What's Next? (The answer may surprise you.)
By Cliff Mintz
G. Steven Burrill has devoted his entire career to helping life sciences companies start up operations and sustain their growth. In 1994, he started Burrill & Company — a venture capital (VC), private equity, merchant banking, and media life sciences firm. The Burrill family of life sciences venture capital funds now manages more than $950 million in assets and has played a pivotal role in helping establish the next generation of American biotechnology companies.
A prolific writer and highly sought after biotechnology speaker, analyst, and financial advisor (both nationally and internationally), Burrill is one of the early pioneers and shepherds of the American life sciences industry. Last year, he was awarded the Alan Cranston Living Legend Award and the BayBio Pantheon DNA lifetime achievement award for biotechnology leadership. He is the author of a series of annual biotechnology reports which are a must-read for life sciences executives and scientists alike. His latest and most intriguing report is entitled Biotech 2009-Life Sciences: Navigating the Sea Change.
Burrill contends there are three things driving the sea change that is occurring in today’s life sciences industry: 1) restructuring of the financial markets, 2) changes in regulatory and healthcare reimbursement policies, and 3) major advances in science and medicine. I had an opportunity to chat with Burrill about his views on the impact of the financial crisis, personalized medicine, and healthcare reform on the future of the life sciences industry.
The financial meltdown has affected almost all sectors of the American economy. What impact has it had on the U.S. life sciences industry?
Burrill: For the past 40 years or so, we have had a reasonably good equity market with available and relatively cheap access to capital. Although there were significant economic downturns in the life sciences sector, first in 1987 and then again in 2002 (which the industry weathered), by and large the financial rules guiding equity markets hadn’t changed much during the past 20 years. That is to say if public companies built value, financial markets appreciated that, stock prices went up, and investors were happy. However, the current economic meltdown has caused a dramatic and permanent restructuring of the financial markets and has changed the way we do business. This has resulted in a lack of access and availability of investment capital to many life sciences companies that desperately need capital infusions to maintain operations.
Today, investment banks and other sell-side financial institutions have little or no interest in investing in companies that have a market valuation of under $1 billion — they simply can’t make money by servicing the needs of smaller companies. Similarly, hedge funds and institutional investors that make up the buy side of the business (if they still exist) have limited liquidity and also have little or no interest in investing in companies with a market capitalization under $1 billion. If you think about the implications of this for a minute, you quickly realize that most public and private U.S. biotech companies are under a billion dollars in market capitalization. This means that there has been, and will continue to be, a permanent withdrawal from the capital markets by many of the players that made the biotechnology industry possible in the first place. So, dramatic restructuring needs to go on within the capital markets for there to be a legitimate, bona fide financial market for the life sciences industry in the future. Further, what is being penalized and suffering most from the current restructuring of the capital markets is innovation — the lifeblood of the American life sciences industry. Thus, I believe the U.S. life sciences industry landscape will change dramatically in the next five years and look much different in the future than it does today. There will likely be fewer life sciences companies because of consolidation through mergers and acquisitions and a lack of sufficient amounts of venture capital.
While the financial crisis has taken a large toll on emerging and smaller companies, the large pharmaceutical, biotechnology (over $1B in market cap), and medical device companies have fared slightly better. Having said that, it isn’t time to write the obituaries for the biotechnology, biomedical, and innovation industries. The rule set has changed and companies will have to do things quite differently than they have in the past. But in the end, a stronger industry will emerge; we’ll learn how to play with the changed rule set and build different kinds of new companies.
Another thing to consider is the availability of investment capital. Investment bankers like to talk about capital markets in terms of being opened or closed. By and large, investment capital was always available — what changes dramatically is the cost of capital and whether or not companies are willing to accept it. For example, in the past it may have been possible to do a $20 million financing for 10%-50% of a company’s equity. Today, you might be able to get the same deal done for 60%-90% of a company. The power today is clearly on the side of the people with capital and is moving away from the entrepreneur, where it has resided for the past 30 to 40 years.
If you look at big pharma market cap trends during the past five years, there has been a dramatic loss of confidence and value in the big pharma industry. This is likely to continue as we move forward. On the other hand, if you look at the innovation index or smaller, high-growth biotechnology and medical devices companies, there has been substantial growth during the same period (with the exception of a six-month window in late 2008). This suggests there is still a substantial upside and growth potential for smaller, innovative life sciences companies.
You run a venture firm that invests almost exclusively in life sciences companies. What existing or emerging technologies would you recommend for investment?
Burrill: Historically, the life sciences industry has relied on revenue from high-value-high-margin therapeutics (Rx) and lower-value-lower-margin medical devices and diagnostics (Dx). However, with healthcare reform going forward and the changes in science that allow us to move closer to a personalized, predictive, and preventative medicine world, there is going to be a reversal in the Rx/Dx value proposition — that is, I believe Dx rather than Rx will drive future profitability in the life sciences sector.
In the future, the Rx business will be transformed from a high-value-high-margin into a high-volume-low-margin proposition, whereas the Dx side of the business will change from a high-volume-low-margin to a high-value-high-margin opportunity. If you think about this in software and hardware terms, the value of the drugs (hardware) is going to come down, whereas the value of the software (devices and diagnostics) is going to increase. The reason for this is that for regulatory approval and reimbursement/payment, payors are only going to pay for drugs and treatments that work. Consequently, healthcare professionals will be forced to become more reliant on diagnostic tests before they prescribe certain medications or treatments. This trend is moving us closer to the era of personalized medicine and away from the one-size-fits-all therapeutic model that has historically dominated the pharmaceutical and biotechnology industries. In the near future we are going to see a dramatic shift — which has already begun — toward a value proposition that favors the Dx side of the life sciences business.
Do you think that personalized medicine is going to dominate and transform the life sciences industry?
Burrill: Yes, and here’s why. Profit margins on the Rx side of the business are going to continue to shrink as the industry becomes more and more “genericized” — about 1/3 of pharma revenues will be lost to generic competition in the next few years. Margins will also continue to decline as we rely more on diagnostic tests that can indicate which medicines will work for different patients. The same diagnostic technology — much of it coming from the genomics revolution — is also being used in drug development for target identification, lead generation, and patient selection in clinical trials. This should help reduce drug discovery and development costs and allow life sciences companies to cope with lower expected margins on their products.
Over the past decade or so, medicine has been moving away from broad clinical definitions and description of disease states (e.g. breast cancer, lung cancer, prostate cancer) to a world of mutation-specific medicine where the mutations that cause these diseases are identified and permit physicians to determine which drugs or treatments can be used most effectively to treat patients.
How will advances in diagnostics technology affect the quality and delivery of American healthcare?
Burrill: We are moving very rapidly toward personalized medicine. The driver of this change isn’t just technology, but the payor community, which includes single payor-government healthcare systems around the world, insurance companies, and employers. These payors can no longer continue to pay the costs associated with a one-size-fits-all healthcare model where many approved drugs are ineffective. It has been estimated that about 55% of the drugs consumed in America don’t work for the patients that they were prescribed for. Also, 80% of all approved cancer therapies fail to provide positive outcomes for many cancer patients.
If you take a closer look at this, you quickly realize that the cost of healthcare can be dramatically reduced by using diagnostic and personalized medicine technology to correctly choose the safest and most effective treatment options for different patients. If this was the norm and not the exception, I suspect most healthcare systems and third-party payors would be willing to pay for most drugs, even if they are expensive. Nevertheless, a personalized medicine approach to healthcare would tend to lower costs by removing massive amounts of waste and inefficiency from the system. Moreover, when you think about our current healthcare system, we tend to treat diseases late, when people are gravely ill and reversibility is low. Molecular diagnostics are going to allow us to treat diseases much earlier (when reversibility is high), which will guarantee better patient outcomes and help to reduce healthcare costs. That said, I believe the use of modern diagnostic technologies will allow us to begin to move away from a late-entrance, sickness care system model to an early-intervention, wellness care one.
Does the U.S. healthcare system need to be reformed?
Burrill: We spend $2.2 trillion each year on healthcare in this country; that’s a lot of money! By 2015, healthcare costs are estimated to exceed $4 trillion. If you go to the American people and ask them how much of that $2 trillion is spent on drugs, they will tell you 60% of all healthcare costs is drug-related. In reality, only about 10% of total healthcare expenditures is spent on prescription drugs. The common perception of most Americans is that the drug industry is the cause of the massive healthcare problems in the United States. However, what is mainly responsible for skyrocketing healthcare costs is an aging American population and the advances in medicine and technology. Death has become controllable and optional. This has caused health costs at the end of life to explode. Not surprisingly, approximately 80% of all healthcare expenditures have been found to occur during the last six months of life. Put simply, American healthcare costs continue to rise because we as a society are currently incapable of rationing medical care.
Where healthcare reform ultimately needs to get to — and the Obama administration knows it — is a better system for rationing and disbursing healthcare. Right now, insurance companies and the payor community are largely responsible for healthcare rationing. However, increasingly, the payor community is becoming the government. And, therefore, it will ultimately be up to the U.S. government (through Medicare/Medicaid run by CMS) to determine what treatments it will pay for. It is important to point out, though, that there is enormous pressure and perverse incentives in the current system that might prevent healthcare reform from occurring. For example, if you attempt to transform a $2.2 trillion so-called “sickness care system” into a $2.2 trillion wellness care one, there will be a group of people who benefit and another that will be marginalized. Therefore, it is unlikely the current entrenched healthcare system can be easily replaced by an emergent wellness system with different market dynamics, without a lot of pain and suffering for many of the existing players.
What will a reformed U.S. healthcare system look like?
Burrill: The healthcare system in this country is moving toward a more patient-centric model that will focus on preventative and wellness care rather than sickness care. One of the cornerstones of the new system will be the digitization and centralization of medical records. This will help to cut costs, provide greater access to medical information, and speed healthcare delivery.
One of the major challenges that must be overcome to ensure healthcare reform can take place is managing a belief held by many Americans that medical care is a right and guaranteed at any cost. Like it or not, with Medicare and Medicaid increasingly paying for most of healthcare, we are rapidly moving to a single payor system in the United States. I believe that the United States, like most of the rest of the word, is moving toward a two-tiered health system — one managed by the government and another run by private insurance companies. Regardless of what the new healthcare system looks like, the federal government will be forced to adopt a rationed healthcare system model that relies on the best available scientific and medical evidence to make decisions about drugs that provide the best patient outcomes.
What will the pharmaceutical industry look like 10 years from now?
Burrill: For the past 50 years, pharmaceutical companies were built using a standard, vertically integrated business model that called for early-stage drug discovery, development, manufacturing, marketing, sales, and distribution. Today, because of pricing pressures, more stringent regulatory guidelines, and increased drug development and manufacturing costs, many pharma companies are moving away from the vertically integrated business model to a horizontal one where many drug development activities are outsourced to third-party vendors.
Interestingly, while many of the larger companies have already outsourced some of their R&D and manufacturing operations, they are increasing their marketing and distribution capabilities. Further, many of the executives who have recently been chosen to run these companies haven’t come up through the R&D side of the business but have been recruited from companies outside of the life sciences industry. Most of these executives have a firm understanding of consumer-driven marketing and consumer products but are deficient in their understanding of the drug development process.
The lack of innovation at pharmaceutical companies is hurting the sector. These days, innovation is increasingly coming from outside of a company (through licensing deals and acquisitions) and not from internal drug discovery and development activities. That said, companies that once relied on internal drug discovery and innovation to create new products are slowly being transformed into consumer product-driven companies that excel at marketing, sales, and distribution of their products.
There is definitely a sea change taking place, and the life sciences industry may never be the same!