Wednesday, March 26, 2008

Why Investors Don’t Like Biotech Alliances

We all know that the public markets are not funding biotech. Add up all the dollars invested in biotech IPOs and follow-ons over the last three years ($16.2 billion) and it doesn’t equal even half of what VCs and other private-equity players have put into the industry ($33.3 billion).

But alliance dollars continue to climb.

And yet investors don’t seem to like them very much.

Since November 2007, there have been nine deals by public biotech companies with upfront payments (equity and cash) of greater than $20 million – to us a reasonable proxy for a biggish deal. Among them: Isis Pharmaceuticals’ mipomersen deal with Genzyme ($325 million upfront); Merck’s with GTx on its Phase II SARM and two backups ($70 million upfront); and Sanofi Aventis’ multi-antibody arrangement with Regeneron ($85 million upfront).

And yet, with all this mostly undilutive capital flowing in, the market’s reaction has been distinctly negative. The median share price among these nine biotechs is down 15% from the day the deal was signed.

The entire decline can’t be blamed on the deals. Dynavax signed a deal with Merck on its Heplisav hepatitis B vaccine, getting $35 million in upfront monies. Since then the stock is down 59% -- though that decline was almost entirely due to the fact that the company had to halt its Heplisav trial for safety reasons.

And to be fair, equities in general have hardly been popular in the run-up to and aftermath of the Bear Stearns fiasco.

But you’d expect better from companies with pretty darned good news. Regeneron, for the third time non-exclusively monetizing its VelocImmune antibody production system and this time adding a rich co-development deal on a series of programs, with spectacular downstream economics, has nonetheless lost 16% of its value since it announced the deal.

The day the market heard of the Isis/Genzyme deal, Isis shares jumped 28% -- undoubtedly helped by the amplifier of the JP Morgan conference, during which the deal was announced. Within a month, the company had given up nearly all of those gains (pre-Bear Stearns, mind you). It’s now trading 1% above its pre-announcement price. (Read about the comparative value of the Isis deal here.)

There’s a sort of dog-in-the-manger quality about all this. If investors won’t put in new money, you’d figure they’d at least appreciate it when Big Pharma did. Nope.

Certainly, they used to. At one time, a Big Pharma deal was the required validation for an IPO or additional public round. But now it’s clear that the market no longer gives a damn about such imprimaturs. Big Pharmas’ frequent missteps in development haven’t shined up their product-picking reputations. More importantly, biotech’s institutional investors now have the teams to do their own scientific and clinical homework.

Second, the M&A-based logic of the market leads investors to the conclusion that any product-based deal subtracts value. We’re not aware of any data that actually supports that conclusion (we’ll look into it, of course). But as long as acquirers are willing to pay a nearly 100% premium to what IPO investors are willing to pay, investors are hardly willing to jeopardize a potential merger windfall by selling off rights to a key product.

And finally, investors just don’t like some of the deals biotech is signing, despite the big dollars attached to them. One reason, noted Bill Slattery of Deerfield Partners at the opening BIO-Windhover panel in New York: deals often give Big Pharma development control.

That’s an apparently sensible practice. After all, large drug companies have the development experience to know what they’re doing. Two decision-makers generally take longer than one. And no one wants two voices, with potentially two sets of data, going to the FDA about the same molecule.

But investors are beginning to see things differently. Big Pharma frequently chases only the major indications for a biotech's programs, which may mean they ignore the smaller uses to which the molecule might be better suited – and for which it might be approvable. No approval -- no milestones, no royalties, no value in the biotech, no brass-ring M&A shot.

Take Merck’s deal with GTx. Merck paid the biotech $70 million in cash and equity to get development and marketing rights to its Phase II SARM Ostarine (a terrific validation since J&J had given up rights to the same thing a few years before), $15 million in R&D fees, and a potential $422 million in additional regulatory milestones.

But despite a 63% one-day jump -- good data reported from its most advanced drug, the Phase III prostate cancer therapy toremifene (Acapodene) -- the stock is still off from the day it signed its Merck deal. Indeed, over the three months following that deal, the company lost 33% of its value.

We’re sure there were a variety of reasons for the decline. But one of them is that investors don’t like the fact that Merck now has all development rights to Ostarine. Should toremifene fail, GTx’s future will largely be in the hands of Merck. And for all Merck’s good intentions, its first obligation will be to Merck shareholders. Which is why GTx shareholders have reason to be skeptical.

And more generally why investors are skeptical of biotech deals.

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