Funding research and development through spin-outs

In a bid to cut costs AstraZeneca is spinning out its efforts to find new drugs for gastrointestinal (GI) disorders to a new company called Albireo. Part of the decision reflects AztraZeneca’s recent problems with its drug, Nexium, an ulcer treatment, which has been declining in profit and its decision to direct its energies on respiratory, cancer and infectious diseases.

Based in Gothenburg, Sweden, Albireo is inheriting one clinical and a number of pre-clinical GI programmes and key researchers in the field from AstraZeneca. The company is to be funded by a syndicate of growth capital firms, led by Nomura Phase4 Ventures, together with TVM Capital and Scottish Widows Investment Partnerships. So far Albireo has raised $27 million.

The creation of a spin out by a large pharmaceutical company is not new. In 2000 Roche established the biotechnology company Basilea Pharmaceutical to develop drugs for infectious diseases and dermatology, an area Roche had developed for the previous 15 years. One of the reasons for spinning out Basilea was to allow Roche to focus its efforts on its core areas of research and development. Basilea inherited Roche’s know-how, intellectual property and compound library in antibiotics, antifungals and dermatology.

Spinouts can be an attractive means of cutting down on costs while creating a new avenue for partnerships and filling dwindling drug pipelines. Both Roche and AstraZeneca retain minority equity interests in their spin out companies and have the option of licensing their products. This could be an important source of revenue and drugs in the future. Today Basilea has two drug candidates in the pre-registration phase, one in clinical phase III and a number of promising early-stage programmes. Two of Basilea’s drugs have received fast track designations from the U.S. Food and Drug Administration.

The impact of large alliances on share prices

Our attention was drawn recently to an analysis called “Why Investors don’t like Biotech Alliances” produced by In Vivo.*

The article took nine large biotechnology alliances and examined the impact of alliances on the share price of the biotechnology companies involved. Among the the alliances examined were Isis Pharmaceuticals’ mipomersen deal with Genzyme, Merck’s with GTx on its Phase II SARM and two backups and Sanofi-Aventis’ multi-antibody arrangement with Regeneron. The company’s analysis demonstrated that the median share price of the the nine biotechnology companies is down 15% from the day the deal was signed.

The analysis came up with a couple of explanations for this effect. Amongst the most important reasons given were that investors do not like the loss of control resulting from a large alliance and that large alliances make the already mind-bogglingly difficult job of calculating the value of a biotechnology company even more difficult. Needless to say we thought that this analysis was very interesting and so we decided to take a deeper look at the issue.

A couple of things immediately struck us about this analysis. To begin with, the small number of alliances examined all seem to have been signed over a three to four month period at the end of 2007 and beginning of 2008. No comparative analysis was done with companies signing alliances at other periods, companies that have never signed large alliances or indeed the sector overall. As it happens the companies examined saw their share prices fall by the same degree as other biotechnology companies (overall around 9%) in the same period. So the analysis cannot be used to demonstrate that alliances reduce the value of biotechnology companies. The most that can be shown is that over the short period in question, a period of unprecedented turmoil and when markets in general were falling, a handful of large alliances did not significantly increase the market value of the companies in question. A poor basis for a generalised conclusion about alliances overall.

We were also puzzled by analysis based on the change in the share price of the company at the point of signing an alliance and subsequently because, unless the event is completely unexpected, factors that may impact the share price of a company have been taken into account by the time of the signing. An appropriate analysis would take the change in the share price of the companies months before the alliance was signed rather than the date of signing the alliance. As it happens many of the companies saw a significant run up in their share price in the months before signing the alliance only to see it fall back after the alliance had been signed. This is normal.

One further thing occurred to us. The biotechnology industry is an industry built on partnering and we suspect that the valuation that many, many biotechnology companies trade at is based on the assumption that they will sign alliances with larger, better capitalised, companies. If that is indeed the case, then we would not expect an individual alliance to have a significant impact on the share price of a biotechnology company.

* Roger Longman, “Why Investors Don’t Like Biotech Alliances”, In Vivo Blog, March 26, 2008, http://invivoblog.blogspot.com/2008/03/why-investors-dont-like-biotech.html

The analysis is correct in pointing to the challenges presented by issues of control in partnerships, but all companies in all sectors that have partnerships, alliances and joint ventures face exactly the same issues every day of the week. Talk to any software company dealing with Microsoft or Oracle, talk to any construction company undertaking work in foreign countries. Indeed, talk to an energy company with interests in Russia.

The analysis is also correct in pointing out the challenges presented by the valuation of biotechnology companies. But why would a biotechnology company with alliances be easier to value than a biotechnology company without alliances?

So, all in all, an interesting analysis but we are far from convinced.

Pfizer invests in web-based software company

Pfizer has announced that it is in talks to become a strategic investor in Imaginatik, a web-based software company. Imaginatik is listed on Aim, the London small companies index and produces collaborative software designed to allow ideas and insights from employees in large organisations to be shared collaboratively. Imaginatik was founded in 1994.The company had revenues of just $1.15 million in the six months to September 2007 down from ?1.27 million in the same period in 2006. The company had 43 annual licence customers in September paying an average licence fee of ?53,500 down from $72,500 in 2006 from 35 customers. The company produced a loss of $469,000 in the six months to September 2007 compared to a profit of $155,000 in 2006. Not exactly Google type of numbers.

Web-based collaborative software itself has been around since the days of Lotus Notes and there are hundreds of packages available ranging from the software used to run Wikipedia that can be used free of charge to hundreds of other specialised packages designed to match particular market niches.

The deal has left observers wondering why one of the largest pharmaceutical companies in the world whose expertise is in drug development is investing in a tiny software company. It is clearly not revenues, revenue growth or profits. Imaginatik has made gloomy trading statements in recent days and the simple fact of the matter is that web based companies like Imaginatik either scale up very rapidly or fade away. At the moment Imaginatik seems more likely to follow the latter track.

Pfizer went so far as to nominate Imaginatik for a technology pioneer award at the World Economic Forum at Davos earlier this year. Why Pfizer should single out this particular web software supplier and not other software suppliers to Pfizer or indeed one of its many innovative biotechnology partners is a complete mystery to us.

One industry observer commented ‘The only reason I can see that Pfizer would want to make this type of investment is if they were offered a massive discount on the licence fee to make it worth their while lending their name to the Imaginatik’s efforts to spin a company with declining revenues and a declining income per customer into a success story. Either way, I don’t know what partners or potential partners will make of the deal.’

It could be that Pfizer have found something compelling in a company selling a faily basic web-based collaboration package, however at this point we remain to be convinced.