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Sloan BioPharma Business ClubBioStrategy Seminar
Series
Venture Capital Investment in Biotech in
2003 Challenges and Opportunities
Michael Lytton General Partner Oxford Bioscience
Partners mlytton_at_oxbio.com December 11, 2003
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The pharmaceutical industry faces an
unprecedented crisis of confidence from within
and without
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Why?

• The lack of RD productivity
• Are the new RD problems too tough?

• Either because of increased regulatory hurdles
• Or tougher diseases to treat
• Or managerial inadequacies

• Patent expirations and re-importation contribute
  to price pressure

• Are drug companies dinosaurs who havent realized
  that the temperature is dropping?
• Set up to market primary care-oriented chronic
  care blockbusters when medicine is moving toward
  specialty and acute care

• The industrys astonishing public image

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Flat RD Output Despite Rising Spend
Number of FDA approvals
RD spending
(B)
(1)
NDAs
CAGR8
IMDs(2)
All others
Top 10 pharma
NMEs(3)
CAGR9

• (1) Excludes new manufacturer NDAs, new use NDAs,
  and NDAs for drugs already marketed without NDA
  (NDAs here is the sum of NMEs and IMDs)
• IMDs (Incrementally Modified Drugs) are new
  derivatives, formulations and combinations
• NME (New Molecular Entities) include both
  chemical and biological therapeutic agents,
  excludes contrast agents and diagnostics
• Source IMS World Review, CMR International
  quoted in Parexel 2001, FDA , Parexel

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The Sobering Conclusions of the 2003 Bain Study

• It costs 1.7 billion to bring a new drug to
  market
• (55 increase over average cost 1995-2000)
• New drugs deliver a 5 return on investment
• (average 9 return 1995-2000)
• One new compound reaches the market for every 13
  discovered and placed in preclinical trials
• (one in eight 1995-2000)
• One in six drugs delivers returns above their
  cost of capital

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Sales Erosion Post Patent Expiry is Intensifying
Top Ten Pharma(1)
Sales decline by patent expiry cohort
of peak sales
Useful patent life was unchanged at
12yrs Erosion post patent expiry increased
91 - 96
97 - 01
Years after patent expiry
(1) Drugs surveyed had sales 500m (2001m)
Source IMS Lehman Brothers BCG analysis and
assumptions
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Percentage of Drugs Dropped at Each Stage of
Development

Source Tufts Center for Drug Development
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I am not certain that our research operations
are any better than a biotech company, a small
pharmaceutical company, or a university
departmentThere may come a time when we do not
do any of that. Tachi Yamada, CSO,
GSK, quoted in the Financial Times, on the
possibility of spinning off GSKs RD units
entirely less than 12 months after announcing
dramatic restructuring of RD to increase
productivity.
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The Biotechnology Industry in the mid-1990s

• Pharma companies wanted certainty in new drug
  discovery. . . So they were prepared to spend
  significant funds to reduce their RD and
  regulatory expenditures
• The search for novelty and the downgrading of
  me-too research (McKinsey's 90 generic, 247 drug
  formula that met 95 of 1995 drug needs)
• Message only novel drugs are worth pursuing,
  and new biotech tools will increase productivity
  and novelty
• The omicization of biotechnology (genomics,
  proteomics, metabolomics. . .) will transform
  drug discovery

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The Tool Company Business Model

• The best product to sell is stock (never make a
  product, never make a profit the
  price-to-dreams ratio)
• The 33 billion raised in 2000 exceeded the
  amount invested in the previous five years
  combined
• 1999 -- 55 of public biotechs have less than two
  years cash 35 have less than one year
• 2000 -- 42 have more than three years
  cash 33 have more than five years cash
• But, this success was over-shadowed by a
  persistent, nagging problem

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The New Discovery Tools Did Not Increase Output

• Accenture survey
• in 1997, drug companies predicted new
  technologies would make them 50 faster and 300
  more productive
• in 2003, drug companies are no faster and no more
  productive
• Why?
• Novelty is risky
• New targets increase RD risk 2X compounds can
  fail and targets can fail (with older targets,
  developer runs only compound risk and chemistries
  are easier)
• FDA cautious about new mechanisms inclined to go
  slow (e.g., Erbitux, Xigris)
• Pharma companies hit the wall of data overload,
  and biotechs fail to contribute improved
  analytical and processing capabilities

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While Hopefully Important in the Long-Term,
Genomics Has Led to Higher RD Cost Pressure
Short-Term
Complicating Factors in the RD
Process Genomics Poorer In 1990, there were
100 literature Increased has led to
an quality literature references/target
- downstream explosion of of Now we average 8.
We are also attrition new potential target explor
ing many more targets than targets valida- befor
e. What we dont know tion about the targets
leads to more problems downstream
and worse attrition. - Pharma RD
executive Source Lehman Brothers McKinsey
Report
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While Hopefully Important in the Long-Term,
Genomics Has Led to Higher RD Cost Pressure
Short-Term
Complicating Factors in the RD
Process Companies Novel New targets will
require novel Increased are pursuing Chem- chemis
tries and will create new RD Costs a much
higher istry barriers in toxicology. proportion
of novel targets - Biotech executive So
urce Lehman Brothers McKinsey Report
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Millennium

• 2 billion in partnership funding since 1994
• Hundreds of targets delivered to partners
• But just one compound completed phase I
• Abbott dropped it partners agreed to end
  alliance
• No other clinical-stage compound from Millennium
  discovery around which it can claim either IP
  rights or pending financial obligation
• Own pipeline acquired and in-licensed
• Velcade
• Acquired with Leukositewho acquired it from
  Proscript when it was PS-341
• As PS-341, originally an anti-inflammatory

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Result There is Still a Need to Reduce the
Overwhelming Cost of Drug Discovery and
Development By

• Reducing the failure rate of compounds in
  clinical trials
• Increasing the efficiency of drug development

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Drug Development Is At Least As Interesting Today
As Drug Discovery

• The value of the new discovery technologies of
  the 1990s was over-promoted and over-estimated.
• Pharma company deal-making post-2001 reflects
  this disappointment.
• The IPO market of 1999-2000 was concept-driven
  the new IPO market is product-driven.

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What Does All of This Mean for Venture Funding?

• Venture funding devoted to life sciences
  increases in the U.S. from 9 (in 2000) to 30 in
  2003 of all venture capital investing
• Fewer, bigger specialized funds
• Multiple reasons to be optimistic
• Product opportunities, instead of technology
  platforms, drive venture investment today

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Scarcity Value and The Cost of Late-Stage Deals
Includes deals signed in phase II, III , and
after filing for approval and only those with
ascertainable upfront payments. Source
Windhovers Strategic Transactions Database
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As A Result, Venture Capital Has Poured In To
Specialty Pharma (a.k.a In-Licensing) Companies

• AlgorX
• Avera
• Biomedicines
• Corus
• Sention
• WHY?

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Because Pharma Companies Have Made Some Notable
Mistakes

• Cyanamid gives up rights to Medivirs alovudine
  because no better than AZT
• But in 2003, goes to BI in ph II for 135mm
  15 royalties
• GSK gives back rights to Icos PDE V inhibitors
  because no clear value in cardiovascular or
  inflammation
• Now Lilly/Icos Cialis
• PG gives back rights to Regenerons VEGF Trap
  because no value in muscle-wasting disease
• But in 2003 licensed to Aventis in Phase I for
  80mm upfrontonly licensable later-stage VEGF
  inhibitor for cancer

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Today, Both Pharma Financial Markets are Paying
For Recognition of ValueNot NME Discovery

• Alvimopan
• GSK pays 50mm UF, MSs of 220mm to Adolorwhich
  acquired it from Roberts (300K 1.9mm
  MSs)which acquired it from Lilly
• Factive
• GeneSoft acquired antibiotic in summer 02 with
  all data for NDA from LG Life Sciences for UF
  14 equityGSK had returned rights to drug having
  developed from ph I thru FDA filing
• Drug approved April
• Macugen
• Pfizer pays 100mm UF to Eyetechwhich acquired
  it from Gilead

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And Then Theres Indiplon

• Neurocrine didnt invent it
• Acquired from Dov in 1998 (for 500K equity
  investment 3.5 royalties plus MSs) which
  acquired it from Wyethwhich got it from Lederle
• With good data and long-term patents
• 100mm upfront, 300mm MSs, 26-30 royalties
  (est.), 175mm short-term credit facility
• Pfizer fully funds all remaining clinicals (ph IV
  crucial)
• Pfizer fully funds Neurocrines sales force
• Neurocrine gets to co-promote indiplon and Zoloft

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But Its Risky for a VC or a Small Biotech
Company to Bet Everything On Consistent
Serendipity

• Unlike a delay in the adoption of a technology
  platform, the failure of a compound in
  development is undeniable and devastating to a
  biotech company a binary outcome is much more
  risky to a biotech company than a pharma company
• It is very difficult to structure an out-license
  in a way that makes sense to both parties (i.e.,
  the buyback rights problem).
• Most of the publicized deals came about through
  connections, not databases or formal
  out-licensing programs.
• Most out-licenses are for single compounds and
  not programs, hence the risk/reward profile is
  binary.
• Within a pharma company, making a mistake on an
  out-licensing deal is a career-ending move (while
  there is no penalty for doing nothing).

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Is it possible to mine existing innovations more
effectively?
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Short-Cutting Discovery Is Todays Dominant Small
Company Model Favored by the US VC
CommunityRe-Profiling, Re-Purposing
Re-Discovering

• Finding new uses for shelved or existing
  compounds thanks to expertise and new assays
• Descartes in pain, Dynogen in IBS/OAB/PE, Hypnion
  in sleep
• New formulation technologies
• Small molecule companies like CombinatoRx,
  Transform
• Large molecule companies like Ambrx, Compound
  Therapeutics, HGS, Mimeon, Nektar, Neose
• Finding new markets for compromised products
• The Medicines Company (Angiomax)

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Financing Development While Having Multiple Shots
On Goal (on a VC-financed budget)

• Proprietary technology (as well as a human)
  "nose"
• Using a comparative advantage to drive
  in-licensing activities
• Out-licensing to a pharma company before the
  clinical development gets really expensive (Phase
  III)

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The World of Specialist Products is Increasingly
Interesting to Pharma

• Because thats where the opportunities are
• Both in terms of unmet need and licensable
  programs from biotechs
• Because of increasing regulatory risk of
  traditional primary care products
• Because launching primary care drugs is expensive
  for even the largest companies

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Dealmaking in Specialist Products
Average Deal Value in Large (50mm) Late-Stage
Deals
Large late stage deals are defined as Phase II
and later deals with a value of 50 million,
excluding FTC-mandated and late life cycle
divestitures. SOURCE Windhovers Strategic
Transactions Database
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Key Points For The Future

• Development will increasingly become Discovery
• Applying innovation to development
• Rediscovering compromised products
• Discovery shortcuts new pharmaceutical sciences
  vs. outright target/molecule discovery
• Business development becomes as, or more,
  important a value driver for pharmas as internal
  discovery
• Unlikely that discovery will soon become
  predictable enough as a result of the biotech
  tools introduced during the 1990s
• Big pharma and large biotech/mid-sized pharma
  companies will increasingly compete with each
  other in markets they used to avoid
• Venture capitalists will fund new companies that
  meet pharmas and large biotechs needs