Personalized medicine and diagnostics are undoubtedly critical to the delivery of better healthcare in the future: getting the right drug to the right patient at the right time. In theory, these therapy-guiding diagnostics should reduce the cost of healthcare while improving outcomes.
But I’m far less sanguine about who is going to fund the new innovations required to bring these diagnostics to market. As I noted in last week’s post-mortem regarding On-Q-ity, venture-backed diagnostics have been a painful sub-sector to invest in and the wreckage is adding up. An SVB report from last year has it pegged as the most challenging subsector in the med tech space (here). According to that report, during 2005-2011, over $1.6B was invested in 106 companies focused on diagnostics. In 2012, according to MoneyTree, another $168M was invested. I’m skeptical on the return profile of lots of these investments.
Here are the six tough realities of the diagnostic space today:
- Diagnostic science isn’t any less risky than therapeutics. The underlying bioscience uncertainty around the relevance and robustness of an assay or test for impacting/predicting outcomes isn’t any different than the uncertainty about whether a drug is pharmacologically active. Many initial observations don’t get validated.
- Capital intensity remains very high for many Dx companies, as the exit point typically requires commercialization. It takes a lot of capital and time to validate a diagnostic and bring it to market. Large validation sets and clinical trials are expensive. OncotypeDx, Genomic Health’s and the personalized medicine industry’s flagship product, was developed with samples from 2600 breast cancer patients as well as ~500 clinical trial patients, according to their 2005 S1 filing. The bar has only gotten higher since then. There are a number of solid private companies with launched Dx products that have consumed >$100M in equity capital: CardioDx, XDx, Tethys, Crescendo, to name a few. These will need to be very large exits to generate a venture return. MDV, a big backer of these plays in the past, has decided to deemphasize diagnostics (here) – it’s a telling sign when one of the leading investors with deep expertise in the field has decided to leave it.
- Diagnostics have a hard time extracting value-based pricing. The difficulty of communicating value and then sharing in that value (be it cost savings or better outcomes) is significant, making many diagnostic models more of a high volume, low cost commodity business where scale is essential. Further, unlike chronic or routine therapeutic use, there are many single use tests on the genetics side, one-offs on acute settings (MRSA), etc that make for challenging price-to-value considerations.
- Regulatory uncertainly is far higher than in therapeutics. The FDA may have a high bar for new drugs, but it’s a bar that in most areas is fairly certain. There are plenty of guidance documents and new, innovative drugs often get very clear paths to approval (SPAs, breakthrough status, accelerated approvals, etc…). There are occasions in the past where the goal posts have moved (like antibiotics, obesity), but even in those areas the regulatory certainty has recently improved. In diagnostics, regulatory uncertainty is a systemic risk. It stems in part from the complexity of CLIA-certified home brew testing vs FDA-approved pathways, and what the future status of those pathways will be. The requirements for approval need to be much more clear if this concern is to be overcome.
- Reimbursement remains a mess. When you have multiplexed tests (like many new personalized medicine approaches) where the diagnostic itself involves multiple activities, reagents, characterizations, etc…, it’s well accepted that the old model of CPT code-stacking just isn’t going to be viable. But its very unclear what the new model will be. The process of getting a “new code” is arduous and uncertain, and typically requires mountains of data. It’s simply not clear how to get paid for expensive but high value tests.
- Lastly, the exit market for venture-backed diagnostic companies remains weak. For reasons #1 and #2, it’s very rare to see a big “early stage” M&A transaction (the equivalent of a $300M Phase 1 exit). But getting companies to revenue stage requires lots of capital (#3) before acquirers are interested. The big national labs (Quest, LabCorp) prefer accretive deals so don’t make frequent buyers of innovation. The public markets may open up for diagnostic and life science tools players, but that’s not been a great path for future appreciation in the field.
All the above is not to say that you can’t make money in diagnostics, and a number of smart investors have and will continue to do so. For instance, HBM made 21.6x or more on the sale of BRAHMS to Thermo a few years ago. And there are a lot of very interesting emerging diagnostic companies, like Foundation Medicine here in Cambridge, that may achieve the escape velocity required to scale. But it’s a tough space, or as I wrote a few weeks ago, “not for the faint of heart”.
At Atlas, we’ve reflected on these realities and decided to stick to what works for us in the Life Sciences – which is early stage therapeutics investing. Looking at our aggregate track record over past 20 years, therapeutics have outperformed diagnostics/tools by a huge margin (5-fold). Over the past few years, four challenging experiences helped tee up the perspective: OnQity, Aureon, Molecular BioMetrics, and Helicos.
- OnQity. Our failed tissue biomarker and circulating tumor cell play; see my recent post for the summary of the story and lessons learned (here).
- Aureon Biosciences. After a decade in the “systems pathology” space, Aureon got two products onto the market via the LDT/CLIA pathway. But payors were reluctant to reimburse fully for the tests in the absence of “more data” (despite several large trials), CPT code-stacking wasn’t working, and the timeline for getting clarity on reimbursement was uncertain. Although a good number of urologists/surgeons wanted to use the test, keeping a commercial organization going was prohibitive and so in late 2011 the company was shut down (here) – even after getting two products launched.
- Molecular Biometrics. MBI had developed a diagnostic in the IVF space for identifying embryos more likely to be viable. We joined the B-round to fund the launch of what we thought was a ready-to-go test. But unfortunately the underlying data wasn’t nearly as robust as initially believed: in hindsight, it was fundamentally a failure of over-fitting data during the hypothesis testing and validation stage. The initial diagnostic signature looked great but was an illusion without the outliers. The product was voluntarily withdrawn and the company shutdown.
- Helicos. One of several companies in the Next Generation Sequencing space, a hot technology area plagued by capital intensity. NGS isn’t necessary a “diagnostic” space, but it’s a new technology area that supports diagnostic applications as commodity solutions. NGS technology and commercial development has just cost a ton and yet the space is commoditizing rapidly. Pacific Biosciences has raised over $600M, Complete Genomics over $200M, and Helicos over $200M. Lots of losses for investors here as these NGS companies struggled to compete with the established competitors, differentiate their offerings, etc…
These four ill-fated deals (spread out over several fund cycles) aren’t representative of all diagnostic companies. I’m sure there are many good diagnostics companies that will succeed and deliver value to both patients and shareholders. But for us, at least for the time being, they give us pause about diving into more diagnostics deals, as they frame up lots of the issues and challenges with the field (the six realities above).
It’s certainly true that investors can mitigate some of the above risks by focusing on near-commercial bets or funding through to the revenue-stage. Roll-ups of smaller diagnostic plays can be had to accrue scale benefits faster (though more of a growth equity than classic venture play). But these investment strategies preclude the funding of early stage innovative diagnostic opportunities.
Further, this approach raises the question of how does one generate a return from early stage diagnostic investing – the translation of academia-derived insights into new clinically-validated diagnostic tests. Who is going to fund the next generation of new innovative Dx plays? I’m hopeful that models of consortia-based funding or pooling of biomarker insights and capabilities will come together. Qiagen’s CEO Peer Schatz speaks eloquently about these types of ideas, among others. The Personalized Medicine Coalition has certainly been a positive force for pushing the field around policy changes and these more collaborative models. Much like the Pharma industry has engaged actively in the early stage therapeutics ecosystem through novel partnership models and active corporate venture investing, the larger players in diagnostics need to do the same in personalized medicine. Much more of this collaborative activity is likely required to attract the much-needed private capital into the field.