VC life sciences and biotech

“Biotech and drug companies are hugely loss making and loss making for a long time,” says Robert James, a partner of Esprit Capital Partners in London. “It’s very easy to invest in a biotech company, but it is very difficult to get out of it.”

Without the support and know-how of the venture capital market in Europe, the region’s biotech sector would have underperformed over the last 10 years and the pharmaceutical giants would have had relatively slimmer pickings to choose from.

There is the view that in their own research efforts the big pharmaceutical companies are hugely inefficient. Given the large amount of money that goes into research, they are not sufficiently feeding their product pipelines, so they have to look elsewhere, and most often the focus is on venture-backed biotech firms.

“The aggression to acquire product and also the technologies that produce those products is greater than it has ever been for the pharmaceutical industry,” says Stephen Bunting, managing director of Abingworth in London. “The relationship extends to all stages and it’s not just company acquisitions but also individual acquisitions of assets and products.”

“Over the last 18 months to two years, the pharma industry has become much closer to the VC community. Pharma companies are very open about what they want and what they don’t want. They have a very deep understanding of our portfolio companies,” he says.

“We have to stick to looking further ahead than the established pharma companies do, otherwise we will not be able to maintain our edge,” he adds.

Although there is a healthy flow of M&A deals across Europe featuring pharmaceutical companies buying up products and to a lesser extent technologies, the number of companies actually acquired is very small.

“There are relatively few biotech companies that will be predisposed to go down the M&A route; others will go down the licensing route,” says Nigel Pitchford, a venture capital partner at 3i in Cambridge.

“Over the next 24 months, pharma will need to take the foot off the pedal and digest some of the assets they have acquired recently,” he says.

While some venture investors talk of the current M&A activity as a window, others believe it is a widening avenue that will continue uninterruptedly, with acquisitions across different therapeutics, diagnostics and even platform technologies picking up pace.

However, what many venture investors believe has to happen is greater participation from the public equities markets to enable companies to grow to their full potential.

“We desperately need US$10bn-plus pharmaceutical companies in Europe, because it is only then that investor attention will be grabbed,” says Dr. Stephen Reeders, MVM managing partner. “If we create more of these large pharmaceutical companies in Europe, I think the public markets will support biotech more, increasing money manager demand.”

Perhaps unlike in any other industry, Europe is home to five of the top 10 pharmaceutical companies in the world.

“I think we need to see more mature markets in the countries where the innovations are taking place. I think the UK public markets really need to develop more,” says Reeders.

“Europe has world leaders in biotech innovation in countries like Denmark, Finland, the Netherlands and the UK. There’s plenty of innovation but we need more backing from the public markets,” says Reeders.

For a generalist money manager, biotech is not that encouraging. Maybe less-so in the US, the public markets worldwide have developed an uneasy relationship with biotech.

In his paper entitled “Can Science be a Business? Lessons from Biotech” published in the October 2006 issue of the Harvard Business Journal, Gary P. Pisano questions whether public equity markets and biotech have a viable future as they currently co-exist.

“Public equity markets are not designed to deal with the challenges of the enterprises engaged in R&D only, which compose most of the biotech sector. These companies cannot be valued on the basis of earnings; most of them don’t have any. Their value hinges almost exclusively on their ongoing R&D projects. But trying to value them on the basis of projects that face years of great technical and commercial uncertainty is next to impossible.”

More than ever, it seems that the onus is on venture capital in Europe to make biotech and life sciences universally accepted investments for all types of investors, whether specialised or generalised.

“What venture needs to do is to focus on global markets, because healthcare products go across borders,” says Reeders. “Venture investors need to be asking if a deal is competitive on a global basis, and if it is, invest in it.”

Healthcare as a percentage of GDP is on the increase everywhere, with the US recording healthcare as 16% of its GDP spend in 2005. Populations are ageing and demand for healthcare will certainly increase demand for more efficacious medication. Biotech may be the engine for innovation, but not all investors are buying this proposition.

“Investors in biotech are much more conscious and calculating of risks than they used to be,” says Hanns-Peter Wiese, a partner at Global Life Science Ventures in Munich.

“The result has been a shift towards financing of later stage companies with products more likely to generate revenue in the foreseeable future, while companies based mainly on a technological platform will find funding very difficult.”

Taking a punt on commercialising intellectual property is just not something that public equity investors do, especially when a class of drug can take 12 years to develop through pre-clinical and clinical trials.

For those venture investors that back drug discovery, the need for public markets funding is clear. It is estimated that securing regulatory approval on a pharmaceutical drug will cost in the region of US$800m to US$900m.

Perhaps the days of investing in pioneering new discoveries that will revolutionise healthcare has been tempered somewhat, particularly following the hype that surrounded the genomics and proteomics areas around five years ago. Now, biotech would appear to be more about business than science.

“Many companies have sharpened their strategy and focused their development programmes on fewer and more targeted products, with the aim of getting them into clinical trials in shortest time possible,” says Dr Stephen McCormack, a partner at Global Life Science Ventures in Munich.

“The focus is now clearly on commercialisation of products and product pipelines, rather than advancing the knowledge base and intellectual property positions,” he says.

It is not unusual for a biotech company to have at least one R&D alliance with at least one major pharmaceutical company and increasingly to have one or many more licensing agreements which they license to pharma to help fund their own R&D projects.

Although this fragmentation of know-how and skill is considered a structural weakness of the biotech industry, public equity investors are encouraged by drug licensing.

“Licensing deals are generally seen to be a pre-cursor to the IPO route, but this is not the preferred exit route. Biotech IPOs are cash generating and it is rare for a VC to exit fully – this usually happens at least a year post-IPO,” says Pitchford.

“An IPO is not the ideal route for a VC to cash in its return, so that’s why the M&A route is preferred. Cash is the ultimate form of liquidity,” he says.

“The public markets do not pay the valuations for our companies when we go down the IPO route,” says Antoine Papiernik, managing partner at Sofinnova Partners in Paris. He says that bankers typically implement valuation metrics on an IPO below the level that venture capital wants to see.

There is some anecdotal commentary to suggest bankers generally will not go higher than the 50% to 70% step up at IPO, compounding the fact that the public markets are a financing source and not an exit source.

There public equity markets are open to biotech, more-so in some European countries than others.

“I’m a bit more optimistic about the US public markets over the next 12 months. However, I think Euronext looks interesting, as does the Swiss Exchange,” says Bunting.

“UK investors are interested and want to take a long-term perspective on biotech companies. Bankers feel there needs to be more biotech companies in the UK,” he says.

“Although the German stock exchanges have got better, it is definitely more difficult to raise funds here than in the US because the US investor is willing to take a chance, whereas German investors are risk-averse in comparison,” says Dr Bernhard Schirmers, Partner, SHS Gesellschaft für Beteiligungsmanagement mbH, in Munich.

“If anything, we’re looking to the US for co-investors, giving us the option to flip a company in to the US,” says James. “Investors are still conservative and those companies that get funding are very good companies.”

“Generally speaking, the first half of 2007 will be just as good as 2006 was,” says Francesco De Rubertis, a general partner at Index Ventures in Geneva. “We are preparing a few of our more mature portfolio companies to consider the capital markets this year. For biotech, the Dutch, Danish and Swiss exchanges will continue to be strong from a structural perspective.”

A run of multi-billion Euro mergers among European pharmaceutical companies would likely spark public equity interest. Another trend that could lead to increasing confidence in the sector is the growing number of experienced pharmaceutical managers moving back in to biotech – perhaps the more stable marriage of science and business.


Box out: Venture-backed biotech and life sciences

Antibody acquisitions are a hot exit for venture

For a number of venture capital investors that had backed next-generation antibody therapy companies, last year resulted in a series of lucrative exits as the big pharmaceutical companies sought to acquire companies active in this ground-breaking area. The remaining independent companies in that area also look set to be snapped up this year.

That M&A trail in Europe featured deals like the acquisition of Cambridge Antibody Technology, a biopharmaceutical company developing human monoclonal antibody therapeutics, by Astra Zeneca.

By far the most impressive acquisition, considering it is an early stage investment, came towards the end of the year when GlaxoSmithKline announced in December that it had entered into an agreement to acquire privately-owned Domantis, a leader in developing the next generation of antibody therapies, for £230m in cash.

Domantis will become part of GSK’s Biopharmaceuticals Centre of Excellence for Drug Discovery (CEDD) while continuing to operate from laboratories in Cambridge, UK.

The Domantis acquisition is one of largest acquisitions of a pre-clinical drug development company and the strongest return for 3i’s venture team in 2006, which is generating an IRR in excess of 100% on its investment.

According to Domantis, it had raised a total of US$83m, most recently attracting an additional US$29m in a Series B prime venture financing in December 2005 from new investors Novo Nordisk and MC Life Science Ventures (a subsidiary of Mitsubishi Corporation), together with its existing investors, which included 3i, MVM and Peptech Limited.

These funds were being used to expand Domantis’ portfolio of proprietary dAb therapeutic leads and to advance certain dAb leads toward clinical trials.

Domantis was founded in 2000 by Ian Tomlinson and Sir Gregory Winter and backed by the Medical Research Council in the UK and MVM. The price paid by GSK is one of the highest ever paid for a private biotechnology company and it is arguably the most significant deal ever for a private European biotechnology company.

“At the time that Domantis decided to move forward to an acquisition, it was in strategic talks with five big pharmaceutical companies,” says Dr. Stephen Reeders, MVM managing partner and Domantis board member.

This developed in to acquisition interest from three of the companies, with the process from start to finish taking less than four months. The board of Domantis was advised by Lehman Brothers.

“We’ve known for a couple of years that the technology developed by Domantis was working out well. It was a balance between taking an exit now and waiting three or four years to build up the sale price,” says Reeders.

“Some venture investors talk in terms of choosing exits. What we are seeing right now is appetite among the major pharmaceutical companies to develop their product pipeline over the next 10 to 20 years,” he says.

What is so innovative about monoclonal antibodies, laboratory-engineered versions of the antibodies found in the natural immune system, is that they can bind with exquisite precision to targets in the body. This new-generation of anti-bodies can be administered orally and topically and can be inhaled and their production is a lot cheaper than the currently marketed therapeutic antibodies which have to be administered by injection or infusion.

“We’re currently in one of those M&A cycles that we all live for,” says Nigel Pitchford, a Cambridge-based venture capital partner at 3i. “This is driven by the needs of the big pharmaceutical companies having to look elsewhere for products because their own universe of products is limited.”

As is typical in biotech-pharmaceutical relationships, Domantis was talking to GSK and four other companies about pulling together an R&D alliance.

“GSK was sensitive to keeping the people at Domantis who are integral to the platform,” says Pitchford. “There was almost a feeling of natural connectivity between the people at Domantis and GSK.”

Some investors had thought that GSK would make a play to buy Belgian company Ablynx, following its venture capital arm, SR One, participating in the €40m series C financing in August, which was one of the largest private placements in European biotech last year.

The international syndicate of investors was led by new investor KBC with SR One (USA and UK) as the second new investor. All existing financial investors participated in the round – Abingworth Management, Alta Partners, Biotech Fund Flanders, Gilde Healthcare Partners, GIMV (Belgium) and Sofinnova Partners (France). In addition, VIB of Belgium also participated to a significant degree. The total invested in Ablynx since its inception in 2002 totals €70m.

“Ablynx wasn’t for sale but Domantis made a push to go down that route,” says Abingworth’s managing director Stephen Bunting. “The ties in the UK may have facilitated this acquisition.”

However, shareholders in Ablynx generally agree it is a matter of time before another pharmaceutical company makes a play for the company.

“When there are three rare stamps and one gets sold, the other two become more valuable,” says Bunting.

The Domantis deal is part of a trend where pharma companies are willing to pay good money for good quality companies, which has tended to be a US phenomenon in the past.

There are a number of other European VC-backed companies in the antibodies space that might be lined up as potential acquisitions in 2007. They are Borean of Denmark, Affibody of Sweden and Pieris of Germany.