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Forget About the IPO Market: It’s Time for Biotechs To Think Differently

Xconomy National — 

When a company like Plexxikon can’t pull off a big-time IPO, you know something’s out of whack in the biotech world.

Berkeley, CA-based Plexxikon hit the motherlode last week when it agreed to be acquired for $805 million upfront, plus $130 million in milestones, by Japan-based Daiichi Sankyo.

VCs everywhere drooled. That’s because in this most expensive and risky of businesses—where 90 percent of drugs fail in clinical trials, and it typically takes hundreds of millions to develop a new therapy—Plexxikon proved it had a winner after raising just $67 million. That’s the kind of return VCs live to see.

No doubt, this lucrative payday was the result of a bidding war among potential acquirers. But when I spoke to Plexxikon CEO Peter Hirth and president Kathy Glaub by phone after the deal was done, I was struck by how limited their options actually were.

When asked if the company seriously considered an initial public offering—as an alternative to raise money, stay independent, and reward shareholders and employees—he said the company considered it, and walked away.

“There is no IPO market. Not at this valuation, anyway,” he says.

Imagine for a second what that means to thousands of people working at biotech startups, pursuing their IPO dreams. Many still seem to be deluding themselves about how they are building the next Genentech, and walking down the yellow brick road to IPO riches. Heading into this year, industry impresario Steve Burrill predicted that at least 25 biotech IPOs will get done in 2011.

I’ve watched as a number of biotech companies have tried to go public over the past year, only to become calves heading to the slaughterhouse. If Plexxikon can’t get what it considers a fair valuation from IPO investors, it makes you wonder what some of these other companies are thinking. Investors—duh—have been burned by so many biotechs over the years that overpromise and underdeliver that there just isn’t much appetite left on Wall Street even for really good drugs. As Tom Marsico, who runs the $51 billion fund known as Marsico Capital Management, put it in a recent interview with Fortune, he’s bullish on Apple, banks, and a lot of sectors—everything except healthcare.

“Drug development has become very difficult,” Marsico told Fortune. “The low-hanging fruit has been done—the beta blockers, high-blood-pressure medicines, cholesterol-lowering drugs, pain medication, antibiotics, etc. At the same time, the tough stuff—like treatments for cancer, for Alzheimer’s, and for autoimmune diseases—is going to be much more difficult to figure out.”

If you think that’s too dour of an assessment, consider what Plexxikon had going for it:

A drug for about half of patients with metastatic melanoma, a deadly skin cancer. The drug has shown an ability to at least partially shrink tumors in 81 percent of patients—in a field where 10-to-15 percent response rates are the norm. A pivotal study of more than 600 patients has shown the drug can keep tumors from spreading and extend lives when compared to a standard chemotherapy (although we don’t know yet how big the advantage really is).

Plexxikon’s management team has what most investors are looking for—a proven track record. Hirth was previously the president of Sugen, which created sunitinib, which is now a $1 billion-a-year cancer drug for Pfizer. Glaub, who has worked with Hirth for almost a decade now, had previous stints on the business and finance side of Cell Genesys and Genentech. They deflect credit to one another, do joint interviews, and can finish each other’s sentences. They clearly have good teamwork.

The science here, too, has a lot of appeal for the folks who dig hard-core structural biology. Plexxikon seeks to establish an in-depth 3-D understanding of the protein target it pursues on diseased cells, before it specifically crafts a drug to bind with it. And once it identifies the genetic malfunction it’s going after, it works on a companion diagnostic to make sure it gives its drug only to the patients most likely to benefit. The methods Plexxikon used to do this were outlined last fall in a paper in Science.

Critics could certainly argue that by following the partner-early/partner-often business model, and inking five partnerships, Plexxikon was giving away the crown jewels too cheap, too early.

But those deals did generate a regular cash stream, and with the cash flow came the ability to control its own destiny. Plexxikon’s last financing was in 2006. By staying lean, outsourcing a lot of functions, and avoiding hiring a bunch of expensive VPs, Plexxikon remained a 43-person organization to the end, and was running slightly in the black the last couple years, Hirth says. But while the partners helped pay the bills for building a discovery engine, Plexxikon was able to generate some drugs that it retained full ownership of, including one, PLX3397, being primed for Phase II clinical trials.

Plexxikon staked out this partnership model from the start, knowing that most drugs fail, so it was best to share risk with partners. Some biotechies scoffed, saying Plexxikon was “stupid,” Hirth recalls. There are lots of downsides to partnering, like when a biotech product gets lost in the shuffle of some vast portfolio of another company, teams from different companies don’t communicate well, and start pointing fingers at each other when things go wrong.

Peter Hirth and Kathy Glaub

Yet those who cling to a “keep the ball to myself and I’ll sink the half-court shot” attitude are behaving in a way that’s destructive to the industry, Hirth contends. While many companies still dream of becoming a FIBCO (fully integrated biopharmaceutical company) like Amgen or Gilead Sciences, this is really a one-in-500 kind of proposition, at best. Most companies are better off doing some of the innovative science upfront like Plexxikon did, and then find a partner to generate enough cash to keep the doors open, and to spread the risk around.

“We’d rather own 20 percent of a given product, not vertically integrate, and license it away at a value inflection point,” Hirth says. “The industry really needs to re-think itself. Most of the people we know are living 20 years in the past, and they don’t realize they need to change.”

I’m not sure I’d go as far as Hirth. Quite a few entrepreneurs I talk to are well aware the odds are against a successful IPO. Yet if everybody gave up on the FIBCO model, then you probably wouldn’t have seen important new drugs get developed in recent years by Cambridge, MA-based Vertex Pharmaceuticals (NASDAQ: VRTX) and Seattle-based Dendreon (NASDAQ: DNDN). But Hirth and Glaub are definitely onto something. It’s long past time for most entrepreneurs to start thinking about new ways to collaborate, and to spread risk around, while pushing forward with real work to prove one of your drugs works. Then, when you do, take the money. And then, maybe, do it again.

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