MIT BIOSTRATEGY SEMINAR SERIES

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MIT BIOSTRATEGY SEMINAR SERIES

• Trends in Venture Capital and the Biotechnology
  Industry
• Michael Lytton
• General Partner
• Oxford Bioscience Partners
• Boston, MA
• mlytton_at_oxbio.com
• December 12, 2001

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The Biotechnology Industry in the mid-1990s

• Investors wanted certainty in new drug discovery.
  . . So large pharmaceutical companies 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, metabalomics. . .) 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 is over-shadowed by a
  persistent, nagging problem. . . .

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• While Critical for Long-Term Value, Genomics Is
  Likely to Lead 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 exploring many more targets
  than
• targets valida- before. What we dont know
• tion about the targets leads to more
• problems downstream and
• worse attrition.
• - Pharma RD executive
• Source Lehman Brothers McKinsey Co.
  Report, January 2001

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• While Critical for Long-Term Value, Genomics Is
  Likely to Lead to Higher RD Cost Pressure
  Short-Term
• Complicating Factors in the RD Process
• Companies Novel New targets will require
  novel Increased
• are pursuing Chem- chemistries and will create
  new RD Costs
• a much higher istry barriers in toxicology.
• proportion of
• novel targets - Biotech executive
• Source Lehman Brothers McKinsey Co.
  Report, January 2001

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• While Critical for Long-Term Value, Genomics Is
  Likely to Lead to Higher RD Costs Pressure
  Short-Term
• Complicating Factors in the RD Process
• Other Uncertain The trial and error cost
  is Increased high clinical high
  when you have a new RD Costs
• impact develop- drug target without a
  well-known
• tech- ment clinical protocol.
• nologies
• are in
• early
• development
• Source Lehman Brothers McKinsey Co.
  Report, January 2001

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The New Discovery Tools Have Not Increased Output

• Accenture survey
• in 1997, drug companies predicted new
  technologies would make them 50 faster and 300
  more productive
• in 2001, 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., Xigris)
• Pharma companies hit the wall of data overload,
  and biotechs fail to contribute improved
  processing capabilities
• Tool companies must, annually, predict pharmas
  bottleneck next year in the drug discovery
  process
• Startup fratricide 50 proteomics companies

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The Sobering Statistic

• Cost of Developing a New Drug 100 million
• Cost of Failures Associated
• with Development 300 million
• 400 million

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Why do compounds fail to become successful drugs?

• Toxicity Issues 22
• Biopharmaceutical Issues 41
• Efficacy Issues 31
• Marketing Considerations 6

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Drug Discovery Technology The Opportunity

• Reducing the Failure Rate in Pre-Clinical and
  Clinical Development and Increasing the
  Efficiency of Drug Discovery
• Failures occur on account of
• Lack of specificity
• Poor absorption
• Too rapid metabolism
• Toxicity

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Drug Discovery Technology The Opportunity

• Efficiency is enhanced as a result of
• Target selection and validation
• Assay development
• High throughput screening
• Lead optimization
• Generation of suitable back-up compounds
• Appropriate pre-clinical models

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Drug Discovery Technology The Opportunity

• The 1990s revolutionized the study of
  associations and created data overload
• Hopefully we are now entering the decade of
  understanding the behavior of whole systems
• Finding the right target(s)
• Finding the right drug
• Improving the productivity of clinical trials

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For the Time Being, the Only Long-Term Successful
Business Model Is Still Developing a Successful
Drug

• 125 biotechnology products are on the market (50
  to be approved this year)
• 300 biotech products are in Phase III (80 chance
  of FDA approval)
• Currently, there are 40 profitable biotech
  companies, with 60 anticipated by year-end,
  accounting for 25-30 billion in revenues
• As pharma companies drug discovery efforts
  continue to fail to yield results, the value of
  late-stage products rises

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The Increasing Value of a Late-Stage Product

• In 1996, Pfizer paid Warner-Lambert 25 million
  upfront for U.S. and Europe rights to Lipitor
  (Phase III)
• In 1998, Pfizer paid Searle 85 million upfront
  for U.S. rights to Celebrex (Phase III) and
  Pharmacia paid Otsuka 80 million for North
  American rights to Pletal (filed for approval)
• In 2001, Bristol-Myers Squibb pays Imclone in
  excess of 1 billion upfront for its Phase III
  epithelial growth factor for cancer

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The Future More Big Value, Late-Stage Product
Deals

• In-licensing is cheaper than acquisition since it
  avoids dilution and provides the potential for
  off-PL transactions (nearly half the cost of the
  Imclone deal is on BMSs balance sheet)
• The biotech industry responds by trying to create
  fully integrated research platforms through MA
  (e.g., Vertex/Aurora, Lexicon/Coelecanth)
• Alternatively, platform companies become product
  companies as well (e.g., Millenniums
  acquisitions of Cor and Leukosite, Celeras
  acquisition of AxyS)

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What Does All of This Mean for Venture Funding?

• Funding devoted to life sciences increases from
  9 (in 2000) to 15 in 2001 of all venture
  capital investing (approximately 5 billion)
• New funds raised in 2000 and 2001 will push
  percentage to approximately 20 (6 billion)
• Fewer, bigger specialized funds
• Multiple reasons to be optimistic
• Doubling of NIH budget
• More trained management
• Gloomy investment climate leads to more
  reasonable valuations for early-stage investments
  
• Less competition, due to the number of vc firms
  that exited the sector with the Internet boom

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What VCs are Looking For. . .Products

• A novel biological or chemical hypothesis
• A well understood mechanism of action
• Proof of principle
• A broad intellectual property portfolio
• A strategy for partnering so that the risks
  associated with the timing of FDA approval can be
  passed on to someone else
• Multiple shots on goal

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What VCs are Looking For. . .Tools

• Provide new information which addresses an unmet
  need
• Reduce the failure rate and/or increase the
  efficiency of drug discovery or development
  eliminate a bottleneck
• Commercialize via a business model that takes
  account of (i) lengthening sales cycle for
  platform technology deals due to pharma company
  confusion and information overload, (ii)
  commoditization and obsolescence, and (iii) the
  need to ultimately share in the upside of a
  successful drug

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Investing in a scientific hypothesis that has not
  achieved proof of principle
• Investing in a technology that works, only to
  find out that no one cares

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Backing a company with weak management or board
  of directors
• Investing as part of a weak syndicate of
  investors

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Valuing a company based on the valuation of
  comparable companies
• A successful venture fund must earn a compounded,
  cash-on-cash gross return in excess of 30 over
  its ten-year term (at least a 22.5 net return)
• The analysis is driven by multiples (10x or
  greater), not the time value of money
• Valuation is determined by reference to (i) the
  pre-money valuation of the next round, (ii) the
  number of financing rounds required until
  liquidity, and (iii) the amount of money needed
  in each round
• So, comparables are of limited utilityhigh tide
  in the Bay of Fundy is not a useful metric for
  Boston Harbor

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Betting on the timing of a clinical milestone,
  corporate partnering deal, or IPO
• Investing in a company where success is dependent
  on accelerating the FDAs review and approval
  process

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Investing in a company without doing careful
  intellectual property due diligence
• Firing, then aiming or aiming, and not firing
  waiting too long, or not long enough, to change
  management

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Still, There Remains Unlimited Potential for
Mistakes. . .

• Bad Timing
• Monoclonal antibodies
• Antisense
• Sepsis
• Gene therapy
• Diagnostics

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Whats Next?

• Predicting disease at the molecular level through
  biomarkers, and developing a value proposition
  for new diagnostics
• Going from gene to drug to develop new
  therapeutics
• Miniaturizing drug discovery technology to
  enhance throughput (and maintain accuracy)
• New antibiotics that overcome resistance
• Finally, the Decade of the Brain?

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Whats Next?

• Focusing on the right applications to benefit
  from biotech/IT convergence
• Executing successful specialty pharma business
  models
• Quality of life devices and drugs (from
  cholesterol to male pattern baldness, wrinkle
  removal, smoking cessation, weight loss, and
  arthritis pain relief)