BIO 2014: An Industry Surrounded by Insurmountable Opportunity
Biotech is riding the crest of a wave of public and private financial interest unparalleled in the 36-years since the founding of Genentech. Since 2012 public markets have committed $10.3 billion to more than 100 life-sciences IPOs, an industry record. Pharma has been buying/partnering with biotech on an unprecedented scale. Research breakthroughs from cancer immunotherapy to wearable IT to real-time genomics are generating new business opportunities undreamed of a decade ago. Old technologies like gene therapy and RNAi are showing signs of finally achieving commercial relevance. Demand in the form of unmet medical needs is intense. Led by J&J’s Innovation Centers, pharma has suddenly shown an interest in stimulating external discovery/early development. Research continues to generate new hypotheses and targets at such a prodigious rate that commercial development falls further behind every day. The entrepreneurial community overflows with talent from the growth of biotech and the contraction of pharma. As the CEO of one of my portfolio companies once described the challenges he faced, “We are surrounded by insurmountable opportunity.”
It is easy to get carried away when the Fed has filled the money punch bowl to overflowing, the party is on, and BIO is coming to town. We are on the threshold of a new era in biotechnology. What could go wrong?
Well, for starters, when we sober up, we will still be in the pharmaceutical development business—where most things go wrong.
So what is new in an industry that lives perpetually on the threshold of a new era? What is different this time?
It is not the fanfare on Wall Street. We have been there before in 2000 and to a lesser extent in 1995-‘96 and 1990-‘91, and several times before that. Windows always close when the Fed takes away the punchbowl. Today, Janet Yellen seems bent on maintaining markets in a state of permanent inebriation, a strategy untested at this scale, but one that has generally not worked out for party-goers in the past. Despite her efforts, the great biotech boom of 2013 appears to be unwinding, as the Wall Street punters, speculators, and momentum players rush off in other directions in search of instant riches.
We can find plenty of threats in chaotic emerging markets, potential price controls, ever-higher regulatory hurdles, pharma’s dismal public image (10 percent trustworthy rating, just below car manufactures, and airlines) and the like. Some are new and acute, like jail-time in China for marketing missteps. However, biotech and pharma share a chronic problem that is reaching existential proportions, a problem, which, like all good problems, presents both opportunity and risk. That challenge is innovation; it isn’t new, but it is forcing change in the industry, and that is new.
All three sectors—biotech, pharma, and venture—need innovation; all three face inherent but potentially complementary limitations.
It does not make financial sense for pharma or large venture capital to invest in early stage drug development. Wall Street wants money out of pharma and it wants it now. Venture limited partners want money “in our lifetime” (i.e. 5-7 years), which makes starting with a scientific breakthrough and expecting to get paid for a drug more than a little challenging.
In the public markets the excess cash from the Fed that makes possible what biotech investors refer to as “windows” and crass outsiders call “bubbles” has a Catch-22 effect: It drives short-term speculative investment, which is the polar opposite of the smart, patient money that bio-pharma needs to create value. The requirement to “make the numbers,” (i.e. earnings per share) in the face of falling revenues has led to a relentless drumbeat of layoffs and mergers that have reduced the pharma industry’s productive capacity.
The venture industry is testing a whole spectrum of different approaches to starting a biotech company, from Arch’s $175 million Juno start-up, and Third Rock’s large-platform portfolio to the virtual-to-the-point-of-invisible business models at Atlas and Avalon. As exciting as these new approaches are, the need for experimentation reflects the fact that the venture industry has yet to establish an investment model that can reliably provide the returns needed to sustain the industry.
Pharma has reached out to the entrepreneurial community with incubators and other programs aimed at encouraging external innovation. Many of the start-ups are supported by groups relatively new to early stage financing: foundations, high-net-worth investors, and venture philanthropists. The staying power of both the funding sources and pharma, the land of perpetual reorganization, remains to be seen.
Despite all the headlines about billion-dollar-deals, most of the estimated 10,000 private biotech companies around the world will fail. Most of those biotech companies fortunate enough to reach proof-of-concept will be lucky to return invested capital in the up-front payment. Profits, if any, would be paid, contingent on an approval many years in the future, if ever. While the entire industry needs investors for the next generation of start-ups, it verges on impossible for an individual company to negotiate a deal sustaining for the biotech but financially sub-optimal the pharma.
The challenges of development, financing, and exit risks have left a mark on the previous generation of early stage capital providers. Since the great recession, the ranks of life-science venture firms have been cut by more than half. Mega-syndicates of the remaining venture funds can reduce the financing risk, but money will not change the uncertainty of drug development. While bubble-powered public markets can provide a temporary thrill, they don’t afford reliable supplies of either capital or liquidity. Incubators are a necessary first step, but pharma and its new entrepreneurial friends need a sustained commitment to bring more technologies to proof-of-concept, or the new wave of early stage investment will not meet expectations.
The exciting story is the emerging partnership between pharma and biotech. Importantly, both sides are coming to the realization that neither can prosper at the expense of the other. If together biotech and pharma can figure out how to invent new drugs, their partnership has the potential to transform the industry. That is a big “if,” but longshots are nothing new in pharma, and a longshot is better than the odds of either side surviving without the other in this new era of drug development.