The Wall Street Journal ran a disturbing story today about a clinical trial that ran low on funding and has depended on payments by patients to continue. 

The clinical trial in question is an amyotrophic lateral sclerosis ("ALS") study run by James P. Bennett Jr., director of the Center for the Study of Neurodegenerative Diseases at the University of Virginia. 

Is this ethical?  According to The Wall Street Journal:

[S]eeking funds directly from patients. . . raises a number of ethical and economic questions — questions that any research effort considering such a solution would have to face. It means soliciting patients at a very vulnerable time, when they may be desperate for hope. With ALS, for instance, there is no cure; the disease attacks the nerves that control movement and usually leads to death within five years. Already struggling to pay for aspects of their own care, patients could quickly find themselves tapped out.

There is also less accountability for how money is spent when it is donated directly to a study rather than through a grant-giving nonprofit. And while Dr. Bennett has no financial interest in his ALS drug, investigators in other trials may financially benefit from their research role, causing potential conflicts of interest.

Outsourcing has been a heavily debated topic  in the high tech industry over the past few years, particularly given the ups and downs of the Silicon Valley economy; however, outsourcing trends in the biotech industry have not received much attention.  According to blogger Nishith Srivastava, though, outsourcing is becoming commonplace in the biotech world as well.

Why is the popularity of outsourcing growing in the biotech industry?  Srivastava suggests that biotech companies are outsourcing for the same reasons that high tech companies are, writing that:

The increasingly global nature of the pharmaceutical/biotech industry endorses Outsourcing, as most companies tend to exploit the market by gaining competitive advantage. Pharmaceutical companies with little or no experience have realized that mastering the entire skill range within an industry is not viable. Moreover, flexibility is becoming increasingly important within the industry. As a result, companies have started focusing on their core competencies in which they can add greatest value. The growth of the pharmaceutical contract service industry in recent years has led to a significant increase in the number of services and functions available for outsourcing. The cost pressures have led to pharmaceutical manufacturers reassessing their financial situation and, in the wake of the resulting downsizing trend, to the development of a contract service industry specifically targeted at the pharmaceutical industry.

How big an impact is outsourcing anticipated to have on the biotech industry in the future?  Srivastava anticipates that outsourcing will continue to have some role in the biotech world, but he does not anticipate it to have quite the same impact as outsourcing has had on the high tech industry.  Srivastava writes:

[M]any challenges exist for the successful implementation of outsourcing within the pharmaceutical industry. The industry is characterized by inherently high risk; only one in 5,000 compounds actually becomes a product, commercial drugs cost $300 million to develop, and less than 50% of new products return the development cost. Tight governmental regulations compound this risk. Unlike other industries, there have been no transformational developments to drive outsourcing—even marginal performers can succeed. An immature contractor segment also characterizes this marketplace.

Srivastava raises some interesting points, and certainly the high tech and biotech industries have their differences, but it is difficult to see why outsourcing would not continue to play a larger role in biotech in the future.  Outsourcing is being embraced increasingly by even the conservative world of lawyers and law firms–I was just at a dinner where a colleague from out of town spoke of how his large firm is starting to outsource legal work to India, and I hear stories on a daily basis about how law firms are starting to embrace this new form of labor.  If the legal world is integrating outsourcing into its business model , I can only imagine that other industries will not be far behind.  My prediction is that the popularity of outsourcing will continue to grow in biotech, as well as in most other industries, which each share in the need to provide goods and services at a lower cost.

Which five biotech companies should industry followers be watching today?

BusinessWeek.com ran a column today written by Eric Halperin, where he identified five of the most promising biotech companies to watch.

Which companies made his list?

1. Alnylam Pharmaceuticals

2.  Affymax

3.  Jazz Pharmaceuticals

4.  Altus Pharmaceuticals

5.   Trubion Pharmaceuticals

How did Halperin decide on this list?

In the case of Alnylam Pharmaceuticals, Halperin wrote:

In October, pharma giant Merck agreed to buy Sirna for $1.1 billion, a staggering sum for a company very early in the drug development process. The reason? Sirna is one of only a few companies developing drugs based on RNA interference, a technology for which scientists won the Nobel Prize, that involves blocking gene expression.

Alnylam is another. The company has only initiated an early-stage safety trial for its lead product candidate, a treatment for respiratory syncytial virus, but RNAi could be the bigger asset. . . .

What about Affymax?  Halperin wrote:

The company priced above its range in December and has a market valuation of almost $500 million. So why does this loss-making company appeal so much to a few investors? Among other factors, the company received funding from big-name venture capitalists like MPM Capital and Bear Stearns Health Innoventures.

Another is potential sales. The company’s hopes rest on Hematide, an erythropoiesis stimulating agent designed to treat anemia in patients with chronic kidney disease and for cancer patients undergoing chemotherapy. Anemia-fighting drugs are blockbuster sellers—generally defined as more than $1 billion-plus in annual sales—for Johnson & Johnson and Amgen. And Affymax believes Hematide could be longer acting and cause fewer side effects than the existing products. The drug is in several mid-stage trials.

While Halperin is a little vague on his reasons for selecting Jazz Pharmaceuticals, he is a bit more definitive regarding Altus Pharmaceuticals, stating:

Cowen has an outperform rating on the stock. The firm likes Altus’ business model of modifying drugs to treat rare diseases . . . .

As for Trubrion Pharmaceuticals, Halperin stated:

Seattle-based Trubion develops drugs designed to bind to targets on cell surfaces. The lead product candidate, now in mid-stage trials, aims to treat rheumatoid arthritis, a market with blockbuster potential. The company believes it may also have use in treating lupus, though it has not yet begun clinical trials aimed at the disease.

Trubion carries all the usual biotech risks, but investors have warmed to the company anyway. The stock is up more than 50% since its October IPO. . . .

Even though as a lawyer, I focus less on which companies are likely to become the best investments than I do on whether or not the companies will prove to be good clients or how they are impacting the law, I think it is always useful to know what is being said in the investment world about a particular company.  It will be interesting to see how his picks do over the next few years. 

From my perspective, however, given all of the innovation coming out of the biotech industry and all of the emerging biotech start-up companies, I think that it is impossible to narrow down the list of young stars in the industry to five players.  I can only imagine that time will show that Mr. Halperin has omitted many of the biotech companies from his list who will ultimately prove to have been terrific investments.  Some of those could very well prove to be even better investments than the companies on his list. 

In case you missed it, The Biotech Weblog recently reported on Fierce Biotech’s release of the Top Five Regions Targeting Biotech Companies in 2007. 

Contrary to what you might expect, Florida–not California–was at the top of the list. 

What propelled Florida to the top of the list?  Fierce Biotech stated as follows:

Florida scored two important coups when Scripps Florida and the Burnham Institute both were wooed here by economic development officials armed with state cash and determined to transform the state by making it a powerhouse in academic research. The Burnham Institute alone garnered $155 million in state support last year for an expansion program and Scripps gained more than $700 million to back its Florida move.

That investment is beginning to pay off. In recent months Scripps Florida signed a $100 million research agreement with Pfizer and saw its first spin-off–Xcovery–take off. The University of Florida, meanwhile, has been cited by the Milken Institute as a leader in the country for its technology out-licensing and commercialization work. And that work is a key contributor to developing startups in biotechnology.

It may take years for the snowball to really get rolling on the commercial side of drug discovery, but Florida has created a blueprint on laying the foundation for a cluster.

Of course, California was not left off the list entirely.  California made Number 3, right after Singapore. 

This is not the first time Florida’s inroads into the biotech industry have received attention.  Prompted by an article written by Richard Krause of Investor’s Business Daily, Seeking Alpha recently wrote:

It all began in 2003 when the Scripps Research Institute of La Jolla, California, was promised by Palm Beach County [Florida] a significant amount of financing to establish a biotechnology research hub in the state. Scripps accepted the proposed $500 million in financing, and initiated plans for a mega biotech site on the Western fringes of Palm Beach County.  .  . .

This much honey tends to attract more bees. Torrey Pines Institute for Molecular Studies lobbied for financing from Palm Beach County for establishing a large research center in Boca Raton. Palm Beach County denied the request, citing the institute’s relatively small level of federal funding dollars. Torrey Pines finally received $100 million from St. Lucie County, about an hour drive north of Palm Beach. Ground breaking for the new site is expected by March.

Burnham Institute for Medical Research also wants a strong presence in Florida, and has so far received over $300 million in state and local incentives to establish a life science research site near Orlando. Not to miss out on the handouts, SRI International of Silicon Valley opened its new marine technology research complex in St. Petersburg. A permanent facility is expected by mid-2008. Almost $50 million has been invested in SRI so far. . . .

According to Seeking Alpha, "[t]here still is room for the biotech industry to grow in Florida, and there are plenty of research institutes, life science companies, intellectual property law firms, and venture capital groups waiting for a piece of the pie."

Will Florida–or any other state for that matter–ever succeed in attracting biotech to such a degree that it will really rival California as a hub for biotechnology?  The elements that have made California such  a success will be very difficult to recreate outside of the state.  Only in California do you have access to venture capital, a highly skilled workforce, and world-class universities–all in close proximity.  While it would be theoretically feasible to build such a community outside of California, it is difficult to imagine that this could be easily accomplished in Florida or any other location. 

As a native of the Southeast, however, I wish Florida the best in its quest to bring build a biotech hub in its state.  While I continue to be a strong supporter of the California biotech industry, nothing would please me more than to see a strong biotech industry emerge in the Southeast.   

Angel investing is reportedly up in 2007, and the life sciences and health care industries are among the key recipients of the funding.

The Biotech Weblog, which reported on a recent study conducted by the Center for Venture Research at the University of New Hampshire, wrote that:

[A]ngel investing picked up in 2006, and is likely to continue to do so in 2007. And biotech is one the top three bets receiving funds from angel investors. 

According to  Red Herring, the trend since the downturn has been that angel investing has increased five to ten percent annually.   Moreover, Red Herring reported:

Angels continue to be the largest source of seed and startup capital, with 46 percent of 2006 angel investments in the seed and startup stage. This preference for seed and startup investing is followed closely by post-seed and startup investments—about 40 percent of total angel dollars. Healthcare services, and medical devices and equipment continued to account for the largest share of angel investments, with 21 percent of total angel investments in 2006, followed by software at 18 percent and biotech at 18 percent. The remaining investments were about equally weighted across high-tech sectors.

These reports are in sync with the trends we are seeing in the Bay Area towards investing in life sciences and health care.  Certainly, investment is being made in technology, but there continues to be a lot of talk about what is going to be the next big thing.  In contrast, with respect to the life sciences, the prevailing perspective is that there are multiple next big things on the horizon.  My expectation is that the gap will continue to grow over time.

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In case you missed it, Matthew Herper and Robert Langreth wrote in a recent Forbes.com article about an interesting new trend in the biotech industry–applying the open source model to the biotech world.

Herper and Langreth reported as follows:

Novartis. . . the Basel, Switzerland, drug giant, has helped uncover which of the 20,000 genes identified by the Human Genome Project are likely to be associated with diabetes. But rather than hoard this information, as drug firms have traditionally done, it is making it available for free on the World Wide Web. . . .Researchers at Novartis partnered with Sweden’s Lund University and the Cambridge, Mass.-based Broad Institute, a joint venture between the Massachusetts Institute of Technology and Harvard that is funded by billionaire Eli Broad. This international team compared the genomes of 1,500 people who had diabetes with 1,500 who were disease-free. All the patients were from Sweden. To do this quickly, the scientists used gene chips from biotech Affymetrix. . . that allowed them to track 500,000 places in the genetic code where past experience has shown that there are likely to be differences.

The result: a library of genetic differences that are likely to increase a patient’s risk of diabetes. Researchers don’t know what most of these errant genes do, or exactly why diabetics are more likely to have these genes. That is exactly the puzzle a world’s worth of scientists are needed to unravel. . . .

It is inevitable that the biotech world would begin to test the open source model, which has become so popular in the software industry, but it raises some interesting questions about how best to adapt the model from software to biotechnology.  What should such a license look like? Will the biotech community embrace such a model the same way that the software engineering world has?  Is biotech likely to run into the same problems with an open source model that the software world has?

It will be interesting to watch this new trend to see if it takes off, and if so, what it ends up meaning for the industry.

While company valuations are critical to those of us who work with a particular company in a particular industry, few of us really take the time to consider or understand how a company valuation is conducted.

This is why I found Ben McClure’s recent article Using DCT in Biotech Valuation to be of particular interest.

In his article, McClure concedes that valuation can “appear to be more guesswork than science” but asserts that a generally accepted approach does exist to biotech valuation, which relies on discounted cash flow (“DCF”) analysis.

McClure writes:

Using DCF analysis, you can determine what someone would be willing to pay for that drug portfolio. In other words, you determine the forecasted free cash flow of each drug to establish its separate present value. Then, you add together the net present value of each drug, along with any cash in the bank, and come up with a fair value for what the whole company is worth today. A biotech company can have dozens, or even hundreds, of drugs in its developmental pipeline. But that does not mean you should include them all in your valuation. Generally speaking, you should only include those drugs that are already in one of the three clinical trial stages.

McClure goes on to explain that the next step is forecasting the sales revenue from each biotech company’s drugs, stating:

The key is to determine what expected peak sales would be if- and this is a big “if” -a drug successfully makes it all the way through clinical trials. Normally, you will forecast sales for the first 10 years of the drug’s life.

To do this, of course, requires one to make assumptions about the drug’s market potential and the drug’s potential market penetration. After the market size has been established, an estimated sales price has to be determined. McClure writes:

[P}utting a price tag on a drug that addresses an unmet need will involve some guesswork. But for a drug that will compete with existing products, you should look at the price of the competition. . . . Multiplying that price by the estimated number of patients gives you estimated annual peak sales. The biotech company won’t necessarily recieve all of this sales revenue. Many biotech firms-especially the smaller ones with little capital-do not have sales and marketing divisions capable of selling high volumes of drugs. They often license promising drugs to bigger pharmaceutical companies, which help pay for development and become responsible for making sales. In return the biotech receives [a] royalty on future sales.

McClure then explains that costs must be estimated as well as risks, and then the drug’s expected ten year free cash flows must be discounted to determine their present value. Finally, McClure writes:

Once you have gone through all of the steps outlined above to calculate the discounted cash flow for each of the biotech firm’s drugs, you simply need to add them all up to get a total value for the firm’s drug portfolio.