Once Xenophobic, Big Pharma Looks Outside For Financing R&D

Big pharma is increasingly taking a cue from biotech by looking externally to finance internal pipelines.

Facing slower growth and higher capital costs in an era of major patent expiry, big pharma is embracing an increasingly mainstream financing option that it once never considered: selling future royalties or revenues generated by its marketed products to financiers. The financiers, in turn, provide upfront funding which the companies can use for drug development or other high-cost projects, according to a Sept. 25 workshop panel at FDC/Windhover's Pharmaceutical Strategic Alliances Conference in New York.

Sitting on the panel was general partner at Paul Capital Lionel Leventhal, whose firm has engineered royalty and revenue-interest payments of close to $1 billion in capital throughtout the last decade to help biotech and pharmaceutical companies fund the acquisition, development or launch of more than 75 compounds across 23 therapeutic areas.

"We've never been busier," Leventhal told the conference. "The pharmaceutical industry is a vociferous user of capital and it doesn't matter how the markets are doing - they still need capital." With equity markets down and debt less than an ideal way for the industry to obtain the money it needs, royalties and revenue-interest financing is become more mainstream, he added.

Paul is one of a small but growing number of creative financing boutiques willing to give biopharmaceutical companies money upfront in return for rights to a small portion of future revenues or royalties generated by an existing product or portfolio of products. The immediate infusion of this relatively inexpensive capital enables recipients to take advantage of present opportunities - acquire a new product or company, expand a sales force, launch a product, or unlock an asset - without diluting equity or running into the restrictive covenants banks place on commercial loans. Nor does the biopharma company have to adhere to the rigid schedule of repayments that makes up the framework of traditional debt; if the products that generate the royalties do not do well, the financier takes a hit.

The financiers, however, have some assurance that they will make money on the deal because they are obtaining their payback from products that are already proven in the market.

Paul Capital gravitates toward revenue interest arrangements, but it can accept royalties as payback, depending on the recipient's strategy for commercializing the product. In general, the royalty arrangements are used if the borrower has licensed the revenue-generating product to a third-party partner. If its payments come from a product the company sells itself, the revenue-interest model is used - an option that Leventhal refers to as a "synthetic royalty" because the revenue is treated like royalty for the purpose of financing a transaction.

Partners In Finance ... And Strategy

Leventhal explained that a key difference between sale of a passive royalty and the sale of revenue interest is the strategic element involved in the latter.

"Close to 70 percent of the financing transactions we have done ... have been revenue interest transactions where frequently we'll create the opportunity - we'll find a product for a company to buy - and we'll provide the financing," he said. He added that the 14-person team at Paul Capital handling these transactions is made up of former pharmaceutical company general managers and looks more like the business development group at a pharma company than a typical financing firm.

"There will be some business development or some structuring added that is not just taking an asset that exists and asking who wants to bid on it, but basically creating some value, whether it's structured at R&D expenses ... or it's finding the products for a company to acquire, or some other strategic thing."

William Robb, panel member and VP investment partnering at Quintiles Transnational Corp.'s subsidiary NovaQuest, noted NovaQuest's recent deal to support the Phase III development of Lilly's two lead Alzheimer's disease compounds as an example of how his company is offering this kind of financing option to help pharmaceutical companies with their risky R&D.

As the industry faces the contractions that will likely lead to cuts in R&D spending - an area in which firms are used to spending 15 percent to 20 percent of sales - more firms could find themselves following Lilly's lead in monetizing future royalties and revenues.

Lilly announced in July its plan to use private equity to fund the Phase III development of a gamma secretase inhibitor and an A-beta antibody (¹ (Also see "Lilly Taps Investment Firm To Help Fund Phase III Alzheimer’s Trials" - Pink Sheet, 24 Jul, 2008.)).

Under the deal, the global investment firm TPG-Axon Capital provides the bulk of the funding - up to $325 million - with a 10 percent contribution from NovaQuest.

The return structure for TPG and NovaQuest is blended. The firms will receive success-based milestone payments and high- to mid-single-digit royalties on future sales of the two compounds - as well as royalties from an unrelated product that Lilly has out-licensed, to hedge the risk TPG and NovaQuest are shouldering.

In the case of the Lilly/NovaQuest deal, Lilly ultimately retains all control over the direction of the Alzheimer's programs, but NovaQuest is a strategic advisor, offering input in areas like trial design and endpoint selection. TPG remains hands-off; it is not involved in strategy. "What we look for in the assets that we invest in is that they are absolutely strategic to our partner companies as well ... it's the collaboration on the strategic end that creates the best [minimum price variation] story for our partners," NovaQuest's Robb said.

Portfolios & Late-Stage Projects Drive Deals

Paul Capital's Leventhal said these deals are available for revenue-generating products or those entering Phase III, where the approval risk ranges from 70 percent to 90 percent. His firm does not support products in phases I and II. He added that including a revenue-producing product can help lower the cost of capital for a company that's trying to raise money by selling participation - and that including a portfolio of products can reduce the cost of capital even further.

Robb said that NovaQuest has been able to invest in pre-approval assets by building a return structure built on a portfolio of products, as with the Alzheimer's deal with Lilly. "If we can aggregate six or so Phase II/III assets, that will build a return structure that is built not off of a single asset but rather off of that portfolio. The first approvals or royalties now allow us to invest in assets that are earlier stage but achieve that cost of capital objective," he said.

Turning Non-Core Assets Into Strategic Capital

More straightforward, however, is Vertex Pharmaceutical's recent deal, which monetizes royalties from two drugs that Vertex developed in collaboration with GlaxoSmithKline, and which GSK currently markets. Vertex announced in June that it has sold its rights to future royalties from the protease inhibitors Lexiva (fosamprenavir), and Agenerase (amprenavir), which treat HCV, for a one-time cash payment of $160 million to an undisclosed group of institutions and hedge funds (² (Also see "Vertex Sells Lexiva, Agenerase Royalties For $160M" - Pink Sheet, 3 Jun, 2008.)).

Agenerase and its successor Lexiva came out of a long-standing collaboration with GSK; Lexiva, launched in 2003, is a pro-drug of Agenerase, launched in 1999. The drugs generated combined net royalties of $34.1 million for Vertex in 2007.

Speaking at the workshop, Vertex Head of Business Development & Licensing Philippe Tinmouth said Vertex decided to monetize the royalty in late 2007 when "we realized the strategic value of this asset was more in the large sum of money that it could net us to help fund the pipeline - specifically the late-stage development of telaprivir [an HCV treatment] - versus adding $40 million onto our P&L every year."

Tinmouth said Vertex had been considering the royalty transaction since late 2004/early 2005, but that waiting to make the deal worked to the firm's advantage, due to the product's track record on the market. Phase III trials for telaprevir started in March (³ (Also see "Vertex Kicks Off Telaprevir Pivotal Trial Next Month" - Pink Sheet, 13 Feb, 2008.)).

He added that the deal was greeted favorably by Wall Street, with Vertex's stock rising $1 the day the announcement was made.

"It was a sign to the Street that we had taken what was really a non-core, non-strategic asset and turned it into a strategic source of capital. And that was a fairly uniform reaction from all the analysts," he said.

- Jamie Hammon ([email protected])