Biotechs Gain On Favorable M&A Landscape; Will Deal Prices Keep Rising?

The steady growth in the valuation of small and mid-size biotech firms over the last quarter may reflect the increasing leverage such companies have in merger and acquisition negotiations with big pharma.

The F-D-C OTC Index of NASDAQ-traded biopharmaceutical sector stocks closed down 3.3 percent for the quarter (see chart: " ¹ 'The Pink Sheet' OTC Index Of NASDAQ Stocks: Q1 2007 ").

However, if heavily weighted Amgen, which was down over 18 percent for the quarter and is more of a licensee than a licensor, is excluded, the index closed up a healthy 5 percent. The 5 percent gain outpaced the composite NASDAQ Index, which was virtually flat for the quarter.

A number of firms that gained during the quarter had positive deal news. For example, Affymetrix, which jumped 30.4 percent, signed a deal with NuGEN covering a diagnostic and Alkermes, up 15.5 percent, expanded its collaboration deal with Lilly for the inhaled insulin AIR .

However, a number of firms that did not announce collaborations during the quarter also saw gains, potentially in part reflecting the broader impact of a favorable M&A environment on biotech companies' valuations.

Biotech Takes Upper Hand In Dealmaking

During the recent Biotechnology Industry Organization/Windhover Partnering Conference for Decision Makers, big pharma and biotech M&A execs generally agreed that biotech firms have taken the upper hand in negotiation with big pharma.

"We are seeing a shifting in the balance of power," Tempo CEO Alan Crane said.

"It used to be that biotechs had relatively lesser power in the equation and I think we weren't able to achieve appropriate economics in deals. I think that as we look at the current trends, we are seeing more of a reflection of a balance in power," he said.

Crane attributed the increasing leverage for biotech companies to the large amount of available capital in the marketplace. Up until recently, biotech companies had had a difficult time accessing capital, primarily as a result of the perceived lack of attractive exit strategies for venture investors (² , p. 16).

"Biotechs obviously have better access to capital than they did at one time and sometimes very significant access to capital, so the question often is why partner," he said.

Wyeth Assistant VP-Licensing and Global Business Development Kumar Srinivasan agreed: There is "cash slushing around the market. I mean small companies can go raise money."

"Because there is so much liquidity out there in the market and because small companies can raise the money, they don't do a partnership unless they have to. They can raise money. They can continue to advance their program," Srinivasan explained.

Cell Genesys, which surged 23.9 percent during the quarter, is one beneficiary of the large amount of venture capital available. The company announced Feb. 5 that it secured $75 million in committed equity financing from Kingsbridge Capital.

Specialty Deals Are Particularly Expensive

Merck Chief Licensing Officer Barbara Yanni said that biotech companies have been able to secure particularly favorable terms for specialty products.

"Many, many of these very expensive deals are in the specialty pharma area and that is really a theme I see running through this," Yanni said. "There has been in these kinds of areas a shifting of power ... between a biotech company and the big pharma company making the deal."

Yanni said the trend is particularly apparent with oncology, which "is a very profitable area if you can make it."

"I think that, to a large extent, might be what is driving some of these very high up front prices because it is an area where to some extent the biotech can look at the big pharma company and say, 'I don't need to do a deal; I can develop this product on my own; I can sell it on my own and I only need X number of reps,'" she explained.

AstraZeneca Executive Transaction Director Denise Goode said the favorable M&A environment for biotech is also being driven by big pharma's productivity slowdown.

"We have got a productivity challenge and we need biotech to help us fuel and power our pipelines and that is not going to stop," Goode said. AstraZeneca is a poster child for big pharma's development difficulties, having seen a number of Phase III failures over the last year (³ (Also see "AstraZeneca Clinical Setbacks Add To Pipeline Woes" - Pink Sheet, 6 Nov, 2006.), p. 16).

Goode noted that even when a large company has a compound in its pipeline in a particular class, it may seek out a deal in order to have the first compound to market in the class.

"We do have a lot coming through Phase I and Phase II in the pipeline, but it is not necessarily at the head of the pack," she said, explaining that when considering whether to reach a deal for the lead agent, "you do the value equation about are we prepared to share value and pay that money versus being a couple years behind with something where we don't have to share value."

AstraZeneca's April 23 announcement of plans to purchase MedImmune for over $15 billion only adds to the evidence that the price of biotech deals is skyrocketing (see ⁴ (Also see "Astra Wins MedImmune Auction; $15.6 Billion Price Tag Raises Eyebrows" - Pink Sheet, 30 Apr, 2007.)). MedImmune, which announced it was on the block in early April, rose 12.4 percent for the quarter and substantially more after the announcement of the deal.

M&A Price Increases Unlikely To Abate...

Most panel members felt that deal prices will continue to increase going forward. "I think the balance of power is going to either stay the same or continue to favor the biotech company," Wyeth's Srinivasan said.

AstraZeneca's Goode said she could see deal prices "edging up," citing the highly competitive biotech M&A landscape as one reason.

"There are certainly companies, and Roche is an example, who seem prepared to pay very, very high amounts for these sorts of opportunities. Competitively, if we want to compete against those companies, there are going to be pressures on us to pay higher prices," she said.

Tempo's Crane predicted that value of the most expensive deals will not increase, but that the total value of pharma/biotech M&A activity will increase.

"The overall size of the deals will not continue to increase because I think they have been approaching the levels of representing a fair balance of power between the biotech and pharma, but what we are going to see is more and more of these large deals," Crane explained.

...Unless Big Pharma's R&D Output Picks Up

Merck's Yanni was the lone dissenter, asserting that deal prices would plateau as the productivity of big pharma's in-house research and development programs increases.

Yanni noted that biotech firms have also seen high pipeline attrition rates in recent years, although not at the level of big pharma. "We are all losing more products at later stages than we used to and than we would like to obviously," she said.

However, big pharma's pipeline attrition rate may decrease going forward as a result of the implementation of new technology to increase the efficiency of the development process and improve compound selection, she suggested (⁵ (Also see "Merck To Improve R&D Output By Having More Clues At The Start" - Pink Sheet, 1 Jan, 2007.), p. 9).

Yanni pointed out that big pharma's Phase I and II pipeline is currently significantly larger than in previous years. If this expanded early-stage pipeline translates into later-stage success, "then the economics is going to be on its head and big pharma will be less hungry for products," she said.

Biotech Also Benefits From Positive News Flow

While the favorable M&A landscape may have provided an across-the-board bump in biotech valuations, the quarterly performance of individual issues remains tied to news flow.

Dendreon was the biggest beneficiary of positive news, soaring 210 percent, following a favorable advisory committee review of the firm's cancer vaccine Provenge (sipuleucel-T) (⁶ (Also see "Dendreon’s Provenge Cancer Vaccine Shows “Substantial Efficacy” – Cmte." - Pink Sheet, 2 Apr, 2007.), p. 4).

Amgen was among the largest losers, with its decline reflecting ongoing concerns about the safety profile of its erythropoiesis-stimulating agent franchise as well as negative data for its oncologic Vectibix (panitumumab) (see ⁷ (Also see "Strange Bedfellows: Amgen, J&J Work Together In Advance Of EPO Meeting" - Pink Sheet, 30 Apr, 2007.)).

- Andrew Kasper ([email protected])