Nothing to Lose but Your Chains: Out-Partnering Part I

Lots of interest in out-partnering these days from Big Pharma – out-licensing, spin-offs, project financing (see in particular this IN VIVO analysis of Pfizer’s out-partnering strategy).

But let’s eliminate a myth now. Out-partnering won’t raise lots of money for Big Pharma, even by selling tail-end products. Lilly’s entire out-licensing program –the industry’s most lucrative because it is the only one to exploit tail-end drugs- raised about $1 billion over 7-8 years. Now, that’s hardly chump change. But it doesn’t really move the needle when a moderate annual Big Pharma R&D budget is pushing $3 billion.

So if companies are going to get into serious out-partnering, the other reasons ought to be pretty compelling.

They are. Out-partnering frees up scarce resources to put behind other projects by off-loading some expenses. It can force companies to do some salutary comparisons between internal and external projects (would your same-mechanism Phase II program fetch the price your competitor just paid for Way-Cool Biotech’s?)

But we’re going to talk, here and in a post for tomorrow, about other reasons to out-partner. Starting with a relatively dramatic rationale: using out-partnering to remake the business model.

As some smart types from Boston Consulting Group write in the current IN VIVO: “The decline of pharma’s traditional model isn’t imminent; in fact it already happened.”

The consultants go on to tick-off depressing metrics like total shareholder returns. Pharma's return is down 0.3% annually since 2000. Compare that to, say, the exciting auto components sector – up 6.5% over the same period. They argue that drug companies, to get back on any kind of growth track, need to respond with more than the current set of stock tactical answers (portfolio rationalizations, sales-force restructurings, productivity enhancements, pipeline accelerations, more aggressive dealmaking, and especially big M&A).

So how to do this? The consultants propose a fairly intensive internal process, which seems OK to us. But, closet revolutionaries that we are, we’d suggest an alternative route: out-partnering force majeure.

Take the out-licensing of tail-end products. Comparatively small potatoes, as we noted. But let’s say Pfizer were to re-define tail products, taking all primary-care products whose patents were expiring in four years or less (among them, Lipitor, Detrol and Viagra) and spin them out into a public company – call it Pflipitor.

Start financially. Our bet is that investors would be very interested in such a company – something that looks a bit like Forest Labs – minimal R&D expense, intense commercial focus, primary care without the Big R risk, aggressive late-stage in-licensing. And while Pfizer would lose the cash flow, it would have, in its Pflipitor shareholdings, a nice bank account to dip into when needed. And just maybe those Pflipitor shares would actually gain in value over time.

And to be clear: Pfizer shareholders already know the company can’t possibly fill the revenue hole the company has dug for itself (that dead elephant in Pfizer’s boardroom – as well as the boardrooms of plenty of its competitors – is the reason Pfizer’s PE sits below sea level). Spinning out the tail products makes filling that hole somebody else’s problem, and that somebody else will be far more capable, structurally and our guess is strategically, of solving it.

Meanwhile, Pfizer can focus on actually growing a much smaller company. If you remove those four "tail" products, it’s possible to grow at double-digit rates.

And not just because Pfizer's base is smaller. Pflipitor would take with it a whole lot of Pfizer’s overinfrastructured commercial organization, allowing Pfizer to more rapidly switch over to the flexible, partly outsourced, specialty-intensive sales model it theoretically wants to embrace.

There would be other big changes. Pfizer would no longer have the cash flow to support the enormous R&D organization it now carries around like the chains on Marley’s ghost, making it far more pressing to strip out programs that can’t prove substantial advantages over outside, in-licensable competitors. Instead, like a biotech, Pfizer would have to sell equity – pieces of its share of Pflipitor, perhaps – to finance R&D…further incentivizing its R&D execs to cast a cold eye on internal research programs.

Yes, we know: this sounds a bit like throwing the kid into the deep end to teach him to swim. But the drug industry already knows how to swim, we believe. The problem is it's trying to swim while loaded down with chains. Either we’ve got to cut them or get out of the pool altogether.

Image from flickr user foxypar4 used under a creative commons license.