Wednesday, October 22, 2008

The Good News for Biotech: New Regulation Opens a New Path to Profitability

In the absurdist economic world we now endure – simultaneous credit freeze and market meltdown – we hardly know how to be optimistic about biotech. As we noted here, high-risk investments like biotech attract the extra cash investors have in their funds. And since there’s likely to be precious little extra cash for the foreseeable future and, for mutual funds, some portion of that cash likely to have to stay as cash to cover redemptions, the outlook isn’t rosy.

And yet, long term, there is hope for biotech.

Our view (bits of which we’ve expounded on before, here and here) is this: In starkest terms, the regulatory system, the single biggest stumbling block to pharmaceutical success, is tilting biotech-wards. Within FDA, admittedly, there’s a certain skepticism about small-company development programs (of the “they don’t know enough to do it right” variety). But the fact is that fully a third of the 60 NMEs approved between ’05 and ’07 were from small companies.

And the economics of these approvals are likely to bend even more favorably towards small companies. With the passage of the FDA Amendments Act last year, the FDA now has a tool (Risk Evaluation and Mitigation Strategies, or REMS) that allows it more ways to say “yes” to new drugs – by placing extra restrictions that limit the patient population that can access the product.

Put another way, the path to regulatory approval is easier the more willing a sponsor is to accept limits on how a medicine can actually be sold in the marketplace.

Big Pharma, understandably, hates that idea. Their central business model relies on selling a chronic-care therapy to the broadest possible population of patients. But biotech, without the massive investment in marketing and regulatory infrastructure Big Pharma must support, can – if they’re smart – wholeheartedly embrace the notion.

Take the constipation drug Entereg, which GlaxoSmithKline in-licensed from Adolor hoping to have a blockbuster on its hands. FDA held it up for two years thanks to a cardiovascular safety signal (no more cisaprides!) until it was finally approved, with a REMS that limited it to short-term hospital use and a market of maybe $200 million. An economic non-starter for GSK ... but had Adolor developed the drug on its own, focusing from the get-go on the specialist market and constructing its regulatory and commercial infrastructure accordingly, its investors might have done very well, thank you. (As it is, Adolor is trading at a market cap of about $170 million – back in February ’06 the company was worth nearly $1.3 billion)

GSK took away some lessons from the experience, too. Via its blockbuster put-call-option deal with Theravance (written about in detail here), it had the right to in-license, among many other compounds, the biotech’s promising motility agent, TD-5108. But GSK said no to the compound, having lived through the stomach-churning experiences of Entereg and, before that, Lotronex. (That irritable bowel syndrome drug was pulled from the market for fear of causing intestinal blockages and then delicately relaunched with a kind of early prototype of a REMS approval.)

GSK’s decision casts some fairly deep shadows over Theravance’s original strategy: do the early development of significantly improved versions of Big Pharma’s biggest primary-care drugs and sell the results to Big Pharma.

Certainly, the other Big Pharmas to whom Theravance is now free to sell TD-5108 are going to tread very carefully around the compound, since they’ve also seen what’s happened to Entereg, Lotronex, and Zelnorm -- the Novartis irritable-bowel syndrome drug yanked from the market for yet a different side-effect.

And it’s pretty likely some distressing signal will show up with TD-5108, because the FDA has told Theravance, in effect, that the drug will require huge trials if it wants it approved for a chronic-care population.

But the GSK rejection also opens up what may be an even bigger opportunity for Theravance: going ahead on its own, specialist track. We don’t know if TD-5108 has much of a specialist opportunity. However, if it does, Theravance might be able to recapitulate the Entereg approval, by proposing its own relatively restrictive REMS, but on a profitable, express route.

With about $200 million in cash, Theravance has some runway and—when GSK decided not to buy a majority of its shares, its own investors' stuck with Theravance by not putting their shares to GSK—a kind of permission to build an independent road.

What’s more, any REMS Theravance constructs could be an additional patent-hurdle generics must leap. Even if the REMS itself isn’t patentable, few generics firms will be able to afford the kind of monitoring machinery required to compete.

Indeed, here is another case where smaller market sizes may end up being more profitable: generic companies will go after a billion dollar market regardless of the extra costs of special monitoring. But there will probably be fewer companies willing to sell a generic version of Entereg.

We’re not minimizing the cost of building a REMS-based approval road or the difficulties in financing it. But we are saying that those biotechs who can identify these niche opportunities and raise the money for them have a brand-new opportunity. They can choose a comparatively less risky development path than Big Pharma can afford, and then either sell the results to larger drug companies who want, but are unable to build their own, specialist businesses … or go on to construct self-sustaining commercial organizations right-sized for a REMS-defined world.

That’s the kind of choice investors like to have.

Image courtesy of Holaday98 and used through a creative commons license.

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