Big Pharma To Continue Buying Up Solid Biotechs

Like many sectors, biotech was forced to shift gears when the financial crisis hit in late 2008.

Small, innovative biotechs doing early-stage research had a hard time getting financing from venture capital firms and other investors. Most money available went to more established biotechs with products closer to market.

That shift still rings true today, says Jim Datin of Safeguard Scientifics (NYSE:SFE – News), a private equity and venture capital firm. He expects much of the near-term investment to continue going to companies or products with proven disease-fighting technologies.

“A lot of these early-stage biotech companies and products fell out of favor during the financial crisis and recession,” Datin said. “Investors wanted to see more later-stage opportunities to reduce risk.”

Wayne, Pa.-based Safeguard targets its investments to life sciences companies in molecular and point-of-care diagnostics, medical devices, regenerative medicine and specialty pharmaceuticals. It targets information technology companies in financial services IT, health care IT and Internet/new media that have capital requirements of up to $25 million.

On the life sciences side, Datin expects Big Pharma companies to continue buying up biotechs to boost their pipelines. It’s a subject he knows well as an advisory board member at French drugmaker Sanofi-Aventis (NYSE:SNY – News), which recently reached a deal to buy U.S. biotech Genzyme (NMS:GENZ).

Datin recently spoke with IBD.

IBD: Which biotech and medtech sectors are most interesting for VCs and other investors right now?

Datin: We believe the hottest areas in biotech will be those that focus on large molecules, that provide treatments that actually cure a disease as opposed to just masking symptoms. We also see demand for technologies that can actually reduce the cost of health care.

In oncology and cancer, there have been a lot of approvals for treatments that can be dramatically expensive. A lot of the regulatory agencies and insurance companies are trying to find parallels to what the extension of life is vs. what the cost will be.

I was talking to an insurance executive recently. He was saying, “Where do you draw the line? An oncology treatment is going to cost $100,000, and it’s going to help the patient last three months more.”

A lot of insurers have taken the position that they can’t justify approving that expenditure, where over 90% of a patient’s health care is in the last year of his life. The cost is astronomical.

You’re going to see a pay-for-performance model, where quality or extension of life will be tied directly to the cost and the reimbursement that’s provided for it.

IBD: When biotech VC funding languished, pharma companies helped fill the void by acquiring biotechs for their research and technology. Will this continue?

Datin: It’s clear that the pharma companies are stockpiling cash. This is one of the richest times in their history. It’s equally clear that their pipelines are not big enough to produce their expected earnings results. They’re going to have to bridge that gap by doing M&A. That’s predominantly going to come from biotech.

The pharma companies would like these acquisitions to be accretive. They want to make sure they’re not just buying a long-term future pipeline, but instead are looking at revenue and near-term prospects.

I think you’ll see a lot of option agreements for smaller biotech companies. Pharma companies will fund the clinical trials in exchange for the right to purchase the product or company, at a pre-agreed-upon price.

IBD: And if the clinical trials don’t go well, then the pharma companies have the option of not buying the company?

Datin: Correct. They advance the cost of the phase-two clinical trial, which is really the point where a lot of these pharmas will come in. That may cost them $10 million on the low end, to hundreds of millions of dollars on the high end. In exchange for that, they can buy the entire company or product at a pre-agreed-upon price.

But in the event the trial is not productive, they can say all right, thank you very much. It may have cost us $10 million, but it’s better than spending $500 million for a company that failed.

IBD: There’s talk that the FDA will move quicker on the drug approval process. Is that progressing?

Datin: I’d like to believe it. But I’ve been disappointed too often in the past. It’s just rhetoric.

The FDA’s budget has been advanced. They’re adding people. They’re trying to be more aggressive. But the number of approvals each year is approaching all-time lows. There’s a general feeling that the FDA is very risk-averse.

We’ve heard from the FDA commissioner and President Obama that they want to tear down these barriers and make the process more efficient. I’m hopeful, but I’m guarded in my optimism.

IBD: What’s exciting now in terms of innovation and technology in life sciences?

Datin: One thing is, you’ll see biotech and pharma partnering with diagnostics. In the past, they were very different cultures, very different mindsets. It was hard for them to peacefully coexist. With the advent of personalized medicine, that mentality has changed.

I’ll give you an example. Eli Lilly (NYSE:LLY – News) is in the business of selling drugs. But they saw an opportunity in diagnostics — not only from an R&D perspective, but also to build a billion-dollar business.

So Lilly hired a senior executive away from Roche, Tiffany Olsen, to run their diagnostics business. They’re also making acquisitions in this area.

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