E&Y: Emerging trends could save biotech

May 5, 2009 – 4:40 pm by Michael Christel

Ernst and Young today released the 2009 installment in its long-running “Beyond borders� series, the firm’s annual assessment of the global biotechnology industry (you can request a copy of the report here). As you can imagine, E&Y experts have concluded what many other analysts are saying – the global financial crisis and resulting funding drought is making the biotech business model unsustainable. I spoke with Glen Giovannetti, E&Y’s global biotechnology leader, and Gautam Jaggi, mananging editor of “Beyond borders,� about their findings and the distinct trends they say biotech companies must embrace to overcome immediate operational challenges and ultimately ensure their critical role in medical innovation.

According to E&Y data, biotech developers in the United States and Europe raised just $16 billion worth of capital last year, a 46% drop from 2007. In comparison, Mr. Giovannetti says, biotech venture financing remained relatively stable, falling 19% in 2008 to about $6 billion, the segment’s second best year on record.

“The real story here is in the public markets,� Mr. Giovannetti told me. “I don’t think that comes as a big surprise given all the turmoil seen on Wall Street. The impact has been felt fairly acutely in biotech because it’s such a capital-dependent industry in terms of needing to raise money from the public markets to fuel all the R&D.�

According to Mr. Giovannetti, out of 162 publicly traded biotech companies, about 44% had less than a year’s worth of cash on hand as of December, and the figure has climbed since.

However, as the E&Y report outlines, the prognosis for biotech is not all doom and gloom. According to Mr. Giovannetti, the industry’s overall financial showing in 2008 was a relatively healthy one. Revenues of publicly listed biotechs grew 12% globally and 8.4% in the United States. Also, the global industry’s net loss improved 53%, from $3 billion in 2007 to $1.4 billion in 2008, and the U.S. industry reached aggregate profitability for the first time ever,  Mr. Giovannetti says.

Industry dealmaking remained active as well. The total value of M&A’s involving U.S. biotechs reached $28.5 billion in 2008. The figure was $5 billion in Europe, according to E&Y. Headlining the wheeling and dealing was Takeda’s $8.8 billion acquisition of Millennium Pharmaceuticals and Eli Lilly and Co.’s $6.5 billion deal for ImClone Systems Inc. Big pharma continues to expand efforts in the biologics arena, with news of Sanofi-Aventis setting up a biotech plant in France the latest such evidence.

“Biotech is full of optimists,� Mr. Giovannetti says. “You wouldn’t start these companies and be able to persevere all the challenges if you weren’t resilient and optimistic. That’s sort of their common trait, mixed with a dose of realism.�

That dose of realism, Mr. Giovannetti says, is the recognition that the present funding-cycle challenge in biotech is different from the ones the sector has faced in the past. It’s considerably more deep-rooted, systemic, and persistent. According to E&Y experts, with funding – the key input of the biotech business model – strained, the industry’s key output – innovation – is threatened and at the very least in jeopardy of slowing.

“Companies have to respond,� Mr. Giovannetti says. “You try to raise capital, the other way you respond is you reduce your expenditures, you pair back, you restructure, you focus on your lead compound in clinical trials, which is the right thing to do, maybe the only thing to do in some cases to weather the storm. But it certainly increases risk because you’re putting all your eggs into one basket. We’re commenting that there’s a real prospect of slow innovation, a lower number of compounds that will make it through the clinic. For individual companies, there’s a real question about viability.�

To help combat these concerns, E&Y’s report highlights four “paradigm-shifting trendsâ€� that the authors say have the potential to reshape the healthcare landscape and create new opportunities for the biotech industry. These trends include high-quality generics, U.S. healthcare reform, personalized medicine, and globalization. According to Mr. Giovannetti and Mr. Jaggi, how biotech companies individually act on these trends will determine much of the market’s recovery and growth in the years ahead.

- Generics: According to the report, generics based on today’s top blockbusters, many of which are facing patent expirations, should loosen governments’ and insurers’ budgetary constraints and mitigate pricing pressures on innovative drugs, permitting better margins.

“Let’s not forget these are some of the most successful products the drug industry has ever seen,� Mr. Jaggi told me. “You’re really going to have generic, lower-price equivalents of some very, very successful, proven drugs. That could mean that payers could have some more flexibilities, because they would now be paying less for the same drugs. It could potentially mean that there is some more flexibility for pricing the truly innovate products and that those products could now command the sort of prices that would give investors the returns they need to make sure that there’s sustained investment in the sector.�

- Healthcare reform: The report says the potential shift toward universal healthcare in the United States – the world’s largest drug market – will likely incorporate pay-for-performance in reimbursement decisions. Therefore, incentives for true innovation should help biotechs sustain returns.

“Here too are opportunities for the industry if that move to pay-for-performance is done in ways that truly measure and appropriately award innovation,’�  Mr. Jaggi says. “Then that could give biotech companies who develop innovative drugs the right kinds of commercial incentives to make sure investment continues. The industry needs to get involved and make sure that pay-for-performance isn’t just done to contain costs, but is truly a cost-benefit paradigm.�

- Personalized medicine: Personalized medicine will increase the relative value of research and early development — biotech’s traditional strengths — giving biotechs more bargaining power and better valuations, E&Y expert contend. In turn, the report says, more efficient clinical research and development, aided by an increased use of biomarkers, will lower R&D costs, making it easier for companies to make the journey to self-sufficiency.

“An analogy we use in the report is that the biotech industry’s business model is sort of like a marathon relay race, where venture capitalists and different kinds of investors carry the baton for a few years and then pass it on to the next stage,� Mr. Jaggi says. “Here, you have the potential with personalized medicine to make the entire race shorter in a sense.�

- Globalization: According to “Beyond borders,� growing strengths in emerging markets, particularly for large drugmakers, will facilitate creative solutions — from new “win-win� ways of allocating increasingly valuable ex-U.S. rights to creative alliances and new sources of capital. Also, Asian business models could provide solutions for struggling Western firms.

“This fits well in the biotech paradigm because not many biotech companies are going to have the global footprint to exploit that themselves, and are going to need to partner anyway,â€� Mr. Giovannetti says. “As a result, will more residual economic rights in the U.S. market be retained by the biotech company and provide healthier returns? We believe that will be the case.”