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Putting a price on promise

by Jonathan Marino  |  Published January 4, 2013 at 3:23 PM
Christopher Garabedian beamed as he began the conference call, an Oct. 3 announcement pronouncing that Cambridge, Mass.-based Sarepta Therapeutics Inc.'s experimental drug for Duchenne Muscular Dystrophy -- a degenerative genetic disease with no cure -- had met its endpoints in a closely watched, highly anticipated Phase 2B trial. "This treatment benefit is unprecedented in DMD," Garabedian, Sarepta's CEO, said on the call.

Heady times were about to begin for Sarepta, which saw its stock triple in a day as giddy investors bid up shares on the prospects of its DMD drug, eteplirsen. Garabedian noted that the company has plenty of options going forward, but he might as well have said plenty of challenges as well. Though Sarepta is now seemingly at a place every biotechnology company dreams about -- holding all the rights to a potentially breakthrough drug -- it is also on the verge of engaging in one of the least transparent, yet most active and evolving areas of life-science dealmaking: the complex world of pharmaceutical collaborations and partnerships.

Sarepta isn't alone, of course. Invariably, nearly every biotech that doesn't crash and burn needs Big Pharma's help in one way or another at some point. Despite their problems, pharmaceutical companies still offer the financial wherewithal to push drugs through clinical trials; the manpower and sales force to manufacture and launch drugs both domestically and globally; and, potentially, an exit for investors in the form of a buyout -- a particularly attractive option these days given the tepid initial public offering market for biotechs.

This breeds a complex tug-of-war between pharmaceutical and biotech companies. The two engage in a dance that ultimately leads to some type of collaboration that often gives small biotechs the funding they sorely need and Big Pharmas a piece of a drug -- or potentially the whole company -- at a cost far lower than what they would have had to pay later in the drug's development process.

In the process, such dealmaking creates a host of challenges for those involved. Biotechs are under an immense amount of financial pressure and don't have much leverage unless they have a clinically advanced jewel backed by impressive data. Pharma companies, trying to cut down R&D expenses and wary of throwing cash at poorly performing programs, will do all they can to extract a biotech's value for the lowest possible price. The deal negotiators -- particularly on the biotech side -- have few reference points to look to in their talks. As such, dealmaking takes on something of a Wild West flavor.

"There really aren't bankers involved, and there aren't really any databases," says one M&A lawyer with decades of experience in pharmaceutical collaborations and licensing agreements. "We've talked about gathering what data we could, but it's sort of all over the place."

To understand why, first consider the structure of a typical licensing deal: A large pharma company will make an up-front cash payment to a biotech for rights to some sort of asset, be it a preclinical, early-stage, midstage or even commercially available drug, or, in some cases, a technology platform or an entire portfolio of potential compounds. The biotech will then get a series of additional payments tied to either clinical milestones (the drug completing Phase 2 or Phase 3 trials, for example), regulatory events (the drug winning approval from the U.S. Food and Drug Administration or similar government bodies abroad) or commercial success (the drug hitting certain sales targets). Sometimes, the biotech will also get a percentage of royalties on the drug's sales (typically in the 5% to 15% range, the M&A lawyer explained). At other times, the pharma will get an exclusive option to buy the biotech outright at a later date.

Other quirks also exist. The game is vastly different from a traditional M&A deal in that valuations are largely projection-based and difficult to model. Comparables exist, but aren't always available, and in most cases, products are years away from earning actual money in the market. Generally, transparency is in short supply. In Celgene Corp.'s Oct. 4 deal with VentiRx Pharmaceuticals Inc. to develop the biotech's lead compound, cancer drug VTX-2337, the only thing Celgene publicly disclosed was a $35 million up-front payment to fund R&D of VTX-2337 through certain unspecified, predefined clinical endpoints -- but the deal also included an option for Celgene to acquire the company outright.

"It's really a math equation where you throw all these different factors into a giant calculator and you come out with a document that gives you a [return on investment] or a [net present value]," says Michael Lerner, the chairman of New York-based law firm Lowenstein Sandler PC's life-science group. "If it's positive, you're going to do it. If it's negative, you're not."

Those figures come down to a variety of factors, says Robert Baltera, a consultant for pharmaceutical executives and the former CEO of Amira Pharmaceuticals Inc., which partnered with GlaxoSmithKline plc on an asthma drug in 2008 and was ultimately acquired by Bristol-Myers Squibb Co. in 2011.

Such factors, Baltera says, include the indication (or indications) for the drug, the potential market size, how far along the drug is in development, how much it will take to get the drug to market and the strength of the drug's patents (and whether or not there may be potential intellectual property litigation hanging over it).

Where the drug is in development is a major factor in the size of the up-front payment. A recent study by Deloitte Recap LLC -- a subsidiary of the big accounting firm that publishes periodic reports on pharmaceutical licensing and partnership issues -- showed that the median up-front payment for a preclinical compound was $7.3 million, a figure that jumped all the way to $34.4 million in Phase 2 and up to $102 million for an already-approved product.

Merck & Co., for instance, paid Wuppertal, Germany-based anti-infectives specialist AiCuris $142 million up front on Oct. 15 -- and offered $429 million in milestone payments -- for the rights to a portfolio of treatments for viral infection human cytomegalovirus led by a drug in Phase 3 that has already gained orphan drug status. By comparison, Bayer AG paid Evotec AG just €12 million ($15.52 million) up front, but offered a potential €580 million in milestones, to collaborate on a trio of potential drugs for endometriosis that haven't been created yet.

Celgene even recently signed up to seed San Diego's PharmAria LLC, a maker of cancer drugs, while getting an option both to license certain R&D programs and ultimately to buy the company outright.

"The earlier stage the company, the more likely the outcome is going to be an acquisition," Baltera says. "Given where the IPO market is today, that is the more attractive of the two liquidity options [for investors]."

The wide swing in value is no surprise, given that the most significant leverage a cash-starved biotech can bring to the negotiating table is solid data that alleviates risk. This is so much the case that bidding wars can erupt when that data appears. The M&A lawyer noted that pharma companies are now more willing to put more money up front for assets that are worth partnering because of the increased competition.

"The assets that have data that [are] attractive and compelling have probably been partnered, or people are aware of it or are circling around it," Lowenstein Sandler's Lerner says. "These companies have tons of business development guys looking for the next great thing."

The most notorious recent example is Pharmasset Inc., whose hepatitis C compound, then known as PSI-7977 and only in Phase 2, was so sought after that Foster City, Calif.-based Gilead Sciences Inc. had to pay $10.8 billion and buy Pharmasset outright to trump Bristol-Myers and others and capture the drug. But Pharmasset is more the exception than the rule.

Dublin's Amarin Corp., for example, won FDA approval of Vascepa, which many analysts saw as a potential blockbuster drug to reduce very high triglyceride levels, on July 26. Amarin had repeatedly said publicly that its main focus was to keep the asset unencumbered in the hopes of setting itself up for a buyout or finding a partner to help launch it.

Upon FDA approval, its stock shot up. Yet, some four months later, Amarin still hasn't signed a deal, which industry observers speculate could stem from anything from problems securing New Chemical Entity status for the drug, which gives it an additional two years of market exclusivity before someone can file a legal challenge to it, to simply not yet getting the price it wants from a potential licenser or buyer.

Most feel that in this market the leverage in partnerships lies with Big Pharma, largely due to investor wariness among venture firms and the dearth of capital flowing to biotechs -- even though pharma companies need such biotechs to mitigate the risk of drug development and reduce their R&D costs.

"The challenge [for biotechs] is, you need to be able to demonstrate that you have no immediate need for cash," Baltera says.

The next part of the deal structure is the back end, the size of which also depends on the product's distance from the market and its potential. Three of the most significant licensing deals of the past 12 months garnered high numbers because of both their early stage focus and their therapeutic markets. In December 2011, Johnson & Johnson Inc. agreed to pay up to $975 million -- $825 million of which was reserved for milestone payments -- to help Pharmacyclics Inc., based in Sunnyvale, Calif., develop a Bruton's tyrosine kinase, or BTK, inhibitor, an oral treatment option for various cancer indications that was only in Phase 1 and Phase 2 trials.

Abbott Laboratories promised to pay as much as $1.35 billion, including roughly $1.17 billion on the back end, to team with Mechelen, Belgium-based Galapagos NV on a rheumatoid arthritis drug in Phase 2 in February. Also, Allergan Inc. signed a $1.5 billion collaboration with Molecular Partners AG, of Zurich, to develop and commercialize products for ophthalmic diseases such as exudative age-related macular degeneration. That included just two separate $62.5 million up-front payments -- the key compound, currently named MP0260, hasn't yet made it through the human proof-of-concept stage.

Pharma consultant Baltera explains that the further along the drug is in clinical development, the more milestones will be geared toward hitting sales targets. Licensing deals for earlier-stage compounds, on the other hand, will have much more weight placed on meeting clinical milestones. Pharmacyclics has already earned three separate $50 million milestone payments for hitting clinical targets alone through its deal with J&J. The latest $50 million installment came when it enrolled its fifth patient in a Phase 3 study testing the drug, ibrutinib, in a combination therapy on patients with relapsed or refractory chronic lymphoma/small lymphocytic lymphoma. Johnson & Johnson aims to enroll 580 patients total in the study.

Such conversations for Pharmacyclics and J&J likely began some time ago. Baltera says the process of partnering begins well before a drug is in the clinic.

"You really need to be out there working years ahead of time, pitching your story to all the potential buyers of your stock," he says. "You need to establish these relationships early on."

Once the time comes, the process is very similar to an M&A auction. The biotech will attempt to have as many discussions as possible, whittling anywhere from 50 to 60 potential bidders down to 10 to 15 who sign confidentiality agreements. Management will then hold conferences presenting data, and ultimately three or four may offer term sheets, says Baltera.

While doing so, the biotech will need to manage a timeline of its cash position, including a deadline by which it would have to make a decision before deciding to go forward on its own. "If you don't, a lot of the negotiating for Big Pharma is 'Let's just wait until they run out of cash,' and as a biotech you never want to be in that position," the consultant says.

Ideally, the biotech attracts more than one bidder, and term sheets are played off one another until a deal is struck. The biotechs have much less to go on in valuing their programs. "At the end of the day when you're at the negotiating table, your only argument is what is market [value], and what is market [value] if there is no window into it?" says the M&A lawyer.

Big Pharmas, on the other hand, have business development teams casting out projections and models, a process bankers sometimes get involved in, giving them much more to draw from in the negotiations. "Typically, it quickly moves to [the fact that] the selling side wants money as soon as possible and the buyer wants to drag it out as long as possible," Baltera says.

This is a situation Sarepta likely finds itself in right now. Garabedian noted on Oct. 3 that Sarepta has had "a lot of interest expressed" in its program and would begin to entertain a partnership.

"If a partner can bring the economics to allow us to accelerate the broader program and create a true win-win, where we can access those drugs sooner in the U.S., they can get access to those drugs and approve them more rapidly outside the U.S., I think there is a structure that we could consider if the economics are right," he said at the time. Alas, that's something very few biotechs have the leverage to do.

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Tags: Big Pharma | biotech | Christopher Garabedian | clinical trials | early-stage drug | FDA | licensing | M&A | midstage drug | milestone payments | Phase 1 | Phase 2 | Phase 3 | preclinical drug | R&D | Sarepta Therapeutics Inc.

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