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BW Businessworld

Seeking The Magic Pill

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Last week, Daiichi Sankyo, Japan's third largest drug maker, agreed to buy Plexxikon, a small and closely-held biotechnology company based in the San Francisco Bay area, for a whopping $935 million. Plexxikon, founded a decade ago in Berkeley, has never brought a new drug to the market. Its most advanced experimental drug, a new treatment for a lethal skin cancer called melanoma, is already promised to Swiss pharmaceutical firm Roche, which signed a marketing agreement with Plexxikon five years ago. Daiichi Sankyo will only receive a fraction of the new drug's sales. And while trials show the treatment works for 80 per cent of patients, it extends their life by no more than seven to nine months. Melanoma remains hopelessly incurable. Sure, Plexxikon has more experimental drugs in the pipeline. But all are still many years away from making it to the market, if at all.

Faced with the loss of patents on blockbuster drugs, decreasing productivity in their own research labs and rising pressure from investors for more innovative medicines, Big Pharma is gambling more of its deal dollars on riskier bets, in a bid to bolster its fledgling pipelines with new technologies. "They have become desperate," says Larry Lasky, an expert in biotechnology and partner at US Venture Partners (USVP), a venture capitalist fund in the Silicon Valley. "They cannot come up with their own drugs. So they are willing to overpay for good assets, or even mediocre ones. Daiichi's deal just underlines Big Pharma's desperation."

Daiichi Sankyo — already pointed at for its costly take-over two years ago of the now loss- making Indian generic drug-maker Ranbaxy Laboratories — is not alone in its quest for the new pill that will turn around its fortunes. A few weeks ago, French drug maker Sanofi-Aventis paid $20.1 billion for US biotech firm Genzyme, after nine months of wrangling. 

Last December, Merck & Co., the second-biggest drug company in the US, agreed to pay $500 million for SmartCells. The small company, based in Massachusetts, only counts one drug in its pipeline, an experimental insulin formulation for diabetes, which still has not been tested on humans. For a drug in such early stages of development, given the risk involved in research, this is an almost unheard of sum, say analysts.

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In May 2010, Daiichi Sankyo's Japanese rival and the country's second-largest pharmaceutical company by sales Astellas Pharma paid $4 billion for US biotech firm OSI Pharmaceuticals — a 55-per cent premium to OSI's last closing price before the announcement of the tender offer. A few months earlier, PanGenetics, a small biotech firm based in Utrecht in the Netherlands, received $170 million from US drug maker Abbott Laboratories for the marketing rights to an experimental pain treatment still in the first phase of human clinical trials.

Dwindling R&D Productivity
What is fuelling the biotech gold rush is a steady decrease in the productivity of big pharmaceutical companies' R&D efforts, says Lasky. "They just don't have good scientists any more." According to the website of the Food and Drug Administration (FDA) that approves new medicines in the US, pharmaceutical companies filed only 23 new drug applications in 2010, the lowest number in more than 15 years (except for 2002). In 2009, drug makers had submitted 37 new drug applications.


Several high-profile drug recalls, such as Vioxx in 2005, after it was found that Merck's arthritis treatment dramatically increased the risk of heart attack, have also tarnished the reputation of drug makers. As a result, new drug applications are coming under increasing scrutiny from the FDA. Antidepressants have been linked to possible higher rates of suicidal thoughts in children and teens, and diabetes drugs to heart side effects, raising the bar of safety and the length of clinical trials for new drug approval. Only last year, 21 new drugs were approved, compared to 26 the previous year. In comparison, the FDA had approved 36 new medicines in 2004.

Structured Acquisitions
Unable to bring out new drugs from their own labs, pharmaceutical companies have been scouting aggressively for new experimental drugs to in-license, and are buying up small drug research companies to refurbish their pipeline of new products. 
With the economic and financial crisis that shook the US in 2008, small biotech companies are also finding it harder to raise money from venture capitalists and private equity funds, and have, therefore, become easier targets. 

According to a recent report by Zachs Equity research, the trend is likely to continue. "Most of these companies (small biotech firms) find it challenging to raise cash, thereby making it difficult for them to survive and continue with the development of promising pipeline candidates," says the report. "Therefore, it makes sense for them to seek deals with pharma companies that are sitting on huge piles of cash." 
Pharmaceutical companies are, however, trying to hedge their bets. Now buyers are making a portion of the purchase price contingent on the success of the target company's new products in clinical and commercial development, to reduce the risks associated with the takeover. In the case of Daiichi Sankyo's recent acquisition, shareholders of Plexxikon will receive upfront only $805 million. The remaining $130 million will be paid out once its skin cancer drug reaches the market, according to a Daiichi Sankyo statement.

US drug maker Eli Lilly's purchase of Indianapolis headquartered Alnara Pharmaceuticals, in July 2010 is another example of what analysts now call "structured acquisitions". Eli Lilly paid only $180 million upfront. Alnara will receive another $200 million only if its experimental drugs are approved by the FDA.

Similarly, SmartCells, acquired by Merck last December, will not get the entire $500 million upfront. Part of that amount will be paid only if the new products meet clinical and regulatory goals, Merck said in a statement. 

Investors in Beverly, Massachusetts-based SmartCells could also get more money depending on future sales. "Pharma companies are getting smarter," says USVP's Lasky. "Biotech companies still try to convince potential buyers that many people are after them to inflate prices. But the reality is that with the financial crisis, less dollars are getting into startups. Venture capitalists are becoming more risk adverse. So getting bought out by Big Pharma is often, ultimately, their only option."


(This story was published in Businessworld Issue Dated 21-03-2011)