Crossing the Chasm to a Sustainable Biopharmaceutical Industry

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By Anthony J. Giovinazzo

The case for a biomedical merchant bank

Overview
Should Canada have a sustainable biopharmaceutical industry? Can it become a biotech nation, or does it lack the critical mass to reach the scale needed to do so? Should it invest in its own biotech firms or continue to develop companies, technologies and people destined to join the ranks of American and European biotech? Perhaps even more importantly, should Canadians continue to pay high prices to U.S. and European companies for therapeutics based on technologies that, at one time, were publicly funded in Canada?
Canadian scientists, entrepreneurs, investors and politicians have pondered these questions for many years. Perceptions differ widely among stakeholders. The existence of several hundred biotech companies in Canada is considered evidence that we have a viable industry, although large, foreign marketing pharma subsidiaries are included in this analysis. Despite the existence of under-funded, undervalued, struggling Canadian companies that have been touted as success stories (because of the significant rise in valuation when acquired by U.S. companies), few Canadian biotech firms and investors realize the significant valuation, market cap and return on investment of mature, complete biotechs, or the retention of high-skilled jobs.
Obviously, not every Canadian company, project or technology is a viable proposition for marketed products, or has the potential for $1-billion valuation. Nevertheless, considerable amounts of Canadian investment in science, technology, drug-development projects and competencies wind up in European or U.S. investors’ hands. Examples include the sales of biotech firms like Neurovir Therapeutics Inc. (acquired by MediGene AG, Martinsried, Germany), Allelix Biopharmaceuticals Inc. (acquired by NPS Pharmaceuticals Inc., which later merged with Enzon Pharmaceuticals Inc., Bridgewater, NJ), Cita NeuroPharmaceuticals (acquired by Vernalis, Winnersh, U.K.) and the technology of Calvin Harley, PhD (which launched Geron Corp., Menlo Park, CA).
Successful biotech investment requires more available money for a longer time and at higher risk than in many other sectors. It also needs experienced investors and analysts with sufficient confidence and resources, plus the appropriate mandate to invest in biotech with the necessary scope, time horizon and risk-profile. To play in this sector, these investors must be comfortable with the strategy and risk involved. They must possess in-depth knowledge, expertise and experience in state-of-the-art life sciences, international drug R&D, and recent developments in pharmaceutical markets — as well as intellectual property, regulations, and legal and financial management — all within the context of today’s competitive global environment.
One clear issue for Canada is that the biotechnology industry has not captured the imagination or will of institutional investors, while the natural resource industry — which has similar timelines, risk levels and needs large amounts of capital — has done so. Further, the nascent venture capital industry is under-resourced from two perspectives: capital and experienced drug developers. It may be necessary to have several publicly listed winners in the $500 million or greater market cap level that reward private equity and institutional investors to motivate a change in investment interest. There may be a need for a catalyst, which could be identified and put in place.
In the last several years, many articles have been written about what may be ailing or hindering this industry, as well as the need for more public funding to universities, the Canadian Institutes of Health Research (Ottawa, ON) and other public research institutions. The case for this increased public funding is well made: on a per capita basis, Canada falls behind the U.S. and other G7 countries. The case has also been made for more SBIR- (Small Business Investment Research) type grants to allow hospital- and university-based research to mature, before being handed off to venture-backed biotech companies.

Management
One argument offered for the lack of progress and success has been the lack of experienced management teams in Canada. There may be need for improvement, but it is not the root cause, given the remedy of importing experienced management. Some Canadian venture investors have used this perception to invest sub-critical amounts of capital of $2 million to 5 million (or tranching the advancement of dollars in small increments). U.S. venture capitalists (VCs) often cite Canadian VCs’ lack of drug-development experience, as well as a tendency to doom companies by under-funding them, as a reason for U.S. reluctance to invest in Canadian projects. This notwithstanding, some U.S.-based funds have come to Canada to take control of low-hanging and cheap opportunities.
There are many teams in Canada with some or most of the requisite experience. These teams could be bolstered by importing talent. Labour, like capital, is mobile. The question is: why don’t Canadian companies attract more experienced people from the U.S. and Europe? One fundamental issue may be that they are not prepared to handle salary expectations. Relative to Canadian salaries, these might seem exorbitant. Yet Canadian venture investors and boards of directors should see imported talent as an insurance policy, lessening risks while improving their company’s efforts, pace of development and realizable value creation.

Venture Funds
Interestingly, when comparing the composition and skill base of Canadian biotech-focused venture firms to those in the U.S., most successful U.S. biotech venture funds have both ex-pharma and ex-biotech executives in the senior decision-making roles. These are individuals with 15 to 25 years of real-word drug-development, medical device and health-care information management experience, who have had both successes and failures. This gives them the ability to pick people and opportunities better, set realistic milestones and resource companies with sufficient capital. In contrast, few, if any, Canadian biotech venture funds have senior executives with such extensive backgrounds, though some have built experienced advisory boards and investment committees.

Development Capital
One problem in the Canadian biotech space is the lack of sufficient development-stage and commercialization capital. There are some seed-level funds, university tech transfer offices with capital for patenting, and angel investor networks. At the next stage, firms such as GrowthWorks Captial Ltd. (Vancouver, BC), VenGrowth Private Equity Partners Inc. (Toronto, ON), the Business Development Bank of Canada (Montreal, QC), Ventures West Management Inc. (Vancouver, BC) and GeneChem Management Inc. (Montreal, QC) are actively doing Series A and B rounds. Yet the Series B rounds need to be much larger. What is lacking is a pool of capital with amounts ranging from $25 million to $50 million that can invest in a Series C or mezzanine rounds, before taking a company public.
The lack of large development capital has not stifled, but instead witnessed a proliferation of premature public biotech companies in Canada. This is a possible reason why the larger institutional investor group has been reluctant to invest consistently. The vicious circle of being too small from a critical mass/capital perspective and earlier stage (higher risk, more failures of studies) results in poor stock market performance. Add to this the lack of analyst coverage, which further exacerbates the situation.
In order to go public at a substantial valuation, or become an attractive takeover target (and allow Canadian stakeholders to reap the substantial upside of value) a company needs to have a clear commercialization vision, coupled with more than one late-stage (Phase IIb or III) drug candidate and several mid-stage candidates. In addition, it needs to have one or two significant strategic pharma relationships. To reach this scale, a company needs to raise and spend approximately $75 million to $125 million. In this scenario, a company might go public on the TSX or Nasdaq at pre-money valuations of $180 million to $225 million or more. Then it would need to substantially grow its value. To accomplish this, these companies need to be globally competitive from a scope, depth, strategy and efficacy perspective. Their drugs must be new and innovative, efficacious and safe, on an international scale.

The Merchant Bank
Inspiring the investor market to invest consistently in the biopharmaceutical space could be seeded with several successful companies going public, or, if they are already public, reach market capitalizations of $500 million to $1 billion or more. A merchant bank, independent of banks and insurance companies, with a capital pool of $1 billion to $2 billion could accomplish this. It would be seeded with $500 million of commitments from the larger pension pools in Canada, with 10 to 20 of the more than several hundred such funds with $20 million to $50 million each.
With this type of commitment, the remaining $1 billion to $1.5 billion should be achievable from other pension and insurance private equity investors in the U.S. and Europe. The bank would have a small team of 15 to 20 people, with senior management having pharma and/or biotech experience. The bank’s strategy would be to seek out public or private companies in Canada, or proactively establish de novo companies in three to four specific sectors, namely oncology, neurology, respiratory or cardiovascular. The objectives would be: to create targeted vehicles that would be recipients of up to $200 million in capital commitments, with new and more experienced board members; to recruit more experienced management teams; and in-license or acquire technologies, drug candidates or whole companies (from the U.S. or Europe). As these companies mature, they would also move backwards in building their pipelines by consolidating several of the smaller Canadian companies in each of their respective fields. An initial and crucial step for choosing companies would be the establishment of a well-documented strategic plan that sets the vision and goals for each company with an emphasis on a competitive positioning in each of its chosen technology/indication areas, as well as what technologies, drug candidates and/or companies would be targets going forward and why. The merchant bank would have a 10- to 12-year life, and would return its capital or the securities in its invested companies to its investors.
The resulting three or four companies would have sufficient capital to grow their pipelines with late-stage assets (as well as make mistakes and correct them), the best people, and clear and well-defined strategies. With the necessary critical mass of technologies, several drug candidates in all phases of clinical development, and substantial pharma partnerships, these companies could be successful IPOs with substantial market capitalizations, and substantial news flows. These companies would by nature be asset accumulators and would not rely on only Canadian source technologies. Companies of this size would garner institutional interest, as well as multiple international analyst coverage.
Many will criticize a directed approach like this, but if executed properly, it could put Canada on the map as true player in this field, as well as give our capital markets confidence.
Canada’s wealth is still largely based on non-renewable natural resources and manufacturing. It would be very unfortunate if Canada to remain mired in such an economy, like many of today’s petro states or developing world economies. Instead, as noted in the Economist last year, Canada should apply its vast resources to transform itself into a strong, modern knowledge- and science-based economy with well-developed services and science/technology companies. Canada must turn its attention opportunities that can create new and renewable resources. Otherwise, we will not only block future generations of Canadians’ access to high-quality employment, opportunities for outstanding education, scientific research and health care, but also lose major opportunities to benefit from the competencies and entrepreneurial qualities of Canada’s citizens. This can only serve to impede our ability to reap the benefits from accessing innovation, investment and learning opportunities in the biotech sector with the potential for high rewards for those investors who have an appetite for significant potential value at longer term and higher risk.

Anthony Giovinazzo can be reached at
ajggco@hotmail.com