Tuesday, September 4, 2001
The value chain
Counting the market
What it takes
The $100B & below club
Sidebar: The Back to School syllabus
Sidebar: Back to School: The market speaks
Sidebar: Back to School: Follow the money
Every year, at the end of Summer, BioCentury publishes its
"Back-to-School" Commentary, which focuses on themes that we think
have major strategic importance to the biotech industry.
This year's 9th annual report focuses on value chain management,
and asks whether a sufficient number of individual companies, or the biotech
industry in general, are yet focused on building business structures capable
of accomplishing the imperatives of bio-industry.
In fact, we would argue that the first principles for biotech
industry development are few and simply articulated:
- The goal of the biotech industry is to create actual treatments
for unmet medical needs.
- The value captured by the biotech industry must at least
match the value it creates.
In the first case, it is not the business or responsibility
of the biotech industry and its investors to actualize scientists' pet projects.
It is to create products. The genomics-driven investment in front-loaded science
and discovery technology has been a necessary investment, but not the only one
required to accomplish this goal.
In the second case, despite the compelling amount of science,
technology and deal flow announced by biotech companies each week, top-tier
valuations remain almost the exclusive perquisite of a handful of companies
that have brought therapeutic products to market. Of the 22 top-tier names in
the BioCentury universe - companies with market caps above $3 billion - 19 are
product plays and 3 are high-end suppliers of equipment and consumables.
Indeed, one cannot help but notice that there are only two
genomics-based names in the top tier - Millennium Pharmaceuticals Inc. (MLNM)
and Human Genome Sciences Inc. (HGSI) - which are now fully integrated PRODUCT
companies. And one of the most striking trends of the past few months has been
the increasing number of discovery service and tool companies announcing plans
to move downstream toward more fully integrated drug development business models.
This latter move has been mirrored by the financial markets,
which have let the air out of the discovery bubble (see "The Market
While the equity markets are prone to irrational enthusiasms
in the short run, in the long run we think there is enough experience and data
to demonstrate the limitations of business models that capture relatively small
pieces of the value chain.
Investors have poured increasing amounts of money into the
front end of the value chain, seeking a quick payoff from the technology while
avoiding the perils of the lengthy drug development process. And in the short
run, many of these "risk-adjusted" investors enjoyed profitable early
exits by investing in discovery and tool companies during the genomics frenzy
(see "The Value Chain", A2, and "R&D Money Flows",
But the path forward for these companies still must be resolved,
as chart after chart reveals no clear trajectory compared to the value trajectory
demonstrated by companies with therapeutic products on the market.
In particular, it has been very hard for service and tool companies
to grow substantially beyond $1 billion or so in market cap. Thus, going forward,
the challenge is to create a long-term upward trajectory for companies making
real advances in the discovery space.
Product companies not immune
At the same time, as the perils of one-horse product companies continue to be amply demonstrated, the odds continue to weigh against portfolios containing a handful of compounds. The old model of biotech drug development, in which the failure of a Phase III compound reduces a company to preclinical status and a market cap to match, demands to be replaced by an industrialized process capable of the repetitive introduction of products into clinical development (see Back-to-School #8, Sept. 5, 2000).
Even some highly successful product companies such as Agouron Pharmaceuticals Inc., which developed what is arguably the best protease inhibitor on the market for treating HIV/AIDS, have concluded that they would be unable to reach critical mass on their own.
In January 1999, Agouron agreed to be acquired by Warner-Lambert for $2.1 billion, a 27% premium to its market cap of $1.7 billion. In deciding to be acquired, Agouron concluded that its pipeline and R&D capabilities lacked the diversity and scale required. The company calculated that it would have needed to operate at two to three times its current spending level to develop a consistently productive pipeline. But the company lacked the resources to do so (see BioCentury, Jan. 27, 1999 and Feb. 1, 1999).
Thus, this year's Back-to-School argues that integration and industrialization are two sides of the same coin:
- Service/tool companies need to integrate through the value chain, leading them into drug discovery and development.
- Old model product companies need to adapt the new industrialized model, integrating the latest discovery tools to create a more risk-balanced portfolio of product candidates spanning multiple stages of development.
Indeed, in both cases, we would argue that biotech companies ultimately must choose either to integrate or be integrated.