Beyond borders - Global biotechnology report 2011
 |
21 Iunie 2011 |
 |
ERNST & YOUNG S.R.L. |
Adresa
Strada Dr. Felix Iacob, Nr. 63-69
Cladirea Premium Plaza, Etaj 15
011033 Bucuresti, Sector 1
Telefon
+40-21-402.40.00
Fax
+40-21-310.71.93
Website
www.ey.com
What an eventful year! Consider just a few of the biggest news stories. In a remarkable showing of people power, a series of demonstrations toppled a long-standing autocrat, while Western planes bombed another entrenched dictator, in Libya. The world was riveted by fears of radiation from a near-meltdown at a nuclear power plant. The British monarchy hosted a royal wedding that was followed eagerly by people the world over.
Sound familiar? We’re not talking about 2011, but 1986 — the year our first biotechnology report was published. Indeed, many of this year’s noteworthy events echo those from 25 years ago (with some key differences — the revolution was in the Philippines rather than Egypt, the nuclear accident was in Chernobyl rather than Japan, and the British royal groom was Prince Andrew rather than Prince William). That may be fitting, since biotechnology is an industry where certain themes repeat themselves with unerring regularity. Over the last 25 years, our reports have chronicled concerns and challenges — constrained venture capital, cool public markets, fears that future generations of companies might not be able to go the distance — that are still relevant today.
But biotechnology is also an industry that has seen tremendous dynamism and remarkable change. Significant numbers of companies have bucked the odds and made the journey to sustainability. The industry has brought scores of life-saving drugs to market, from targeted therapeutics for cancer to pioneering treatments for rare diseases. And looking ahead, as health care systems the world over seek greater efficiencies and proof of outcomes, the targeted approaches that biotech companies have long used stand to be rewarded.
Perhaps it’s true that in biotech, the more things change, the more they stay the same. But it’s also true that the more things stay the same, the more they need to change. The pressures on the biotech business model have now increased to extraordinary levels, even by the standards of an industry that has long faced funding constraints — something we discuss extensively in this year’s Introduction article.
Sustaining innovation: the global perspective
INTRODUCTION: SUSTAINING INNOVATION
Given the all-encompassing nature of the global financial crisis — and the capitalintensive character of drug R&D — it is not surprising that the last two issues of Beyond borders dwelt extensively on the downturn and the pressure it placed on biotech’s business model. In our Introduction articles, as well as throughout much of the reports, we catalogued the measures companies were taking and highlighted new approaches and models that were already starting to emerge — from project-based venture funding to fail-fast R&D programs to increasingly virtual organizations. And we also raised concerns about the impact on the industry’s business model, as the crisis took a severe toll on funding (the model’s key input) and placed innovation (its key output) under growing strain.
As we write this year’s Introduction article — the third since the crisis hit in the fall of 2008 — the global economy is clearly on the mend. Across most of the West, GDP has been growing steadily though job growth in many countries has not been as robust. Stock markets have roared back (an occasional flash crash notwithstanding) from the depths they plummeted to in late 2008, no doubt benefitting from the efforts of central bankers to keep interest rates low. Venture capital funding has rebounded somewhat, growing by 20% during 2010 in the US alone, where the superheated interest in funding social media and Web 2.0 companies has even led to concerns about whether we may be fueling another dotcom bubble. And emerging markets such as China and India, where the crisis barely registered a blip in the first place, continue to grow at a brisk pace.
Something has to give
However, as we survey the biotech industry a year later, it is clear that the pressures on the industry’s business model have only increased.
The business model: funding
Let’s start by looking at funding — the key input of the biotech business model. The overall numbers look impressive. Across the US, Europe and Canada, biotech companies raised US$25 billion in 2010 — more or less on par with the average raised during the “easy money” era of the four years preceding the crisis. But as we pointed out last year, biotech is an industry of haves and have-nots, and the real story lies in the distribution of those funds. Indeed, more detailed analysis reveals some troubling indicators. The 20% of US companies that were most successful in raising funds garnered 82.6% of capital in 2010 — up from 78.5% the previous year and 68.7% in 2005. Conversely, the bottom 20% of companies raised only 0.4% of funds — down from 0.6% in 2009.
Even as overall funding amounts held up nicely, a growing share of the total was in the form of large debt financings by mature, profitable companies. In the US alone, such financings accounted for a whopping 45% of the total in 2010 — an increase of close to 150% over 2009. In many cases, low interest rates prompted cash-flow-positive companies to increase debt on their balance sheets and use the proceeds for activities such as share repurchases and even — in a first for the biotech industry — dividends. But while balance sheet restructuring and debt optimization may be worthwhile means for large companies to maximize shareholder value, they have very little to do with the question of how the financial crisis has affected the ability of emerging companies to fund innovation. What is most relevant for our analysis is what may be termed “innovation capital” — total funding minus large debt financings by mature, profitable companies. And on this front, the trend is exactly the opposite of the overall numbers. While total US capital raised increased by 15% in 2010, innovation capital actually declined by 20% over the same period.
Meanwhile, another trend — which has compounded the funding challenges faced by companies — is not even picked up in the numbers. It has become increasingly clear from interactions with investors and companies that more and more venture funding is tranched — particularly in early rounds. In the past, a company raising US$20 million in a venture round may have received that money up front; today, it may receive only a small fraction of that total on day one — with the remainder to come only when defined milestones have been met. At the same time, we have found that press releases and other public disclosures typically reveal nothing about whether a round is tranched. So, while it is impossible to know exactly how prevalent the practice is, it is clear that even the 20% decline in innovation funding understates the extent of capital scarcity in the industry. The amount of money truly available to companies is even lower.
The widespread use of contingency-based payments may be relatively new in venture funding, but it has long been commonplace in strategic alliances, so much so that the industry even has a term for it: biobucks. When it comes to alliances, however, most press releases do disclose the amount of funding that is up-front (even as the headlines proudly trumpet total potential deal value), which makes it possible to analyze the trend in up-front payments. Unfortunately, our analysis shows that the trend is on a downward trajectory. For instance, in significant deals involving US or European biotechs (those with a total biobucks value of US$500 million or more), the average biobucks value has held relatively steady over the last five years, while the average up-front payment has declined by 55% over that period — falling by 38% between 2009 and 2010 alone.
Of course, there are good reasons for the use of milestone-based payments. It creates a greater incentive for biotech companies to maintain focus on critical milestones. It permits large and small companies to share more of the risk in strategic alliances. And it allows venture capitalists to improve return on investment by delaying the timing of capital calls from their limited partners. But, carried too far, the “drip feeding” of capital can have negative consequences, for instance, by increasing the incentive for biotech firms to cut corners in their R&D efforts in order to reach the next milestone as quickly as possible.
The bottom line in all of this is that investors are willing to provide funding, but it is being doled out in smaller increments and it comes with more strings attached and more risk “sharing” (which typically means that more of the risk ends up being borne by smaller biotech companies).
The biotech industry has also benefited historically from a healthy IPO market, which has allowed many companies to continue to fund innovation to a valueinflection point. Today, the public markets are much more challenging, with higher regulatory requirements in the US (the largest biotech sector) and a field of investors that is more selective. While the IPO market rebounded in 2010 in number of transactions and aggregate proceeds, the IPO funding option (it is no longer an “exit”) is available for only a few select companies. The “windows” of the industry’s early years — typically fueled by rampant investor enthusiasm — are a thing of the past.
