12:00 AM
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Feb 21, 2011
 |  BioCentury  |  Strategy

Sweet Spot revisited

Genzyme, other biotech pioneers may go, but mid-tier biopharma is growing

Another biotechnology pioneer is being swept away by an innovation-starved big pharmaceutical company, the latest reflection of the bleak outlook of a biopharma industry blanketed by R&D failures, hostile regulators, unwilling payers and the flight of risk capital.

There is no money for innovation, and there is no model for building real, sustainable next-generation companies. M&A is the fate for all who brush with success.

Or so the story goes.

But what if the story isn't true? Or is mostly true, but misses the point?

In 2002, in the doom-and-gloom shadow of the genomic bubble, BioCentury's 10th Back to School essay noted what today has become common wisdom:

"As the rebasing of big pharma continues, it becomes more and more apparent that exceptional growth in the drug industry is less and less likely to come from the top. At the same time, the market cap space between $5 billion and $50 billion is virtually empty save for a handful of weakened pharma names, leaving a vacuum for growth investors that upwardly mobile biotech companies could fill. The latter could provide more realistic growth opportunities, with smaller products than would be required of big pharma."

Indeed, said Back to School, "if biotech does it right, the industry could dominate this 'Sweet Spot' for healthcare growth investors for years to come.

Fast forward to today. What should be made of the fact that despite M&A, more biopharma companies occupy the market cap space above $1 billion than in the fall of 2002?

Or that the average market cap of these bigger biotechs and mid-tier pharmas has grown over that time?

Or that 29 companies have jumped up into the $1 billion space in that time?

Or that 27 big biotech and specialty pharma companies now occupy the Sweet Spot between $5 billion and $50 billion, compared to 20 at the end of 2002 - while only 2 of the 7 pharmas remain in the space?

Or that 6 companies in the Sweet Spot - none of them pharma - raised $11 billion from the capital markets last year alone.

Or that the value of the big pharma space has been flat-lined since 2002 despite pharma's consolidation and acquisition binge?

As the consolidation of Genzyme Corp. by sanofi-aventis Group runs its course, the really important question is what has changed since 2002, and what to think about it.

Indeed, as in 2002, the question is whether the dynamism of the last decade is coming to an end.

It is absolutely true that interesting companies are being swallowed up - left on their own, perhaps they could have grown further into the Sweet Spot.

And it's true that venture capital looks to be shrinking - and perhaps with it the wherewithal to drive investments into the Sweet Spot.

Moreover, the loss of imagination seems to be a real risk - as pioneer personalities seem less visible and valued, the likelihood is that fewer CEOs will be driven to see how far they can build into the Sweet Spot.

Passing pioneers

The first generation of big biotechs has been slowly whittled away: Cetus Corp. in 1991; Genetics Institute in 1996; Centocor Inc. in 1999; Immunex Corp. in 2002; Chiron Corp. in 2006. The most painful was probably the final purchase of Genentech Inc. by Roche in 2009, although Genentech has always seemed to have a life of its own.

Two of the originals remain independent. Amgen Inc. is sufficiently large that only the biggest of pharmas could buy it, but still is probably a tempting target.

Biogen, now Biogen Idec Inc. has been given a reprieve under new management, which has already said it is selling its oncology half. No one would be surprised if the neurology half were acquired as well.

Nonetheless, it is important to put the acquisition of Genzyme into context.

"This is not a bellwether event. This has been going on since the start of the industry. If you look at the top 10 list of every decade, for the last 80 years, it changes every decade. GSK has something like 13 predecessor companies," said Jeffrey Hatfield, president and CEO of Vitae Pharmaceuticals Inc., who has been on both the big and small company sides of the industry.

Indeed, even if there is more churn among the players, it doesn't mean the middle market cap tiers are barren. Far from it.

"If you include the industry from small companies through Pfizer, I'm more bullish than most people are," said Robert Gould, president and CEO of Epizyme Inc. "I see continued turmoil and ferment - that doesn't mean the industry is sick. It means some companies are sick. There are companies that are vibrant and healthy."

In fact, almost every upper tier segment has more players today than it did when BioCentury examined the Sweet Spot for growth in 2002 (see "Distribution by Market Cap".

The Sweet Spot was defined as the space where a company had gotten a first product on the market - which roughly translated to $1 billion-plus in market cap - but before it became so large that the arithmetic for growth no longer worked.

There were four big biotechs and specialty plays in the $25-$49 billion space at the end of 2010 compared to only one in 2002. Taking out Genzyme in the next tier below still leaves nine players valued at $10-$24.9 billion compared to only five in 2002.

The number of companies in the $5-$9.9 billion tier has barely changed - 15 in 2002 vs. 14 today. But the two tiers below have grown. There are 14 companies in the $2.5-$4.9 billion space today compared to 8 in 2002. And there are 28 companies valued at $1-$2.49 billion compared to 18 in 2002.

This is all despite the exit of at least 35 companies through M&A(see "Dynamic Spaces," A4).

Asset accumulators

One of the most striking things about the companies in this space is how very different their roots are. Some have grown up from small, innovator biotechs; some have roots as generics companies; some as specialty pharmas; some are Japanese companies or family-owned small European pharmas that realize they have to modernize to survive.

But no matter what their roots, they all have the same problem: maintaining revenues and growth. Thus, by necessity, any company that gets one product on the market and isn't simply waiting to be acquired must play the role of asset accumulator, a related concept explored by another Back to School essay (see BioCentury, Sept. 6, 2004).

"When you look at a mid-cap company right now - $10 billion in market cap and $1.5 billion-plus in revenue - it's a total mixed bag of widely different companies," noted Jean-Francois Formela of Atlas Venture. "There are different ways of getting there, but once you get to that level, everybody's in the same boat."

By the same token, once companies reach the middle tiers, they don't all behave the same way. But it's clear many of the mid-tier companies that are doing well have embraced, re-embraced, or never gave up on innovation.

At the same time, the innovators are becoming more practiced as aggregators.

Among the companies mentioned frequently in this regard by industry veterans are Celgene Corp., Vertex Pharmaceuticals Inc. and Gilead Sciences Inc., as well as Biogen Idec and Cephalon Inc.

Vertex has always been science-driven, which looks like it will finally pay off this year. The company is waiting for U.S., European and Canadian approval of telaprevir, widely regarded as the leading HCV NS3/4A protease inhibitor.

The company also plans NDA and MAA submissions in 2H11 for VX-770, an oral cystic fibrosis transmembrane conductance regulator (CFTR) potentiator. This molecule also would be a first-in-class drug.

Indeed, Vertex has not relied solely on its own science, playing the role of aggregator to obtain VX-770 through the 2001 acquisition of Aurora Biosciences Corp., as well as two Phase I HCV compounds from a cash and stock deal for ViroChem Pharma Inc.

Gilead has built itself on first-in-class science in the antiviral space. But it also has tried to build new franchises through aggregation. Most recently, the company acquired Arresto BioSciences...

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