Biotech’s new normal is search for efficiency

Coming out of a harrowing financial crisis and recession, the outlines of a “new normal” are starting to emerge in the general economy and biotech industry, Ernst & Young says in its global biotechnology report for 2010, Beyond Borders.

On the surface, E&Y says it would appear that the worst is indeed over for biotech.  “Aggregate funding levels rebounded nicely in 2009 and strategic alliance activity remains robust.  Financial performance has been fairly strong — particularly under the circumstances — with remarkable improvement on the bottom line as companies have engaged in belt tightening.  The market cap of smaller companies, which had taken a beating, has rebounded impressively, making up much of the ground that was ceded in late 2008 and early 2009.”

While benchmarks such as capital raised, alliance activity and profitability are heartening on the whole, they only tell only part of the story as the availability of capital remains challenging for many companies, E&Y says.  “Unlike previous funding droughts, the current crisis has not been driven by vacillating investor sentiment toward biotech stocks, but rather by a fundamental and systemic recalibration of credit and capital markets.”

In an interview with biotuesdays.com, Paul Karamanoukian, Canadian life sciences leader for E&Y, points out that capital funding continues to impact Canadian biotech companies more than any other issue.  “Since 2003 in Canada, we’ve seen a significant decline in financings, IPOs and venture capital and, as a result, a drop in the number of companies in total.”

If there is a common theme defining the “new normal”, the E&Y report contends it is the “search for efficiency.”  In adopting the “new normal”, Canadian companies are cutting overheads, lowering their expectations on value to more realistic values and looking for operational efficiencies versus a purely science development approach to business, Mr. Karamanoukian says.

After the end of the era of easy money globally, Beyond Borders says investors are looking for more efficient ways to fund innovation and achieve returns, governments and insurers are demanding better outcomes for every health care dollar they spend, and Big Pharma is focused on filling its pipelines and ways to conduct R&D more efficiently.

How will each of these pressures shape the “new normal”?   Among early trends, E&Y figures that access to capital will remain difficult for many, if not most, emerging companies.  There will be a decline in the number of traditional start-ups funded by VCs and a corresponding increase in project- and asset-based funding.  And the number of public biotech companies will continue to fall, driven by acquisitions, market attrition and the lack of a robust IPO environment.

E&Y has set out five guiding principles for the “new normal”:

• Seize funding opportunities. The era of easy money is over, and capital will be relatively scarce for some time. Broaden your search to include non-traditional (and non-dilutive) sources of funding. Be realistic — you may need to reset your valuation expectations for today’s markets — and take funding when it is available.

• Capital efficiency matters. To go the distance, you will need to use capital efficiently. Design studies and trials to fail faster. Prioritize the pipeline, using commercial as well as scientific indicators. Work with third parties — not just to cut costs but also to unleash    operational efficiencies.

• If you build it, will they pay? The finish line is not marketing approval but payor acceptance.  It’s never too early to think about reimbursement. Invest early in pharmacoeconomic analysis to inform R&D decisions.

• Collaborate creatively.  These are universally challenging times, and creative partnering structures can free you from turbulent public markets and help you go the distance.

• Differentiate your asset. Creatively structured collaborations can help companies go the distance, but now there are fewer potential buyers, and they are more distracted and have fewer resources.  To become a partner of choice, demonstrate what truly differentiates your product or platform.

Mr. Karamanoukian says that these five guidelines are very apropos of the Canadian scene as well.  “The need is to become more business savvy and strategic in order to stretch your dollars.”

In 2009, the Canadian biotechnology industry raised slightly more than $733 million (U.S.), an increase of $255 million compared with 2008, with public companies raising about $633 million.  However, this money went to a relatively small set of companies, with one transaction — the $325 million debentures issue by Biovail — accounting for 44% of the total amount raised by the industry.  In the absence of this transaction, the year’s total would have been only $408 million — the lowest level in the last decade.

For the second year in a row, there were no IPOs.  There was also a sharp decline in venture capital, falling to $100 million in 2009 from the earlier year’s $207 million.  E&Y says this is a “major source of concern for the Canadian industry’s long-term prospects.”

The credit crisis and bleak capital markets forced several Canadian biotech firms to turn to non-traditional sources of capital, including government funding and the sale of tax losses, which accounted for $22 million.  And many public companies compensated for the funding shortfall by turning to some interesting research collaborations, E&Y says.

While financing for Canadian public companies fell to a 10-year low, there was a significant increase in partnering activities in 2009 — a positive development for the Canadian industry, E&Y says.  For the first time, there were six licensing agreements signed by Canadian biotech companies, with potential values in excess of $100 million each.

The largest licensing agreement was Cardiome Pharma’s (NASDAQ: CRME; TSX: COM) deal with Merck (NYSE: MRK), involving more than $60 million in up-front payments and $640 million in potential payments for the achievement of regulatory and commercial milestones, and royalties.  The second-largest deal was between OncoGenex (NASDAQ:OGXI) and Israel’s Teva Pharmaceuticals (NASDAQ:TEVA), with a $60 million initial cash payment and additional payments of up to more than $370 million for royalties and milestones.

Combining acquisitions and business failures, E&Y says that the number of public companies in Canada declined 11% in 2009 to 64 from 72, while the number of private firms declined 9% to 260 from 286 in 2008.

As in the U.S. and Europe, public companies in Canada engaged in significant cost cutting to survive.  Unfortunately, much of the cost cutting came at the expense of R&D spending, which fell 44% in 2009.  “R&D is the driver of future growth in this sector, and this sharp decline could have long-term repercussions for the Canadian industry,” E&Y says.

Despite cost-cutting measures, there was no appreciable improvement in the industry’s survival index as 2009 ended with 57% of companies having less than one year of cash on hand.

Boosted by an overall stock market recovery, however, the industry’s market capitalization surged 56% during the year.  Even with this recovery, however, the industry only partially made up for the ground it lost in 2008, when it lost 61% of its market value.