In Searches of Returns

The life science venture capital business model is in a constant state of evolution in order to meet the challenges of current market conditions.  Faced with strong headwinds generated by a multitude of factors, including an economic downturn, a more stringent regulatory environment, and longer product development timelines, life science VCs are increasingly looking toward investments outside of the traditional biopharma investment mold.  New investment areas such as consumer, industrial biotechnology, and healthcare IT are increasingly attractive to VCs; however, that is not to say that investing in those sectors does not come without its own risks. 

For instance, non-biopharma companies can often be just as capital intensive as biopharma companies.  In the case of consumer healthcare companies, they often require even more capital upfront than biopharma companies in order to support the creation of full-scale commercial teams that have to be built early on the start-up’s life.  And unlike biopharma companies, consumer companies often need to generate several years of sales traction and growth before attracting an acquirer. 

In addition to capital risk, exit options and timelines for non-biopharma healthcare companies are not as clear-cut as in biopharma.  While the IPO window for biopharma start-ups has been pretty much closed for the last three years, biopharma M&A activity has been solid over the same timeframe (see recent report by HBM Partners).  The HBM data implies that if you build a good biopharma product, there will most likely be an acquirer on the backend.  The same cannot be said for consumer, industrial biotech, and healthcare IT.  For example, industrial biotech exits can be challenging as there are only 4 major players (ADM, Cargill, Dow, Monsanto) out there, which often makes an IPO the preferred exit route.  Needing to go IPO in a turbulent equity market is a scary proposition for most investors.

There are a number of venture funds that have developed new investment thesises around consumer, industrial biotech, and healthcare IT.  In the second half of this entry, I will focus on three life science venture funds – Aisling Capital, TPG Biotech, Versant Ventures – and their investments in non-biopharma companies.

Consumer

One of the largest life science funds ($650M fund raised in 2009), Aisling Capital made its name by investing in clinical stage therapeutics companies.  With its most recent fund (Fund III), Aisling shifted its focus a bit and has completed two consumer (Scerene Healthcare and Zeltiq) investments.  Both Scerene and Zeltiq are developing aesthetic medicine products, an attractive investment area due to lower regulatory burdens and minimal reimbursement risk (patients usually pay cash). 

Over its 6 year life, Zeltiq has raised about $100 million from a strong pool of VCs including ATV, Frazier, Venrock, as well as Aisling.  The company is developing a medical device that noninvasively and selectively reduces fat without damaging the skin or surrounding tissue.  In early July, Zeltiq filed a registration statement to raise up to $115 million in an IPO. 

To go from founding to IPO in 6 years is an impressive feat, considering the biopharma industry average is closer to 7.5 years.  Should the IPO proceed as planned, the company and investors should receive a tidy return on their investment. 

Industrial Biotechnology

In 2002, TPG Biotech was spun-out of TPG, one of the world’s oldest and largest private equity funds.  TPG Biotech has always had a broad interest in the types of life science companies they pursued, but more recently the fund has made a number of industrial biotechnology investments.  Industrial biotech is a natural extension for life science venture funds because the underlying science for those companies – genomics, molecular biology, cell biology – is similar to that of biopharma companies.  The risk with making such investments is that they are incredibly capital intensive.  Whereas biopharma start-ups can outsource much of their work to CROs, industrial biotechs have to create large industrial facilities, which requires quite a bit of capital.  

There are two TPG Biotech investments that I would like to highlight – Amyris and Elevance Renewable Sciences.  Both of these companies convert common natural products (biomass) into high-value chemicals.  Those chemicals are presold to interested parties and then Amyris and Elevance make a profit on the margin (presold price - cost inputs = margin).  Unlike biopharma where the cost of inputs are basically nothing, industrial biotech companies purchase organic raw materials that can have major price swings due to changes in global commodity prices.  Therefore, the goal for many industrial biotech companies is to use stable, non-commodity inputs, and develop a cheap manufacturing process so that profits are large and predictable – something that is not so easy to do on a large scale.  

While capital intense and subject to raw material price swings, the ability to presell future inventory at attractive prices (among other reasons) makes industrial biotech an interesting non-biopharma investment play.

Healthcare IT

Versant Ventures is generally regarded as one of the top biopharmaceutical and medical device venture funds; however, few realize that the fund has recently made a number of interesting healthcare IT investments.  The cost of developing new software platforms has plummeted over the last 10 years, which has dramatically lowered the capital requirements for those companies.  Instead of spending 2-5 years of time and money on development, software companies are now launching almost immediately and VC dollars are being pumped into those companies to support commercial rollouts. 

I really like two of Versant’s investments – CodeRyte and RedBrick Health.  A lot of healthcare IT companies say they create efficiencies for healthcare providers, but the reality is that few actually do so.  CodeRyte is a natural language processing (NLP) platform that reads the text of a physician’s patient report and automatically assigns the appropriate billing codes.  This product increases coding compliance and saves money on administrative costs without requiring the doctor to receive special training or hindering his or her ability to see the same number of patients.  RedBrick is an personalized incentive platform that encourages employees to take a greater role in controlling their own healthcare.  By purchasing the RedBrick platform, employers can incentivize employees to make responsible healthcare decisions which will ultimately improve employee heath and save the company money.  

Conclusion

Not all life science VCs will veer from the tried-and-true biopharma model.  As the HBM Partners data shows, there is a robust pool of biopharma acquirers that are willing to pay attractive multiples for great VC-backed companies.  That being said, there are challenges (FDA, lack of capital, etc.) to that model and branching out from biopharma might be a reasonable risk mitigation strategy for some VC firms.  It is too soon to tell if that is a worthwhile strategy, but for now at least, it is exciting to see the breadth of investments being made by life science VCs.   

Academic Drug Discovery

Translational research has been a hot topic amongst the academic life science research community for the last couple of years.  As research centers across the country attempt to form their own translational groups, a common thread amongst those institutions has emerged - the desire to have in-house drug discovery and early clinical validation capabilities.  Academic research centers are known for their ability to identify novel biologic targets and providing in-house drug discovery services enables academics to take their work to the next stage of product development.  

While proponents of translational research are quick to laud the vision of universities in creating soup to nuts drug development capabilities, others are not so supportive.  

Many critics challenge the notion that academic research centers should veer from their mission of conducting basic research.  Politics aside, it is very much an open question as to whether or not academic centers can execute the drug development process at the same level as pharmaceutical companies or CROs.

The Old Days

Historically, universities created compound libraries through the generosity of pharmaceutical companies.  In return for gifting compound libraries, pharma companies would receive modest tax breaks and academic goodwill.  However, the reality is that most of those libraries were gifted for a reason - either having little strategic value for the pharma company, or they were already picked over (scaffold fatigue).  Universities also found that it was challenging to use the libraries (not your typical post-grad skill set) and often cost $10,000+ to run large-scale screens.  This is turn caused university screening cores to run smaller, more directed screens, which limited their ability to find attractive leads.  

New Models

According to a recent Nature Reviews Drug Discovery article, there are 78 small molecule–focused drug discovery centers at universities or nonprofit research organizations in the US.  The report discussed some interesting stats:

• 2/3 of the drug discovery centers have high throughput screening infrastructure
• 2/3 have hit-to-lead medicinal chemistry expertise
• 1/2 have in vivo efficacy capabilities

In looking at those numbers, roughly half of the drug discovery centers appear to have the ability to perform IND-enabling work.  Building a competency in preclinical drug development takes lots of time, money, and talent, and it might be a stretch to say that 35+ research centers truly have that capability.  Even simple (if there is such a thing) drug discovery programs require scores of medicinal chemists, formulation chemists, toxicologists, etc.  Pharma is able to support disease-focused teams with deep preclinical drug development expertise, a luxury that universities cannot afford. Therefore, universities must work extra hard to find super talented researchers who can wear multiple hats during the development process. A good example of one university that seems to be doing all the right things is Duke University.

In 2006, Duke founded the Duke Translational Research Institute (DTRI) to expedite the translational development of drugs that were being discovered within the institution.  DTRI became the umbrella organization that was to oversee the management of the university’s clinical research activities.  Aided by a $52 million NIH grant, the DTRI hired a strong management team with start-up, VC, and CRO experience.  The DTRI provides CRO-like services for Duke faculty, as well as for outside groups, and is now self-funded.  In 2008, Duke hired Allen Roses, the former head of pharmacokinetics for GSK, to helm the Duke Drug Discovery Institute (DDRI).  Folding DDRI into DTRI gave Duke the ability to provide drug discovery, lead optimization, clinical development services for all faculty members, as well as outside groups.  DTRI is a good example of the kind of university-wide coordination, recruiting of talent, and capital required to execute a successful drug discovery program.

Engaging Venture Capital Funds

Ultimately, the goal of university drug discovery centers is to advance technologies to the point where investors and pharma companies become interested in licensing those technologies.  Pharma companies are more likely to fund collaborations with individual PIs or research groups around a specific indication than VCs, which prefer to license technologies directly into a start-up.  For pharma companies, they have a vested interest in developing long term relationships with Key Opinion Leaders, whereas VCs focus more on investing in a specific technology that fits into that particular fund’s investment thesis and timelines.  

As pharma pipelines have dried up and VC dollars become more scarce, both groups are increasingly looking for similar attributes when they evaluate technologies that are derived from university drug discovery units:

• Viable biology 
• Novel target in a relevant disease area
• Target is druggable (at least theoretically) / responder studies

The Future

Generally speaking, academic institutions are good at identifying interesting biologic targets, while pharma companies are good at generating molecules against those targets (See Osage blog - June 13, 2011).  Creating drug discovery centers at universities challenges that paradigm and co-locates drug discovery and development functions within the university.  Going it alone for universities enables them to have greater oversight and ownership of the development process, but at what cost?

With the NIH budget being flat for the past five years, it is hard to believe that drug discovery units at universities will be able to grow through grants.  Instead, universities will increasingly need to serve outside customers to cover their overheard and to subsidize services they provide to faculty.  Targeting outside customers brings the institutions into competition with CROs which likely can beat them on service offerings and prices.  

Despite these headwinds, there are a number of roles that academic drug development centers can play:

1. University talent could be directed to solve problems that hinder drug development for all stakeholders, such as creating models that better predict human versus animal toxicology, or generating improved disease models.  
2. VCs are hesitant to invest in cardiovascular, diabetes, and obesity diseases due to increased FDA regulatory burdens.  These are diseases that effect a large part of the US population and academic drug discovery units could certainly play a role in driving innovation in those areas.

It is too soon to tell if the academic drug discovery effort will be successful.  Ultimately, I think a couple of models will emerge and the early success of Duke’s discovery program certainly provides a blueprint for others to follow.

Riding Investment Waves

In Pennsylvania, we currently have the modern day equivalent of a gold rush going on in our state (the Marcellus Shale) after the discovery of the country’s largest natural gas deposit.  To get in on the rush, gas exploration companies are offering vast amounts of cash to landowners in exchange for future development rights.  I say future because the economics of natural gas drilling is not yet on par with gasoline, leaving the widespread adoption of the fuel very much in question.  Yet, even with that risk, large exploration companies are willing to spend considerable amounts of money up-front in the hopes that they will receive a handsome payday in the future. 

The economics of natural gas exploration in Pennsylvania is somewhat analogous to that of life sciences product development, wherein investors are willing to spend large amounts of money up-front on the development of life science products, hoping that those products can tap into future markets that are expected to be in the billions of dollars. 

Taking on such risk, whether in natural gas exploration or life science product development, can be daunting for all but the most intrepid entrepreneurs and investors. 

How does one participate in sexy investment trends, such as natural gas exploration, but not take on the risk associated with it? 

The answer is to identify products and services that support those companies working at the bleeding edge of an investment trend.  In the case of natural gas, that means identifying those companies that provide the infrastructure (raw materials) and logistics (housing, food, transportation) that are required by the exploration companies to prospect for gas.  

Like the natural gas industry, there are those life science companies that swing for the fences, identifying new trends and investing big in them, and those companies that provide infrastructure and services to support the homerun approach of their peers (sometimes even these companies can be home runs).  Below is my analysis of two such companies and the products they created to support the development and adoption of bleeding edge technologies.

Avid Radiopharmaceuticals

With an aging US population, the prevalence of Alzheimer’s is growing at an astonishing rate.  Every major drug developer has tried to develop medicines to treat the disease, but with little success.  A key development challenge for drug developers is that Alzheimer’s, especially in its early stages, can be challenging to diagnose.  Poor diagnosis has meant that drug developers have typically sought later stage patients.  These patients are harder to treat as much of the damage done by amyloid aggregates (I am not mentioning tau or prion in this blog post) likely cannot be reversed by therapy alone.  Early diagnosis is therefore a priority of patients, clinicians, and drug developers. 

Avid Radiopharmaceuticals (an Osage portfolio company) has created a radiolabeled ligand that binds to amyloid-beta, a protein that often aggregates in Alzheimers’ patients brains and is considered by many to be a hallmark for the disease.  Unlike drug developers focusing on homerun therapeutics, Avid chose to develop a diagnostic that could aid clinicians in their ability to track disease progression.  While the diagnostic has yet to be approved, Eli Lilly bought Avid for $300 million upfront and is making the company it the cornerstone of its Alzheimer’s drug discovery effort. 

Embrella Cardiovascular

As percutaneous procedures mature and increase in complexity, device companies and clinicians are attempting to insert ever-larger catheters through the arties of patient’s.  Large catheters have a high likelihood of rubbing against artery walls, knocking off plaque and debris that has accumulated on the epithelium.  Once freed, that flotsam may embolize on its passage through the arteries and into the brain where it eventually could cause a stroke.  Early clinical trials for Transcatheter Arotic Valve Implantation (TAVI) procedures in Europe have confirmed the risk of stroke as several patients did, in fact, have strokes.

Embrella Cardiovascular created a simple solution to the floating debris problem; it developed a small net that catches embolisms when inserted into the patient’s heart.  The product is simple to use, relatively cheap, and provides a nifty solution for decreasing TAVI-associated stroke, which could been a stumbling block for the adoption of TAVI procedures.  Being a relatively simple device, Embrella required only $7 million of capital before it was acquired by Edwards Life Sciences for $43 million.

Summary

There will always be those companies that are willing to invest significant up-front resources in risky projects in hopes of generating a substantial future windfall.  What is often less talked about is the role that numerous other companies play in supporting the efforts of those “wildcatters”. 

Adjunctive technologies, when applied to bleeding edge markets, can often generate significant interest from strategic acquirers as those companies seek to build out their product offerings and expertise around a specific development area, such as Alzheimer’s or TAVI.  Identifying trends and products that companies need to better facilitate the development and adoption of core products around a growing trend is a surefire way to start a company that will have significant strategic value to potential acquirers.

Rare Diseases - Pipeline & Trends

Note to Readers: This entry was co-written with Eileen Moison of Osage University Partners and is Part II of a two part series. Part I can be accessed here - link.

The first rare disease entry focused on the various players in the industry, venture activity, and universities that are licensing rare disease technologies to start-ups.  This entry will focus on the pipelines of the biopharma and start-up companies, types of therapies those companies are developing, and trends that I am seeing in the industry.

Large-Cap Pipeline Analysis

As the graph shows, Genzyme (now part of Sanofi) is the preeminent rare disease company, a distinction the company earned from its deep pipeline of enzyme replacement therapies (ERT).  Genzyme helped legitimize the rare disease business model (small patient numbers and high reimbursement rate) and laid the groundwork for its peers to follow.  More recently, Genzyme’s preeminence in the field has been challenged due to major manufacturing issues, which created a short-term shortage of ERTs.  Genzyme’s loss was Shire’s gain, as the rare disease up-start received accelerated approval for several products, resulting in the company’s rise to the top echelon of rare disease drug developers (which is also why analysts now believe Shire is a top acquisition candidate).

ERTs dominate the number of approved rare disease therapies for large-cap biopharma.  One could argue that the low-hanging ERT fruit (ex: lysosomal storage disorders) has been already picked, but recent M&A activity would indicate that pharma is still bullish on ERTs.  For example, while Eli Lilly has technically been in the ERT space for quite some time (the company sells recombinant HGH), it was only recently that it developed a cohesive strategy around the rare disease sector. In early July, the company acquired venture-backed Alnara Pharmaceuticals (investors: Third Rock, Frazier, MPM, Bessemer, and Longwood), which is developing an ERT for exocrine pancreatic insufficiency (EPI). 

In addition to lysosomal disorders, companies are broadening out their ERT development efforts in areas such as mitochondrial and urea cycle disorders.  

Given the fact that the first US rare disease legislation dates back to 1983, it is surprising that there are so few established players in the rare disease space.  Genzyme is really the only major start-up (Biomarin & Alexion are talked about later on in this entry) to have created a standalone biotech around the rare disease model.  

While pharma companies are piling into the rare disease space, the number of larger (BioMarin, Alexion, Celgene) companies to acquire is rather limited.  The lack of mature acquisition targets likely portends to a situation where pharmas will grow their rare disease units through smaller acquisitions, which are bread-and-butter investments for VCs.  In that sense, the stars are aligning for VC investment in rare diseases as there is a large pool of eager acquirers, reasonable development and regulatory hurdles, and a clear unmet need / utilization path.

Mid- & Small-Cap Pipeline Analysis

BioMarin is a good example of a rare disease focused company that is building out its infrastructure to support a standalone company.  A sign of BioMarin’s maturity is the fact that the company has expanded its drug development abilities, developing both ERTs and small molecule therapies.  Other companies poised to make a similar jump include Alexion and Amicus.  Genzyme showed that establishing a standalone rare disease drug company is feasible; however, given the current equity investment climate, shareholders seem more willing to support acquisitions than funding long-term value creation through pipeline investment.  

The recent acquisition of Cephalon, maker of Nuvigil and Provigil for narcolepsy and related sleep disorders, by Teva highlights the willingness of pharma - even a generic pharma company - to enter into the rare disease fray.  Based on their maturity, BioMarin and Alexion would be bolt-on acquisitions for pharma companies, while other clinical-stage companies such as Amicus, Aegerion, and GTC could be considered attractive acquisition targets for their future potential.  

Start-up Pipeline Analysis

The diversity of therapeutic programs being tackled by start-up companies highlights the maturation of the rare disease space.  While large-cap pharma has predominantly focused on developing ERTs, start-ups are using a variety of therapeutic modalities, including small molecules, biologics, and even gene therapies, to treat rare diseases.  As the low-hanging fruit continues to be picked, expect more combo therapies to be employed to tackle multifactorial diseases. 

Another change that is already taking place is the resurgence of gene therapy.  As the cost of long-term care for rare disease patients continues to rise, insurers are increasingly looking toward gene therapy as a possible cost savings approach (surprising, but true).  Bluebird Bio, a gene therapy start-up focused on rare blood disorders, has indicated that it could possibly charge up to $750K for its one-time medicine.  While many would balk at that price, in lifetime terms, $750K upfront is considerably cheaper than $100-200K per year over 10+ years of therapy for a standard ERT. 

Gene therapy companies have made incredible strides over the last 10 years, but it is hard to say when, if ever, their use will go mainstream as there are considerable clinical and ethical risks associated with it.  Rare diseases could provide the impetus needed to generate widespread support for gene therapy use.  

The Future

With over 6,000 different types of rare diseases to treat, the drug development rush into rare diseases is just beginning.

The globalization of the pharmaceutical industry will ultimately be what drives the future success of rare disease companies.  Genzyme already generates about 70% of its sales from abroad as rare disease is increasingly becoming a global health concern with Asia at the forefront.  The health ministries of Japan, China, South Korea, Taiwan, and Singapore have all recently passed rare disease legislation to speed up the development of drugs, many of which will only serve those local populations.  In turn, expect biopharma to increasingly look to serve local Asian rare disease markets.  

To promote rare disease drug development in the US, there are should be a renewed focus on modifying our existing framework for promoting innovation in the space.  As biopharma continues to trim its R&D infrastructure, start-ups are shouldering a larger burden of early drug discovery work and existing legislation, such as R&D tax breaks, do little to support start-ups (which do not generate revenue and therefore are not taxed).  Legislation should be enacted to further promote and support innovation in rare disease drug development.  

Rare Diseases

Note to Readers: This entry was co-written with Eileen Moison of Osage University Partners.  This is Part I of a two part series.

Rare disease medicines represent a promising therapeutic investment class for both venture capitalists and strategics.  VCs are attracted to rare disease investment opportunities because they typically require less capital to achieve valuable inflection points and the regulatory process is often more straightforward than other therapeutic classes.  For strategics, rare diseases have become a viable business model for even the largest of pharma companies.  

As a foundation, it is helpful to know the various players involved in the rare disease market.  The graphic below breaks down rare disease companies into 3 segments: private & independent start-ups; publicly-traded small-cap companies; and publicly-traded large-cap companies.  As there is no mid-cap category (the slide only had so much space), some companies like Shire are depicted as bridging both the small- and large-cap categories.

Spacing limited me from adding all of the major players in the rare disease space but the slide does a pretty good job of highlighting the variety of companies, both by company maturity and focus.  Having multiple players involved at all stages of company development highlights the robustness of the rare diseases drug development space.

What I find somewhat interesting is how people commonly view rare disease investing by VCs as a new phenomenon.  The reality is that VCs have long invested in rare disease companies like BioMarin, Alexion, and Genzyme.  Below is a chart listing the most active venture funds in the rare disease segment.  

According to recent PhRMA stats, there are 450+ rare disease medicines in active clinical development (Link Here). Many of these 450 assets have been financed by venture capital firms; however, it generally wasn’t until the last few years that large pharma started paying attention to rare diseases.  

The challenge for rare disease investing over the last 2+ decades has been a lack of acquirers.  Looking back at Alexion, Genzyme, BioMarin, InterMune, etc., all of the venture investors in those companies achieved exits through IPOs.  That trend is changing now that many of the original rare disease start-ups have matured into mid- and large-cap companies that are able to acquire younger companies.  Genzyme and other former start-ups have proven that the rare disease business model works, which has provided a blueprint for pharma to dip its toe into the rare disease market.

Novartis has long been at the forefront of rare disease drug development.  Other large-cap pharma companies such as GSK, Roche, Pfizer, Sanofi, and AstraZeneca are all ramping up their efforts in the space.  This should have a positive impact on venture investment and start-up creation as there are more exit opportunities than ever for rare disease companies.

University IP Drives Rare Disease Investment

Rare disease research is primarily conducted at institutions that specialize in basic research, such as the University of Florida, Penn, and Yale.  I think its great that there is such a diversity of institutions that conduct rare disease research, including land-grant universities, private universities, and specialized research centers.  Given the diversity of licensing institutions (see graph on the right), it makes me think that there is a lot of great rare disease IP out there waiting to be uncovered.  

With over 6,000 different types of rare diseases and over 450 medicines in the clinic, rare diseases provide a number of interesting current and future investment opportunities for VCs and strategics.  Should reimbursement rates hold firm, rare diseases will continue to be a hot investment area for the foreseeable future.