Biotech’s Capital Intensity Challenge: A Post-Mortem on 2007’s Biggest Deals

Posted August 29th, 2012 in Capital efficiency, VC-backed Biotech Returns

“Raise all the money you can whenever you can, and then raise some more”.  “The more a company raises, the more successful it is”.  Resumes boasting about how much an executive has raised in their prior companies.  These sentiments are all part of a generally-accepted norm regarding success in the biotech world.

Unfortunately, as this blog has sounded off about frequently, these beliefs are in direct contrast to reality: the bane of returns in biotech has been its equity capital intensity.

Raising lots of money is not indicative at all of successfully generating a return for shareholders, but as a sector we tend to celebrate it.  I’ve vented on this subject before, highlighting our tendency to cheer for trophy financings (here); the first company I highlighted as potentially challenged in that post was Pacific Biosciences.  About 1.5 years later, its the poster child of “Go Big, Go Bust” stories, having raised ~$600M over the past five years and now has an enterprise value of -33M.

And raising a lot of money is not always indicative of a management team that’s doing what it’s supposed to: working on behalf of their shareholders.  When your option pool and ownership are always reloaded to the latest Radford compensation survey benchmark, you’re indifferent to dilution and of course want to raise more money.  BD candidates that brag to me about having raised $100M for XYZ Biotech, without big returns to back it up, instantly lose points in my book (as my brain is thinking, “how come they didn’t do more with less equity capital?”).

Two important and related observations on this theme of raising capital are worth emphasizing.

  • The amount of capital raised by a venture-backed private biotech has no clear correlation with its exit value.  The scatter plot of Figure 6 from this Kevin Lalande analysis is an excellent visualization of this point. The odds of a $300M exit are seemingly just as likely for a company that has raised $40M as it is for those that have raised $150M.  Obviously capital starvation doesn’t give a new company a chance, but above a reasonable threshold this observation appears to hold true.
  • For “successful exits” (IPOs, M&A), the amount of capital raised by a venture-backed private biotech tends to be inversely proportional to returns (here).  Because your odds of getting to a top decile outcome don’t change with raising more capital, then raising more must by definition inversely related to the returns (you can only play with numerators and denominators).

To exemplify these rather abstract observations with some specific companies, I thought it would be instructive to look at the Top Deals of 2007, the annual list that is pulled together and annotated well by FierceBiotech.  I’ve looked at the top 10 largest financing rounds of the year, all of which were greater than $50M.  In general, these are companies that have raised $100M+ in equity capital over their “lifetimes”.  Since five years have passed, it gives us a chance for more of a post-mortem, to see what they’ve done with all that capital.  Here’s the rundown:

  1. Zogenix – 2007 financing was $78.8M, the biggest of the year.  The company struggled to IPO but got public in late 2010 with a major valuation haircut (fraction of cash invested) as the only way to feed a very high burn rate supporting its formulation improvement for a generic migraine drug.  Stock is off nearly 50% since its 2010 IPO.  Venture investors lost significant portion of their capital.
  2. Ception Therapeutics – $77.7M.  After progressing their lead antibody into the clinic, Ception was bought in an earn-out deal by Cephalon and ended up getting paid both the upfront the milestones ($350M in total).  Positive exit in the 3-4x range.
  3. Targanta Therapeutics – $70M.  Company got public after the 2007 pre-IPO round, and continued its effort to get a late stage antibiotic program approved; the FDA rejected it with a Complete Response in late 2008 in the midst of the financial crisis.  Company lost most of its value and was sold to Medicine’s Company for $15M in 2009.  Venture investors lost most of their capital.
  4. Portola Pharmaceuticals – $70M.  Company has been developing several interesting drugs in partnership with Novartis, Biogen, and Merck, having raised $307M in venture capital to date.  From what I’ve heard, things are going well, but with Merck handing back the Phase 3 platelet drug the burn is likely to increase.  Valuation is very high today, which could handicap returns unless it becomes a rare outlier (a possibility given the story).  Fair to say from a returns perspective, it’s too early to tell but a positive work in progress.
  5. AVEO Pharmaceuticals – $58.5M.  Company got public in 2010; share price is now 10-20% below its Series C (2005), Series D (2007) and Series E (2009) rounds.  So despite having a drug in front of the FDA, AVEO is currently a negative return for its venture investors (the ones who have held large portions to date) or at most a marginal win (1.3x) for those that exited in 2011 (looks like Flagship has exited, whereas MPM, Highland have been holding at least some of their positions).  Time will tell if they can recover and generate a return, but the odds are against it at this point.
  6. Cogentus Pharmaceuticals – $55M.  Company was focused on a combo pill of Plavix with Prilosec, and never finished its Phase 3 COGENT trial (got 3800 of 5000 patients) before running out of money and declaring Chapter 7 in 2009.  The company had raised $85M over its lifetime, but bankruptcy led to a full loss for its venture investors within two years of this 2007 financing.
  7. Phenomix Corporation – $55M.  After having raised nearly $165M for its clinical program (DPP-IV) and platform, this San Deigo based biotech shutdown after a Forest Labs bailed out on their Phase 3 DPP-IV partnership.  Full or near full loss to its investors.
  8. Sagent Pharmaceuticals – $53M.  Backed by Vivo Ventures, this Spec Pharma story got public in April 2011 and shot to a valuation over $500M.  This was a >5x homerun for Vivo, assuming they exited.  Its now valued at closer to $230M, and has raised $250M to date.  So it was a win for Vivo and the other venture investors, though a more modest one today than in 2011.
  9. Microbia – $50M.  Now called Ironwood, it raised its 2007 round at $6.25 a share.  Ironwood’s currently trading near ~$13, so its 2007 investors are sitting at approximately 2x after 5 years.  Similar to the company’s aggregate investor returns: IRWD has raised nearly $600M and has a market capitalization of $1.3B.  It’s been a modest ~2x positive return for its private investors.
  10. Sangart – $50M.  This two-decade old biotech has now raised over $280M for its blood substitute products, including another $115M since this 2007 financing.  Its lead program remains in Phase 2 studies, as it was in 2007, and the company has been through a restructuring in 2009.  It’s hard to believe this one will generate returns for its pre-2009 shareholders, but who knows.  Clearly still a work in progress.

So of the 10 biggest financings of 2007, here’s the scorecard: 40% are significant losses (Zogenix, Targanta, Cogentus, Pheomix), 10% sitting at or near cost (AVEO), 30% are “winners” above 2x in returns (Ception, Sagent, Ironwood), and 20% are still works in progress (Portola, Sangart – if we’re generous on the latter).  I’ve not done the analysis, but my guess is that most of the Top Financings of the 2005-2008 timeframe have a similar distribution.

What’s fascinating is that this distribution of returns is actually not very different from the aggregate biotech venture distribution over the past 30 years (here): 50% of biotechs have lost money or returned only their cost, and 35% made more than 2x invested capital.  But this historic industry distribution includes not only later stage plays like the above ten deals, but also all of the raw, high-risk startups and earlier stage companies that never make it to the perceived “big leagues” of Top 10 financings.

Conventional wisdom would think that these more “mature biotech companies” capable of raising piles of capital would have improved outcome distributions vs less well-financed biotechs both in terms of invested capital loss ratios (risk) and upside return potential (return) – sadly, they seem to have a distribution no better (and perhaps worse) than the historical venture-backed biotech return curve.  Given the later stage nature of the above Top 10, it reinforces a prior blog post about the misperception of risk in later stage biotech investing (here).  Biotechs that move downstream into full Phase 3 development, FDA registration, and commercial stages face considerable and often hard-to-manage investment risks, but fundamentally lack the margin of safety that these activities have within Big Pharma’s budgets and organization – and therefore pay huge penalties when the inevitable delay or rejection occurs.

Two conclusions from these observations: (1) big biotech financings haven’t delivered lower risk or better return profiles, highlighting yet again that capital intensity is a biotech investor’s bugbear; and (2) as a sector, I think we need to reframe the types of deals and managers that we celebrate: equity capital efficiency, not chart-topping financings, is a virtue we should be extolling in biotech.

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