash changes hands.

The biggest negotiating obstacle, apparently, was the equity split (right now, 85% GSK, 15% Pfizer) – but according to Redfern, once they’d abandoned the attempt to price the pipelines, and instead started to adjust ownership based on cash flows, “the heat went out of the valuation debate.”

And then there’s the optionality of the thing – one of its main advantages, believes Redfern. The JV could fund its business development with its own equity rather than dipping into cash. When the financial markets get friendlier, the whole thing could be spun off. And presuming success even close to what Gilead has achieved, the JV owners would get big stakes in a growth company that would theoretically trade at a significantly higher PE.

And that same equity would reward the JV’s employees in a way Pfizer and GSK stock simply can’t. Not to mention the fact that it’s a lot easier for an employee to see his personal contribution to growing a company 1/29th the size of Pfizer.

And one other aspect of optionality, notes Bill Ringo: if this works, “it provides us a model we can duplicate elsewhere.” He hasn’t apparently talked to GSK yet about repeating the idea in another therapeutic area, “but if there were another opportunity to do the same thing again with GSK, we’d do it.”

We recognize that plenty can go wrong with this deal. GSK’s firmly in the driver’s seat, with seven members of the nine-person board. And Pfizer could get tired of that. We also sense that Pfizer and GSK are not on the same page when it comes to R&D accountability (we think GSK is going to be tougher on its researchers than Pfizer will –rewarding more and firing more).

But whether it works or not, the drug industry should be paying close attention to this deal. Even more attention than to the big mergers. All of those are one-time events; it’s hard to see that they’ll be in any significant way transformational. Mostly, they’re stop-gap measures. (OK, we did argue the opposite way around about Pfizer/Wyeth – though most of the reader response was pretty skeptical).

But the GSK/Pfizer JV is repeatable. And scalable. It moves the industry in the direction it needs to go: smaller, customer-focused, financeable. And it gets our vote for the most innovative deal we’ve seen so far this year.

Image from flickr user joefutrelle used under a creative commons license.

Sticker Shock May Open Innovation in Pharma

Proposals advocating “open” or “collaborative” innovation in pharma R&D are suddenly cropping up throughout the pharma industry in a variety of forums and iterations. J&J’s head of global R&D Paul Stoffels talks about it, as does GlaxoSmithKline’s Andrew Witty. Not that collaboration itself is news – business development is a mainstay of pharma strategy.

These new ideas, however, refer to collaborations in areas where pharma previously feared to tread--at the earliest stages of research, across several companies--and involve sharing of intellectual property. In the past, such ideas were unthinkable, but pharma companies are well aware their R&D models need an overhaul, if for no other reason than sticker shock: Innovator companies spend $90 billion a year on global R&D, but stand to lose $32 billion in cash flow over the next five years as key products go generic. No one expects that they’ll be able to compensate for that loss – which means less money for R&D.

Enter the management consulting firm Bain & Co., which also strongly advocates moving the industry toward more collaborative research in this article just published in the most recent issue of IN VIVO. Recently the head of Bain’s North American healthcare practice, Chuck Farkas, spoke to IN VIVO Blog about his group’s thoughts.

In one of Bain’s models, groups of companies would “pool” research and development assets within a disease area or class of compounds, sharing in some manner in the commercial success of any compounds that emerge from the collaboration. Another very different model calls for sharing IP, resources, and talent to identify the best mechanism of action to tackle a particular disease, after which each company would compete separately in the marketplace.

That latter kind of open innovation wouldn’t necessarily limit the number of companies pursuing particular molecules and therefore wouldn’t create systemic efficiency, but it could eliminate duplicate investment in early-stage work and improve productivity by enabling scientists who would normally compete to work together, Farkas explains.

Especially in the latter model, commercial execution would be paramount. Competitors would win on the merits of their science—but the balance of power would likely shift to those with the most cunning in the market. That’s what happened in the consumer goods and certain sub-sets of the IT industries, where R&D pooling became a norm.

Today’s pharmaceutical R&D model, which industry is gradually restructuring, was formed around a bubble that has burst, Farkas observes. Companies are "asking how to share more of the R&D" he says. "There is massive pressure to be far more rational in R&D.”

Bain's ideas are part of a trend, of course, at least rhetorically. In a February 13 speech at Harvard Medical School, GSK’s Witty advocated patent pooling—that is when patent owners agree to license their patents to others—and said GSK is doing just that with assets aimed at treating certain neglected tropical diseases.

The head of global R&D at J&J, Paul Stoffels, a Belgian physician, has also been writing about and speaking publicly on what he calls “open innovation,” in which pharma companies network “across internal organizational disciplines and geographies” and externally as well “to share in both the benefits and costs of innovation.”

The extent of their commitments isn’t clear, however. Witty’s remarks received considerable publicity—but GSK’s program is directed at markets that don’t generate much profit, for big pharma anyway. And J&J’s minimal efforts involve small steps in niche markets.

But Farkas and others are adamant: the pressure of driving earnings as revenues fall “will force companies to look at dramatically different R&D models." And as they do, commercial competence--itself evolving in response to external pressure--will take on a whole new meaning.--Wendy Diller

image from flickr user benlyon used under a creative commons license.

The Value of Re-Cycling: $87 million?

The drug industry’s littered with examples of products that have started life in one indication and got to market in a totally different one—think of Viagra et al.

But most of these reinvention stories involve a fair bit of luck—the right scientists taking a chance and managing to get it past the bosses. Since then, Big Pharma’s R&D productivity issues have prompted the birth of a handful of systematic re-positioners like Aspreva or Melior.

Or like Gene Logic. This firm—originally a genomics database group—has stuck its neck out and put a number on the value of repositioning assets: $87 million. That’s to say, repositioning a failed Phase II compound in a new indication creates an asset worth $87 million more, in net present value terms, than an equivalent in-licensed drug. That’s almost a 30% increase, according to the company.

To find out exactly how they get to these numbers—there is rhyme and reason—you’ll have to wait for June’s IN VIVO. But it’s based around the notion that a re-positioned drug has an additional two-to-three years of patent life over its non-repositioned counterpart. Since there’s no “original” indication (the drug failed, right?), then once the compound’s composition of matter patent—typically seen as the strongest IP protection—expires, the method of use patent, filed later based on a novel indication in Phase II, still has bite. (Normally, when a drug’s composition of matter patents expire, generics can compete in the original indication that the drug was approved for, and in practice also compete off-label in other, unexpired indications.)

The arguments look reasonable. At least, they do to the five Big Pharma partners that Gene Logic has attracted in the last couple of years, including, earlier this month, Abbott Labs.

But are these partners really buying into Gene Logic’s economic model—which is, by the company’s own admission, without precedent and totally unproven—or do they simply figure that they’ve got nothing to lose? Gene Logic takes on all the early risk in identifying a new indication. There’s no cost to the larger partner unless and until Gene Logic finds a viable new indication for the compound—in which case it will owe milestones (estimated at $60-$100 million per compound) and, potentially, royalties. There’s no automatic opt-in for Gene Logic—it can only take rights to repositioned compounds if the pharma partner explicitly rejects them.

Effectively, Gene Logic’s had to bend over backwards to persuade Big Pharma to hand over shelved assets---everyone knows this isn’t a favorite pastime. They’ve had to remove all the hurdles and pitfalls.

The tactic has worked, thus far. But Gene Logic won’t be able to afford this deal-structure for long. Either they won’t find new indications, in which case they’ll go bust (or change strategy again). Or they will, but that will push up development costs, so they’ll have to get more from their partners.

So if you’re a Big Pharma with stuff on the shelves, move fast.

Can P&G Stomach the Risk Even When It's Reduced?

P&G Pharmaceuticals has been the Henny Youngman Rodney Dangerfield! of the drug industry: it couldn't get no respect. And so last year it remade itself, becoming what it calls a “search and development organization,” apparently on the model of Shire and Endo.

When it announced it was abandoning discovery, in February 2006, P&G was both admitting it couldn’t compete in research—and that it couldn’t stomach the risk. It laid off, or transferred, most of its researchers; it has spun off at least three research programs (more on that in another post); and now it’s got 45 people scouring the earth for licensable products in its chosen therapeutic areas: gastro-intestinal, musculo-skeletal and women’s health. Two key criteria: P&G only want drugs for patients that have “high involvement in their disease”; and they want products for which the development risk is “reduced.”

They’ve got some ambitious goals. To reach their growth targets, they want to launch one new product every 4-5 years – and that drug needs to become – echoing Jack Welch’s famous maxim for GE—number one or two in its category. To get to their launch target, P&G figures it will need to do 2-3 deals per year.

The question, however, is whether the kind of products that get to be #1 in their categories are also the kind of products that P&G management will be willing to pay for. It’s a challenge, admits Jeff Davis, who runs new business development. P&G has a shareholder base which demands 4-6% growth a year—that’s the kind of growth that justifies not reduced-risk research, but no-risk research, the sort that figures out how to get more or less pulp into orange juice or no-drip caps onto detergent bottles.

Moreover, while Big Pharma isn’t generally ponying up for reduced-risk development projects (in general, they still want NMEs), spec pharma is, and paying Big Pharma-sized upfronts. But P&G figures it can win these deals by emphasizing its consumer-focused marketing approach (it had an entire team of R&D, finance and marketing execs outfitted with an electronic system that, for a week, at all times of day, signaled them to react to the unpleasant gastrointestinal events of ulcerative colitis patients). And if—as this blogger believes--spec pharmas are going to be P&G’s biggest dealmaking competition, then P&G really will have an interesting advantage.

The pitch worked for Aryx Therapeutics, one of two companies with whom P&G has signed deals since its reorganization (the other is Nastech, for nasal-delivered parathyroid hormone). The Aryx drug, for GERD and gastroparesis, hit all the P&G criteria: a GI product (for GERD and gastroparesis) and risk-reduced (works like Propulsid but, apparently, avoids the drug-drug interactions which killed it). “We had three virtually identical term sheets,” says Aryx VP and COO John Varian but chose P&G because of their “focus on the consumer.”

Still, P&G is hardly burning up the dealmaking track. They’ve done two deals since their restructuring—the last in July 2006. Davis is confident that in ’07 his group will be able to get to terms sheets on 2-3 programs. There are plenty of biotechs who'll appreciate the P&G approach. But we wonder whether the Consumer King will tolerate the risk of signing them.