Supersize my Pipeline

In the mid-1990s, Scangos heard about a new company called Exelixis, which sparked his interest for its gutsy approach to disease research. Scientists co-founded the company on the idea that molecular pathways were conserved well throughout the animal kingdom, and studying diseases in model systems could be more fruitful than extrapolating pathways from human genetic data. "In those days it was controversial," especially without the comparative genetic data to prove how related certain pathways were. The functional approach appealed to him; Scangos applied for the job of CEO and was hired.

Focusing on animal models during the genomics boom wasn't the only unconventional decision Exelixis has made. Unlike most biotechs that have one or a handful of products, the company decided to invest in a large drug pipeline, becoming a mini-pharmaceutical company. The plan was to eke out enough investment interest from bigger players—another unpopular decision at the time, but one Scangos believes will help it weather the current economic storm. "We've had a different philosophy from most biotech companies throughout our existence," Scagnos says. Indeed, by the end of 2008, it had established a cash reserve and major deal with Bristol-Myers Squibb at a time when very little corporate money was changing hands.

Creative capital

In its early days, the company's business model focused on finding promising drug targets and selling the intellectual property to pharma companies—"a high risk, low reward model," says Scangos. With the cash the company earned from intellectual property, it reinvested in the upfront research.

In 1999, Exelixis decided to acquire a new small company, Metaxen. "It's unusual for a company that's not profitable and has no drugs on the market to acquire another company," says Morningstar senior analyst Karen Andersen. But the plan, says Scangos, was to turn Exelixis into a mini-pharmaceutical company. "That was the only way to make money." When Scangos started, the company had 20 employees; after it acquired Metaxen, that number reached 180. Today, roughly 685 people work at Exelixis.

The first step in building a drug discovery company is to create a library of small-molecule compounds. Exelixis bought 800,000 compounds after its acquisition of Metaxen, but it wanted much more. Companies typically use an algorithm to determine the right number of compounds to provide a good screen—big enough to be thorough, but not so big that the company wastes time and money over-screening. That algorithm would have put a company like Exelixis at up to 200,000 compounds. Instead, Exelixis built a library of approximately 4.5 million—larger than that of most large pharmaceutical companies. It was a gamble, but Scangos and the president of R&D, Michael Morrissey, say their oversized library lets them find compounds that require less fine-tuning for clinical use later in the process.

"They really are building a new-aged pharma company," says Eric Schmidt, a financial analyst who covers Exelixis for Cowen and Company. They don't "have any history or entrenched ideas about drug development."

In 2004, the company made another big pharma-type move: It hired a financial strategist, an expense that is usually reserved for much larger companies. Frank Karbe, a former investment banker at Goldman Sachs & Co., brought with him new ideas on how to make the entire company more money-savvy. Not only did he start providing the company with financial forecasting, he helped train upper and middle managers to think with fiscal strategy in mind. "If you decide to do something, it has to make business sense," Karbe says he told them.

Facing failure

By 2008, Exelixis had one of the fullest pipelines in the small-molecule industry, with 14 compounds in clinical development, says Schmidt. It had built up collaborations and partnerships with companies such as GlaxoSmithKline, Bristol-Myers Squibb (BMS), Merck, Genentech, Sankyo, and others. But in taking on the development of so many drugs, they had taken a big risk. "A lot of other companies make an effort to whittle down their pipeline," says Andersen. "If you're a small biotech, you're conscious of how quickly you're burning through cash." The general rule is: the bigger the pipeline, the faster the burn-through.

While it may have been risky, that large pipeline is what will help Exelixis survive the current financial upheaval, says Scangos. The key difference today is that biotechs "can't go sell stock as a way of raising money," because stock prices are so low, says Scangos. "We have a number of assets that can attract high value partnerships—even in these times." The company reported earning $29.6 million in its fourth quarter, up from $29.3 million for the same period the year before.

But they still hadn't gotten a single drug on the market, and their stock began to plummet from highs of $12/share in 2006 and 2007 to a low of $2.40 in November 2008. "Investors got scared that they would run out of cash," says Andersen. As a sign that the company was taking more care in its cash spending, it laid off 78 people—or 10% of its workforce—in November. Still, some analysts see the company's cash spending as a problem. In her most recent analysis, Andersen wrote of Scangos's $1.3 million 2007 salary and bonuses, "we think his salary and option grants are excessive for an unprofitable biotech."

"We told Wall Street we'd end [2008] with $200 million," says Scangos. It may have seemed like overconfidence, but Exelixis had a few tricks up its sleeve. First, the company had a few drug candidates that looked unusually promising. One compound, XL184, was an inhibitor that hit MET, RET and VegF—three cancer pathways at once. "We saw tumor shrinkage in a lot of types of cancers," and a control of disease in 84% of patients with medullary thyroid cancer, says Scangos.

Also, in June 2008, before banks began clamping down on loans, Karbe had finalized a deal with Deerfield Management, a healthcare investment organization, to keep a fund of $150 million on reserve for the company whenever it might need it. That cash reserve (for which the company paid 2.25% interest, in addition to warrants) allowed the company to negotiate a deal for the drug "from a strong financial position," says Karbe. "This deal [with Deerfield] is looking better and better every day."

"It's innovative, it's in place. Whether it's good for the stockholder," says Schmidt, "the jury is still out on that one." (At the time this article went to press in mid-March, Exelixis stock was at $4.50.)

At the last minute, December 12th to be exact, Exelixis entered into a $240 million dollar agreement to co-develop and co-market two of its cancer drugs with BMS, including XL184. "That was an extraordinary deal at this point," says Schmidt. Of the 14 drugs in its pipeline, nine have been the subject of partnerships. The BMS deal helped the company end the year with $284 million in cash or cash equivalents.

While investors would be happier to see the company bring at least one drug to market, both Schmidt and Andersen have given the company a high or "outperform" rating. The thing that differentiates Exelixis from other companies, Schmidt says, is "their track record, the number and the [financial] quality of the deals."