Unprecedented change in the drug industry: More notes from Ernst & Young

CHICAGO - The latest version of the Ernst & Young annual report on the biotechnology (and pharma) industry is chock full of good information and needs time for digestion, so much so that it might be the source of several more articles.

This year's report, entitled: “Beyond Borders: Global Biotechnology Report 2009”, which I just received in the mail a week or two ago (note: it used to be that E&Y handed these out in quantities at the annual BIO International conference, but like any company facing cost constraints, it is only available now by request on their website), in particular has some great graphics depicting the challenges of being in the drug business.

My only complaint about this well-written report is that its focus is purely on the drug side of the life science business and shows little information on medical devices, perhaps with some exception, diagnostics.

One of the 2-page E&Y report graphics that impacted me was a chart showing 2 large boxes with the title: “Unprecedented Changes”:

• Box #1: Patent Expirations and Big Pharma's Reinvention
• Box #2: Global Financial Crisis

Although not listed, I would also add U.S. Healthcare Reform and FDA Reform as perhaps 3rd and 4th boxes. While these additional boxes seem to be U.S.- centric, the reality is that the U.S. market still represents more than 40% of the global drug market, and anything that happens in this market has worldwide repercussions. Additionally, the FDA is quickly becoming a global presence with offices in key locations around the world inspecting manufacturers for quality control. Yet an additional 5th box is Personalized Medicine, which is still in its infancy but will be the way of the pharma world 10-20 years from now with the advent and development of biomarkers.

I have written extensively on aspects of the first box: the sheer volume of blockbuster drugs (a “blockbuster drug” is defined as as drug with at least $1 billion in annual sales revenue) coming off patent between 2005 and 2016 is so vast that the pharma industry must dramatically reconfigure itself or disappear. Additionally, the emerging “Biosimilars” generic legislation in the U.S. might have a similar effect both on Big Pharma and Big Biotech (I hope the folks at Amgen and Genentech are paying attention here!). As a result of this frightening quantity of blockbuster drugs coming off-patent, there are two opportunities/benefits:

1. Generic pharma/biotech industry will grow by leaps and bounds - companies like Teva and Novartis are probably well-positioned but other generics including new global players in India and Eastern Europe and possibly even South America, may emerge as even larger companies
2. U.S. consumers/patients taking medicines that are coming off-patent will soon see a large drop in their monthly healthcare bill particularly if they are on chronic therapy (e.g. blood-pressure, cholesterol-reduction, arthritis, diabetes, etc.).

If you take into account that many of these drugs coming off-patent in the next 7 years are used by the U.S. “baby-boomers” as they age into their sixties and seventies, this will represent a significant chunk of money being “saved” by the consumer (and “lost” by the pharma industry).

Getting back to the “Unprecedented Changes” identified by E&Y, the article posits that these changes are driving new approaches to surviving and thriving in the market. E&Y explains that there are different groupings of “new necessities” that are engendering new business models. These groupings focus on key players such as:

• Top Innovators: with explicit choices
• Big Pharma: with a need to change its existing business model
• Small-cap companies: survival
• VC's: need to achieve sustainable returns

According to E&Y, the Top Innovators' explicit choices, due to the quality of their product portfolios and R&D, are:

• Greater flexibility to retain rights, upside and independence
• Greater bargaining power with Big Pharma on any deal

Big Pharma needs to change in the following areas:

• Boost R&D productivity
• Implement and foster innovative cultures
• Figure out how to capture external breakthroughs (get over the “not invented here” syndrome)
• Cut costs while maintaining earnings
• Leverage their global organizations
• Sustain their viability in terms of their internal ecosystem

The Small-cap companies are faced with the following survival issues:

• Erosion of their bargaining power
• Continuous need to raise capital at a time when valuations are down considerably and there is little or no IPO market
• Try to retain some upside in their products and deals
• Increased focus on cost containment and burn-rate reduction

Finally, the VC's are also faced with some tough decisions and issues:

• New paths for finding a successful exit to their investments, particularly with a closed IPO market
• Identification of novel ways to enhance returns
• Raising money from Limited Partners (LP's) becoming increasingly challenged
• Emergence of more well-financed Pharma VC's

This analysis, then, leads to some new business models for all of the groups:

New Business Models By Group

Top Innovators	Big Pharma	Small-cap companies	VC's
License and leave alone	Option and leave alone	More options around geographic rights	Investing in public companies (PIPE's)
Buy and leave alone	Larger up-fronts for sustainability	Consolidate to survive (roll-ups)	Build it to slot it? (medtech model)
Nonexclusive licensing	Acquisitions with earn-outs	Monetize non-core assets	VC's with extended fund lives
	Precompetitive cooperation	Rifle shots (lean companies)	Partial exits
	Early IP lockups	Later stage specialty pharma approaches
	CRO/PE :at risk” transactions	Creative project financing

Source: E&Y “Beyond Borders: Global Biotechnology Report 2009”

Although many of the above models may not seem new to those of you in the industry trenches, it is clearer that all of the above groups are needing to change their tried and true business model perhaps with the exception of the Top Innovators who always been able to maintain control of their own destiny. Unfortunately, these companies are few and far between.

It is interesting to see many Big Pharma companies, in their thirst for new products, now willing to take some risk on pre-clinical data that might not be robust. This is a significant change as most Big Pharma companies would not look at anything previously that did not have at least phase I data (unless it was a discovery tools type of company).

I hope that there is also change in the current VC model as many VC's have abandoned the early-stage company investments. On the positive side, angel investor groups have jumped into fill, at least partially this void; however the reality is that angel investors have less appetite for drug-related investments and prefer medical device investments as the timeline to an exit is too long for them.

There is certainly much to chew on in this year's E&Y Report. See you soon!

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