Has The Downturn Changed Dealmaking?

By Suzanne Elvidge

While the biotech, pharmaceutical, and healthcare industries have traditionally appeared immune to the vagaries of global economics, 2008 and 2009 have seen a downturn in the global financial markets across all industries, and many biopharma companies are reporting a crisis in funding. According to Mark Edwards of Deloitte Recap LLC in December 2008, biotech funding was at its lowest level since 2002. The U.S. IPO window closed in November 2007 with the Nanosphere IPO. There were 35 IPOs in 2007, and none at all in the first half of 2008, a position that hadn’t changed by May 2009, according to Reuters.

The Impact On Dealmaking
The financial downturn is expected to have an impact on dealmaking, with companies looking to fill the funding gaps that would previously have been provided by IPOs or VC funding. Avance, a life sciences financial solutions provider, conducted a survey, which included biotech and pharma executives, analysts, consultants, and investors, among others. According to the survey, biotech and pharma executives expect the financial crisis to lead to more deals, while consultants and investors expect fewer deals. All groups expect smaller deal volumes and more back-loaded deals, where charges are levied toward the end of the deal term.
This article looks at the impacts of the recession, which, according to the U.S.-based NBER (National Bureau of Economic Research), began in December 2007, marking the end of an economic expansion that began in November 2001. It analyzes the changes in biopharma dealmaking between 2007 and 2008, with reference to dealmaking data from earlier years.

Looking At The Data
Before analysis of the data, it is worth considering a number of points. Databases can only capture data from published deals, so any data analyses will have certain limitations. The data analysis focuses on the period 2007 to 2008. At the time of writing, we were only 18 months into the downturn, so there is only a limited amount of longitudinal data to assess — we can only draw firm conclusions over the next few years, and perhaps only retrospectively.

The databases used are the PharmaVentures’ PharmaDeals database (www.pharmadeals.net) for the overall deals numbers and Deloitte Recap LLC’s database (www.rDNA.com) for the biotech outlicensing deals.

Overall Deal Numbers
According to data from the PharmaVentures’ PharmaDeals database, global deals have fallen from 3,342 in 2004 to 2,637 in 2008, apart from a slight increase in 2007. Deals remained at a similar level between 2006 and 2007 and then fell 11% between 2007 and 2008.

The number of earlier stage deals (discovery stage through to IND [investigational new drug] and phase I to phase II) rose from 2007 to 2008, and the number of later stage deals remained at a similar level or fell.

There may be a number of reasons behind this. Launched drugs, especially many of the blockbuster drugs, are maturing and moving off patent, where they become susceptible to generic competition. Many of the large pharma companies are seeing their pipelines of drugs in development (which should be replacing these offpatent drugs) drying up. Because of the attrition that is part of the drug development process, there are only a finite number of late-stage drugs available, so the companies are moving to license earlier-stage products to fill the pipelines. This is not caused by the financial downturn, but rather by the lack of investment in basic R&D.

More closely related to the economic downturn, biotech companies especially might be looking to make deals earlier than they might have done prior to the economic downturn. This may be either to offload early-stage projects to reduce the cash-burn required for development or to replace the sources of funding that used to be filled by IPOs, VCs, and other investors, in order to direct money into other core projects or simply to keep afloat. Large pharma companies are still cash-rich and can take advantage of the buyers’ market.

“This is a two-way relationship,” says Taskin Ahmed, editor, PharmaDeals Review. “One cannot live without the other, because biotech companies are often focused on innovation but need funding to develop their early-stage research projects, and large pharma need innovative products to fill their pipelines.”

The rate of dealmaking for three key pharmaceutical markets — neoplasms, circulatory system disorders, and digestive system disorders — remained steady between 2004 and 2007, but all three showed a drop between 2007 and 2008. Neoplasms deals fell by 8%, circulatory system disorders deals fell by 32%, and digestive system disorders fell by 70%.

This follows the overall pattern of falls in numbers of deals. Deal making in cancer, although dropping slightly, remains strong. This is an area still with unmet medical needs, recognized by large pharma, so biotechs with demonstrable superior assets can still command a high premium. However, the fall in digestive disorders deals is very dramatic. This may reflect that the digestive disorders market is more mature, with fewer unmet needs and many low-cost generic drugs available, so not attractive to companies looking to boost their early stage pipelines.

Focus On Biotech Out-Licensing Deals
Biotech companies are generally smaller and younger than pharmaceutical companies. Traditionally, they are more likely to license products to larger partners after preclinical and clinical development, rather than continuing on through to registration, launch, and distribution through a sales force. While this is still true of many biotech companies, as the industry has matured and grown, these deals are just as (or actually, as the data shows, even more) likely to be with other biotech companies than with pharmaceutical companies.

Looking at data from the Deloitte Recap LLC deals database, the overall number of biotech outlicensing deals fell steadily from 1,044 in 2006 to 962 in 2007 and 739 in 2008, a 23% fall between 2007 and 2008. This reflects the overall fall in deals seen in the PharmaDeals database.

Despite the fall in number of deals in the prerecession period, the total value of deals rose from around $80 billion in 2006 to over $110 billion in 2007, continuing an upward trend. As the financial downturn began to bite in 2008, the total value fell back down to around $80 billion in 2008.

Breaking down the data into deals between pharmaceutical companies and biotech companies (pharma-biotech), and deals between two biotech companies (biotech-biotech), the number of pharma-biotech deals fell steadily from 390 in 2006 to 331 in 2007 and 289 in 2008 (a 13% fall between 2007 and 2008). The number of biotech-biotech deals fell from 654 in 2006 and 631 in 2007 to 450 in 2008 (a 29% fall between 2007 and 2008). Looking at the proportions of pharma-biotech and biotech-biotech deals, despite the steady decline in numbers from 2006 to 2008, overall, biotech-biotech deals outnumber pharma-biotech deals by almost two to one. In the early stages (lead molecule, preclinical, and phase I), this is more pronounced, with around twice as many biotech-biotech deals than pharma-biotech deals.

The total value of pharma-biotech deals continued to increase from 2006 to 2007, peaking at almost $35 billion in 2007. It then fell to around $31 billion in 2008. That same year, the total value of biotech-biotech deals reached $12 billion.

Looking at statistical measures of the total deal values, for each year, the median (middle of the distribution) value was significantly lower than the mean, suggesting that large deal sizes are skewing the data. The median deal size rose from $58 million in 2006 to $92 million in 2007 and fell 26% to $68 million in 2008, while the mean deal size continued to increase, from $153.1 million in 2006, to $227.8 million in 2007 and $230.5 million in 2008. Because outliers can skew means, this suggests that while one or more significantly large deals may have pushed the mean higher in 2008, more of the deals were of a smaller size, pulling the median figure lower. This reflects the higher proportion of lower value biotech-biotech deals.

The increased proportion of biotech-biotech deals compared with pharma-biotech deals between 2007 and 2008 reflects the collaborative nature of biotech companies in comparison with pharma companies, suggesting that, even though absolute figures have dropped, biotech companies are more focused on dealmaking than pharma companies are as a response to the economic crisis. The deal values are lower, but this may mean they are looking to nonfinancial or less financially focused deals, including deals involving exchanges of expertise.

“For biotechs, protecting cash flow is key to survival, which means licensing terms have become more crucial than ever before,” says Fintan Walton, CEO of PharmaVentures.

“In light of recent financial difficulties, some biotech companies have found alternate methods of financing,” says Christian Dokomajilar, senior consultant at Deloitte Recap LLC. “Arrangements based on future royalty streams, for example, have allowed some biotech companies to secure funding, albeit expensive, and increased valuations to survive the years ahead.”

Breaking deal terms down to types of payments, between 2007 and 2008, mean up-front, R&D, and milestone payments all rose. Of the parameters given, only equity payments fell, reflecting the expectation of respondents to the Avance survey that there is less equity investment available.

Looking at deals by stage, between 2007 and 2008, in early-stage deals, mean up-front, R&D, and equity payments all fell but milestone payments rose significantly, from around $320 million to around $420 million. This was the biggest increase in all payment types and all deal-signing stages. Mid-stage deals saw an increase in mean up-front, milestone, and equity payments, and late-stage deals increased in up-front, R&D, and milestone. There was an increase in total (mean) value at each stage.

Early-stage deals are often more focused on milestone payments than later-stage deals, and the move away from up-front and equity payments may be a response to the financial downturn. By derisking the drug development process, companies only pay for what actually happens, rather than what might happen. The mean and median values of up-front payments have increased between 2006 and 2008, with an increase of 46% median and 43% mean between 2007 and 2008, perhaps reflecting companies seeking these types of deals to source funding, rather than looking to VCs or to flotations.

Biotech-Biotech Deals Increase
The overall global number of deals has fallen, as well as the total value of deals. This appears to have had a greater impact on U.S. deals than European deals, perhaps because of differential effects of the downturn in different regions. Though this is comparing data from two different databases, which can be problematic, it appears that the economic impact was greater on biotech outlicensing deals, with a fall in the number of deals of 23% between 2007 and 2008, compared with the overall fall in the number of deals of 12%.

Within biotech dealmaking, despite the slowdown, there has been an increase in proportion of biotech-biotech deals compared with pharma-biotech deals and an increase in early-stage deals compared with late-stage deals, as the industry looks to fill its diminished pipelines, and smaller companies look to fill the gaps left by the loss of IPO and VC funding. The increase in milestone payments shows an awareness of risk, and the increased value of up-front deals suggests an industry that is looking within itself for funding.

Deals valuations, though they are made available on a specific date, are the culmination of negotiations over a number of months or years, so the true economic impact of the downturn may not be seen until well into the next decade.

The economic downturn has reduced the amount of venture capital funding available to small start-up companies. Dealmaking, though it has been affected by the downturn, is still strong and may prove to be the new source of funding for the biopharma industry. From one perspective, there will be companies with truly innovative technologies that simply cannot survive long enough to make financially vital deals. However, the alternative viewpoint is that, by removing the old reliance on VCs, only the leanest and strongest companies will survive, and so this economic situation may strengthen the industry by making it more self-reliant.