Should US biotech have a federal bailout?

We recently came across an interesting informal poll conducted by Fiercebiotech to assess sentiment about a federal bailout of biotech firms. Participants in the poll were asked ‘Does the U.S. biotech industry deserve a bailout?’ Fiercebiotech does not give any details about the size of the poll or the profile of the respondents but 51% of responders indicated there should not be a bailout while 44% said there should be a bailout. Five percent indicated they were unsure.

Be a long time coming anyway. The banks were bailed out because they are part of the economic infrastructure that cannot be allowed to collapse. The motor industry is going to be bailed out because of the jobs at stake. What would be the grounds for a bailout of the biotechnology industry?

Obama’s Stimulus Package to boost public private partnerships

Partnerships are a crucial lynchpin in Obama’s economic stimulus plan. Alliances between the public and private sector are given centre stage in the implementation of several elements of the stimulus plan including housing, healthcare, transport and energy. Local educational agencies and schools, for example, in order to expand are expected to ‘work in partnership with the private sector and the philanthropic community… to identify and document best practices that can be shared’ (House Democrats 1/23/09 Bill Text, Page 247: and Senate “Compromise” 2/7, Page 380). In housing partnerships between non-profit organisations and real estate agencies are seen as an important tool to prevent more foreclosures (House Democrats 1/23/09 Bill Text, Page 224).

Using partnerships to stimulate the economy makes sense. Non-profit and private sectors have different sources of knowledge and expertise which, if shared, can be a tremendous vector for rejuvenating the economy and building consumer confidence. As the Stimulus Package makes clear partnerships can enhance the effectiveness of each grant given under the package. Partnerships also prevent the duplication of efforts (H.R. 1: Final Stimulus Version, page 294).

For Kaiser’s take on the Stimulus Package for healthcare click here

David and Goliath Retold

I have just came across a recently released academic paper titled Small Firm-Large Firm Alliance Dynamics: The story of David and Goliath Retold. The paper by Gautam Kasthurirangan of Deloitte & Touche LLP and Daniel Robeson of the Rensselaer Polytechnic Institute argues that, as the authors put it:

.. high power differences between the alliance partners [in biotechnology alliances] negatively affect the value which the small firm may gain from the alliance operations.

Apart from the fact that, like much academic research, the paper’s conclusions simply do not fit our experience of working in the area of alliances, two aspects of the paper caught my attention: the dataset used to form the basis of analysis and the method the authors used to estimate the value that a small firm may gain as a result of entering into an alliance.

The data the authors used was extracted from the Security Data Company’s database of domestic alliances or alliances between listed companies based in the US. The alliances that were selected were signed over a 14 year period between 1992 and 2006. The final sample size used by the authors consisted ’143 alliances between small firms and large firms’. No definition of large or small are given and no attempt was made by the authors to explain why these 143 alliances were representative of the thousands of other alliances signed between companies across the world every year. Nor did the authors, as they could have done, taken a similar number of alliances between large firms to compare the impact of alliances. This is unfortunate given that the conclusion of the paper can be restated as follows:

Partnerships between companies of the same size, when all other variables are excluded, generate more value for the partners than partnerships between companies of different sizes and that additional value results from lower power differentials as opposed to other factors, for example cultural similarities, similar processes and so on.

The stock market response to the small firm’s stock due to the alliance announcement was used to measure this variable value which the small firm gained from the alliance. However, as recent events have shown us markets are far from rational and the immediate stock market response to any event is at best a very weak indicator of the long term impact of that event on a company. This is all the more so where the company in question is a small company with a thinly traded stock that will over-react to any major news announcement coming out of the company.

From our experience of working with companies with large portfolios of alliances the relative size of the partners in an alliance is not a predictor of the value or otherwise that the alliance partners believe that they are getting from the alliance.

Alliance failure rates, revisted

The failure rate of a typical portfolio of alliances that should, in the ordinary course of events, be expected to fail is a fascinating subject. Well fascinating to those, like us, who analyse alliance portfolios and those alliance managers whose bonuses depend upon convincing senior management that, as a result of their skills, the company has a lower than expected alliance failure rate.

So what is the expected failure of rate of the typical portfolio of alliances? Well various figures ranging from 30% to 70% are frequently thrown around in articles and presentations of the subject. But where do these figures come from and why the astonishing disparity between 30% and 70%? Are these figures based on empirical research or are they estimates based on somebody’s subjective experience in the area? In search of the answer to these questions we thought that we would conduct some meta-analysis (well, that’s what our academic colleagues call it anyway) and go off and find the source of these figures.

So what did we find? Well, we found that most of the estimates originate in research conducted by consultants. For example, the following estimated failure rates were quoted by the Corporate Strategy Board in a report titled Institutionalizing Alliance Capabilities (August 2000):

Source	Year	Failure Rate
McKinsey & Company	1993	33%
The Darden School	1996	60%
KPMG	1996	70%
Coopers & Lybrand	1998	50%
Andersen Consulting	1999	61%
The Lared Company	2000	60%

So that’s where the 30-70% range came from. But, can we rely upon these surveys to produce a reasonable expected failure rate of around 50%? Probably not. These surveys were conducted in a very different economic environment than that which exists today. The business environment has changed out of all recognition since 1993 and today, the discipline of alliance management has changed beyond all recognition and information technology has fundamentally altered the way in which relationships are managed both within and without the enterprise. Given those facts, it seems difficult to believe that those surveys provide a reliable guide to a reasonable expected failure rate today. So does more current data exist? Apparently not. Since 2000, other than the bi-annual surveys conducted by Silico Research and IBM in the biopharma space, we seem to have encountered a dearth of other surveys exploring this area. Of course we may be overlooking research so we would appreciate any links to more recent empirical data.

Throw away all that pre-crisis data

A growing consensus emerging amongst industry executives that we talk to is that the half-life of research data, including alliance and partnering related data, is shortening dramatically. Executives relying upon data collected before the crisis when making decisions in the post-crisis era will introduce a significant element of additional risk into those decisions. So we are advising clients to collect important data from external and internal partners more frequently than they would have done previously if they want to rely upon that data to any meaningful extent.

Roche beats bond record

Roche has got its $16 billion issue away successfully. The bond issue was the largest US dollar-denominated corporate bond sale in history, topping the $10.99 billion sold by General Electric Capital Corp in 2002, according to Thomson Reuters’ data as quoted by Reuters. Reuters also said that the Roche offering was heavily oversubscribed.

Why venture funding is still going into biotech

Andrew Updegrove, partner at Gesmer Updegrove LLP explains why the venture funding that is out there is going into areas like biotechnology, biofuels and solar energy. In summary, they are the few areas left where new companies can produce the home run-scale exits that venture capitalists need to justify their existence, and their fees.

The biotech gloom could be overdone

We’re currently running our annual survey of sentiment among senior executives in the biotechnology and pharmaceutical sectors. What is striking from the responses coming in is the level of gloom amongst respondents about the financial prospects for the life science sectors generally. Respondent after respondent cites a lack of access to capital due to the credit crunch as causing real difficulties for biotechnology and pharmaceutical companies. Relatively few respondents are upbeat about the prospects for the sector.

Could it be that the gloom is overdone? Venture capital investment in the sector appears to be holding up well. The latest PWC biotech venture capital investment report released in October 2008 reports that investment in the third quarter of 2008, after the turmoil in the financial markets began, was over $7 billion, down just 7% from same period in 2007. The more up-to-date OnBioVc.com website, which tracks venture capital investment in the sector, reports that venture capital investment in the sector was $534 million in January. This figure was down 17% on the previous year; not great but hardly cataclysmic in the current environment.

At the end of the day, venture capital companies have to do something with their funds. And the turmoil in other sectors, combined with the positive long-term outlook for the pharmaceutical and biotechnology industries probably means that biotechnology appears quite attractive to the average venture capitalist at the moment.

One thing is for sure, a sector overplaying the short term gloom is going to throw up some very attractive acquisition opportunities to deep-pocketed pharmaceutical and biotechnology companies. Or those with a good credit rating, which amounts to the same thing in the current market. And it may make sense for pharmaceutical companies to make lots of smaller acquisitions that do not affect their credit rating than a few large acquisitions that are put under the watch of the credit analysts.

Is 2009 going to be a good year for alliances?

Not in the biopharma sector, according to the headline of an article appearing yesterday on the Financial Times’ website. The article is headed Big pharma unlikely to enter into risky partnerships.

The article cites industry experts interviewed by Pharmawire. Oddly, the article, doesn’t really develop the argument beyond the proposition that entering into an alliance with a biotechnology company in 2009 will be inherently more risky than previously because of the increased risk that the biotechnology company will subsequently go into liquidation. Having set out that proposition the article focuses almost exclusively on whether it is better for a pharmaceutical company to wait for a biotechnology company to go into liquidation before buying the assets or to buy the company outright. The authors, Gayatri Iyer and Marc Longpr, seem in the end to lean towards the buy outright option.

So far so good. The risk of the partner going bankrupt and the cost of acquisition are, indeed, two factors that need to be considered when deciding whether to buy the company or sign an exclusive license with the company. And, obviously, it doesn’t look good if you sign a partnership with a company that joins the dead pool a few months later.

However, there are other risks involved in an acquisition that the article does not address. For example, how good will it look if you acquire a company only to find that it should have joined the dead pool because of a weight of toxic assets or liabilities on its books? Another risk involved in an acquistion, but not in a partnership, that the article fails to address is the increased cost of rationalising acquisitions in a poor job market and poor secondary market for acquired assets, for example, office leases. How do you realistically value a company’s assets in the current market? The inability to value assets is the reason why the banking system is in such a mess and why a number of companies that have mistakenly seen an opportunity to acquire companies on the ‘cheap’ got into trouble.

In the current market the most important consideration for large pharmaceutical companies has to be preserving their credit rating. An overpriced or misjudged acquisition will threaten the company’s credit, witness the risk to Roche’s rating posed by the Genentech offer. If this is indeed true that an acquisition will pose a significantly greater downside risk than a licensing deal, then it follows that a poor acquisition could well have a greater negative impact on a pharmaceutical company than a licensing deal for the same assets. Granted any upfront payments will be lost if the company subsequently goes into liquidation, but that is the limit to the licensing company’s liability.

On the other hand, biotechnology companies have, like just like every other non-AA rated company, been closed out of the capital markets. They have no other option than to look to the pharmaceutical companies for development capital, and with the sub-prime pharmaceutical companies no longer able to compete on price, there are going to be some very good deals to be struck by those pharmaceutical companies who have managed to maintain their prime credit rating.

All in all 2009 could be a very good, if bumpy, year for the licensing and alliance teams in the prime rated pharmaceutical companies.

Of sheep and goats

We heard an interesting talk via podcast between John Cochrane, of the University of Chicago, talks with EconTalk host Russ Roberts about the financial crisis. John makes the point that highly rated companies are having no problems raising money as the markets fly to quality. Companies with a lower credit rating are having real problems accessing funds. Pfizer has an Aa1 rating, the second-highest rating possible which explains why they were able to raise the funds for the deal.

According to Bloomberg the lenders on the Wyeth deal may act if Pfizer’s rating falls below A2 which shows the reliance placed by lenders on the company’s credit rating.

Roche’s debt is rated as investment-grade but is on review for downgrade because of the Genentech bid. Moody’s currently have GSK and Nycomed on a negative outlook with a view to a downgrade.

The reliance by investors on the rating agencies is a bit odd given the way that the rating agencies let investors down so badly in the sub-prime debacle.