John Rountree, Managing Partner at Novasecta, recently chaired a panel at the Labiotech Refresh conference in Paris on the subject of microbial resistance. The panel included Achim Plum, Chief Commercial Officer at Curetis, Franck Lescure, Partner at Auriga Partners, and Derry Mercer, Principal Scientist at NovaBiotics. The conversation was very interesting, and a number of topics were discussed, ranging from up-and-coming disruptive innovation in the field, to R&D incentives, to public markets and venture capital. The panel was followed by a lively Q&A session with the conference participants.

 

It was recently announced that, to make up for the loss of EU funding for R&D post-Brexit, Theresa May has pledged to increase the UK’s investment in science and technology by £2 billion per year by 2020. In an article in Reuters, Novasecta, said that it is only a “small step” towards calming Brexit nerves in the industry. Putting the investment in perspective, we state that “it is, for instance, significantly smaller than the 26 billion pounds the U.S. government invests in the National Institutes of Health every year, and therefore may not make the UK as competitive as hoped.”

 

Since the financial crash of 2008 the world has got used to a new era of cheap capital and sustainably low interest rates. This has created a new funding environment for pharmaceutical research and development (R&D), which is the quintessential capital-hungry, long-term and high-risk business endeavour. The new funding environment has in turn had a profound effect on the way pharmaceutical R&D has been prosecuted, mostly for the better.

The most visible consequence of the new funding environment has been a fragmentation in the industry’s approach to R&D. New types of companies and funds are being formed and expanded to meet the needs of investors that are seeking higher returns than are available from bonds and low interest rate investments. Similarly companies and funds are evolving to meet the needs of investors looking for safer returns that are more bond-like in character, but with higher yields. Though the fragmentation has created some inefficiencies in R&D, one of the positive consequences has been the emergence of a new and highly focused breed of integrators that are driving innovation to benefit both investors and patients.

In the 1970s to 1990s when capital was relatively expensive compared with today, a diverse group of integrated pharmaceutical companies essentially funded the bulk of the industry’s R&D themselves from the significant profits they reaped from their successful products. The result was a tremendous wave of new drugs and innovations with huge benefits to healthcare systems and patients.

Yet having essentially satisfied their investors with the significant profitability that came from previous success, sadly many pharmaceutical companies became somewhat complacent. After the market crash of 2008, there was a wave of downsizing, cost-cutting and R&D site closures as companies faced a new level of scrutiny from their investors.

In parallel with the financial uncertainty created by the market crash in 2008, the huge diaspora of ex-Big Pharma R&D scientists and executives needed to find new homes. The result is today’s industry structure: a fragmented and highly connected ecosystem of four types of company: first the surviving massive, integrated, profitable and relatively stable Big Pharma companies covering a broad range of technologies and therapy areas; second a multitude of small pre-revenue Biotechs that typically focus on R&D in a specific technology (small molecule or biologics), therapy area, and/or element of the value chain; third an increasing number of integrated MidPharma companies that are both profitable and focused in some way; and fourth a plethora of Contract Research Organisations (CROs) that operate on a service basis to the Big Pharma, Biotech and MidPharma companies, and do not take on the risk of R&D.

The new ecosystem has increased the transparency of pharmaceutical R&D to investors. No longer is R&D investment hidden in the big campuses and profit and loss accounts of Big Pharma. The industry ecosystem has evolved in concert with the evolution of an expansion in the scale and reach of financial intermediaries between pension funds and the companies that are engaged in pharmaceutical R&D. The most notable has been the resurgence in pharmaceutical venture capital funds, both independent and within corporates, but other private equity funds that have invested in profitable and growing service companies and specialist marketing companies have been similarly influential.

The fragmented ecosystem of pharmaceutical R&D has led some companies to suggest that it is best to leave the small biotechs to do the early stages of R&D and the more well funded Big Pharma to do the later stages of R&D and commercialisation. Today’s most notable exponent of this approach is Allergan, which actively promotes its ‘Open Science’ approach comprising its “best-in-class product development and commercialisation platform” as a “magnet for game-changing ideas and innovation”. The consequence of this line of thought is that the very small biotechs that are providing the fuel for the larger companies to develop and commercialise are becoming extremely expensive to purchase. Allergan’s acquisition of Tobira for an up-front of nearly 500% of the previous day’s closing share price is but one admittedly extreme example.

As the price of external innovation and small biotechs has increased, so has the size of venture capital fund raises that are betting on creating the clinically proven science that will attract a high price from Big Pharma when acquired. This self-reinforcing dynamic can only continue to work while investors in Big Pharma tolerate the prices paid for such science, which indeed when externally acquired have less effect on their quarterly earnings (EBITDAs) than the hard work of internal R&D. This feels eerily like the old days when the relatively cheap capital from inside highly profitable pharma companies went into often inefficient, internally-focused R&D and M&A.

The good news this time is that another consequence of the industry’s fragmentation is a new breed of focused and integrated MidPharmas that are breaking the rules of the ‘Big Pharma acquires Small Biotech’ dogma. These entrepreneurial R&D integrators recognise that R&D is a long-term endeavour that requires a deep integration of commercial, medical, science and partnership skills in a chosen focus area. These companies typically command a higher market rating than their Big Pharma peers because of their deep and integrated focus on a platform and/or specialty area. In Europe, such companies include Genmab, Cosmo Pharma, Galápagos, MorphoSys, Sobi, Actelion and Bavarian Nordic. Such companies are the paradoxically integrated consequence of the industry’s fragmentation, and are the ones to watch in terms of creating value for investors and patients alike.

John Rountree is the Managing Partner of Novasecta, a European strategy consulting firm for pharmaceutical and biotech companies.

© 2016 Evernow Publishing Ltd

Reprinted with permission from Mednous November/December 2016 (www.mednous.com)

For biotechnology, the UK capital market is very much driven by its relationship with other international markets, most notably the US and continental Europe. The specific qualities of these larger markets have a substantial impact on the UK, creating a unique landscape of capital and subsequent innovation. This phenomenon is readily apparent in both early-stage and later-stage pre-IPO biotech fundraising. Faced with difficulties raising capital at home, UK biotechs are increasingly relying on funding from their US cousins rather than their more risk-averse, ‘stay-at-home’ continental European neighbours.

In early-stage VC funding, the UK punches above its weight

Early-stage biotech funding is one area in which Europe seriously underwhelms compared to the US. Globally, the US possesses the most significant abundance of venture capital (VC) firms that invest in early-stage biotech companies. From 2013 to 2015, almost $7bn was invested in more than 550 pre-clinical/discovery-stage companies in the US by over 380 different firms, compared to $1.5bn in just over 150 companies in Europe. In the UK, these numbers fall to around half a billion dollars being invested in 34 companies, an average of approximately 10 early-stage UK companies being funded by UK VC investors per year. This may seem small relative to the US, but the UK commands a third of the early-stage capital invested in Europe, with the average early investment size in the UK nearly $15m – larger than the US.

Early-stage UK biotechs are benefiting from US but not continental European investment

Over the last decade, the US has been vastly ramping up its funding of early-stage UK biotechs. In 2006, US-headquartered firms invested in only two early-stage UK-based biotechs. Fast-forward to 2014, and this number had grown to 17, indicating that UK biotechs are increasingly turning to the US for early-stage equity funding, and US VCs are likewise turning to the UK for novel science.

Intriguingly, these biotechs are not turning to continental Europe, which maintained consistently lackluster investment in just two early-stage UK biotechs in both 2006 and 2014. This trend of UK biotechs finding more success with US rather than continental European investors is at least partially driven by a ‘follow the leader’ investor mentality. Although there are a myriad of funds in Europe, there are fewer early-stage VC firms that lead deals in high frequency, with Seventure and Sofinnova Partners being the most notable exceptions. This thereby triggers a quasi-bottleneck of investment funding while interested firms bide their time for a leader to emerge. Another contributor to this trend may be that continental European firms place more of an emphasis on investing in companies in their own countries or regions, whereas US investors have different priorities.

US crossover investors create later-stage investment windows in the UK

Looking towards later-stage companies, one of the more disconcerting remarks often made by biotech folk in the UK is that if Jim Mellon or Neil Woodford aren’t funding a start-up after its first few rounds, it doesn’t have much of a shot. This may be overly dramatic and simplistic, but it encapsulates well the prevalent sentiment that homegrown capital is scarce, especially if one wants to raise £50m+.

Of particular note to UK companies looking for a significant cash infusion are US crossover investors. Over the last few years, when a firm has wanted to raise substantial funds, a growing trend has been for strong contributions to come from hedge funds, mutual funds, sovereign wealth funds (e.g. the lively Alaska Permanent Fund), and other crossover investors – for the most part based in the US. Examples of UK companies recently funded by these sorts of firms include Adaptimmune, Immunocore, and NuCana. The involvement of these funds has pros and cons, with the advantage being that when these players get involved, ‘hard’ (not to mention interesting) science that needs solving tends to get its well-deserved time in the spotlight. Strong IPOs are often the result. On the other hand, these investors tend to stop ‘crossing over’ when general market sentiments are weak, causing vicissitudes of optimal fundraising ‘windows’ in the markets they tend to invest in.

A creative combination of local and US capital is key to UK biotechs

In one sense the UK gets the worst of the European and US markets, having to deal with the risk-averse, isolationist European ethos and the cyclical nature of later-stage US crossover funders. To handle this, a creative and international focus from an early stage is key. Relationships with US investors should be developed and nurtured as soon as possible, for both early-stage and pre-IPO crossover rounds. Additionally, creative and unorthodox strategies should be considered to access US capital, as exemplified by UK companies such as GW Pharma, which utilised a NASDAQ ADR to access public funds, and Astex Therapeutics, which achieved a NASDAQ listing through a merger.

This certainly does not mean that UK biotechs are in a tough position, however. The UK has local green shoots in Woodford’s and Mellon’s funds, a significant improvement from just a decade ago. The US and, to a lesser extent, continental Europe provide biotechs with a ‘second chance’ can they not raise their full round in the UK, with the highly-developed financial services industry helping to leverage these international relationships. In fact, as long as UK biotechs look broader than the UK capital market, they are well placed to benefit from the stronger and larger US and European capital markets.