The Benefits Are Mutual in New Wave of Biotech/Pharma Alliances

The spat that erupted between pharma giant Bristol-Myers Squibb and biotech firm ImClone Systems over their partnership to develop a new cancer drug put the structure of alliances between discovery research firms and big drug makers under a microscope.

Alliances and other forms of development partnerships are increasingly important to biotech companies as a critical source of capital. And they are important to drug manufacturers because they help keep pharmaceutical company drug pipelines full.

By joining forces, biotech and pharmaceutical companies increase their odds of winning regulatory approval to market new drugs, according to research by Wharton health care professors Sean Nicholson and Patricia Danzon. “The main finding is that the market for pharma-biotech deals appear to be functioning well,” said Danzon. “Deals seem to be occurring when they are in the mutual interest of the parties involved and when they increase productivity.”

The research, which appears in a paper titled, “Biotech-Pharma Alliances as a Signal of Asset and Firm Quality,” was based in part on a study of 539 licensing deals made between 1988 and 2000. It indicated that drugs produced by a co-development partnership are more likely to succeed in winning approval from the Food and Drug Administration than those developed by a sole company.

Of 691 new chemical entities approved by the FDA from 1963 to 1999, 38% evolved out of alliances. The average number of biotech alliances per pharmaceutical firm grew from 1.4 per year in the period 1988 through 1990 to 5.7 in 1997 through 1998. The research also indicates that the probability of a drug developed jointly passing through human testing increases by up to 30 percentage points over drugs developed by a firm that goes it alone.

The Wharton researchers’ study disputes a theory that biotech firms used superior knowledge of their company’s products and prospects to dump “lemons” on the big drug companies, said Danzon. Indeed, Nicholson pointed out, “These deals are quite important for both parties. On the pharmaceutical side about a fifth of drugs are licensed” from the biotech companies, which makes them “a valuable source of product.”

Among biotech firms, Nicholson added, “you could have companies that say, ‘We’re not interested in bringing products to market. That’s not what we’re good at. We’re more likely to get our drug to market and get big sales if we partner with a firm that’s good at running large clinical trials and already has a marketing and sales operation.”

Generally, that is the model. But such was not the case with Bristol-Myers and ImClone. In that $2 billion alliance, ImClone was responsible for ushering the cancer drug Erbitux through approvals. After the FDA refused to even consider ImClone’s case in December, Bristol-Myers demanded changes in the original deal. But when a subsequent meeting with the FDA raised new hopes of approval, the companies announced a new agreement. Bristol-Myers will reduce some upfront payments and cap later payments to ImClone and, perhaps more important, put one of its own senior vice presidents in charge of the Erbitux regulatory team. According to Nicholson, the Erbitux alliance should be considered atypical.

More common is the approach of GlaxoSmithKline. Jean-Pierre Garnier, CEO of the world’s second-largest drug-maker, has made licensing a critical part of his company’s research and development strategy. In the past year, GlaxoSmithKline licensed 10 potential drugs from other companies, “and we are on the hot trail to get a few more,” Garnier told New York analysts last month. His company, Garnier added, prefers to buy late-stage products because of the lower risk.

When negotiating with smaller biotech firms, GlaxoSmithkline’s resources and the allure of its massive sales force gives his company a leg-up in competing for promising drugs, according to Garnier. “I think size is very important,” he told the analysts. “You cannot succeed in final clinical development unless you have a worldwide infrastructure. We see that all the time with biotechs and I think ImClone is a demonstration of that.”

Garnier’s comments came several weeks before the FDA turned down biotech Corixa Corp.’s application for approval of a new cancer drug, Bexxar, used to treat low-grade non-Hodgkins’s lymphoma. Corixa, according to news reports following the FDA’s March 13 ruling, was working on the drug and approval process in partnership with GlaxoSmithKline. Corixa indicated it plans to meet with the FDA to determine what additional steps it needs to take to win approval for the drug. 

Mark Edwards, managing director of Recombinant Capital, a San Francisco consulting firm specializing in biotech alliances, says that the deals, for the most part, are proving to be successful: “Alliances can and should be a win-win situation, but it’s sometimes difficult to get there.” Edwards has noticed a trend among biotech companies to license out their products later when there is less risk and more reward. He said that may be because they were able to raise enough capital, particularly during a great funding boom in 2000, to finance the expensive process of clinical development themselves.

According to Danzon, a number of biotech companies are now large and experienced enough to bring their products through the regulatory process, reducing risks for pharmaceutical company buyers. “In the short-term we will see an emphasis on late-stage deals because of the patent expirations the pharmaceutical industry is facing,” she said. “But in the longer term, hopefully, that bump of patent expirations will flow through and I think the normal expectation is that pharma companies should be doing a lot of early stage as well as late-stage deals.”

Beyond adding overall value, Nicholson said the biotech-big pharma alliances also serve a role in the financial community by signaling a proper valuation for the smaller biotech firm. In 1998 biotech companies raised $6.2 billion in pharmaceutical alliances, three times what they raised in the public and private equity markets.

“One of the offshoots is that people sitting on the sidelines will look at which biotech companies are signing deals and the size of the payments and make inferences about the quality of the biotech companies’ products. It is a way for financiers in this industry to find out which companies are of high quality and which ones aren’t.”

Of course this is not the primary mission of the drug companies, Nicholson said. But by using their scientific expertise and experience in drug development to place a value on their own deals, big drug makers assist the financial community, which can be overwhelmed by the complexity and science involved.

“If you look at the Internet companies, that model wasn’t [particularly] hard to understand, and we now know venture capitalists made mistakes. But it wasn’t hard for a venture capitalist who is a generalist with an MBA to understand how this business was going to make money,” said Nicholson. “Whereas even with a scientist or an M.D. in your venture capital firm, there’s no way you can be specialized enough to understand proteomics and hypertension and immunology. It’s impossible and it wouldn’t make any sense. So why not rely on a very large firm that’s been doing this for years?”

Nicholson’s and Danzon’s research shows that biotech companies typically receive discounted payments when they do their first deal with big pharma. Nicholson said the discount is usually about 60% of a product’s true value or about $18 million, based on the average price. On the second license the discount shrinks to 30%. It disappears in the third and subsequent licensing as the research firm establishes itself in the market as a credible producer.

In effect, the biotech’s discount pays the pharmaceutical company for its time and effort in due diligence, Nicholson said, adding that firms that manage to sign several deals enjoy a 23% increase in market value. “This amount is very close to the discount they take in the beginning,” Nicholson pointed out. “Ultimately they are not paying for the discount because they get it back.”

Nicholson said he was surprised to find that deal payments did not depend on the climate for biotech, which is a sector that often rises and falls out of investment fashion. “We thought that when the biotech market is cold and biotech companies are running out of cash they would have to run to pharma firms, but we didn’t find any of that.”

However, Nicholson does not see a day when big drug companies adopt a virtual model and contract out all research, the way Nike contracts out shoe manufacturing. These drug companies, he said, “are still putting billions in their own R&D.”

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