Optimistic Report Predicts Rebound For Biotechnology

In 1993, the Food and Drug Administration (FDA) declined to approve Malvern, Pa.-based Centocor Inc.'s lead compound, Centoxin, sending the company into a near-fatal financial tailspin. Today, after a drastic retrenching, Centocor has recovered to be listed as one of the top 10 biotechnology firms by market valuation in the Ernst and Young report "Biotech '95: Reform, Restruc- ture, Renewal." A new angioplasty therapeutic called ReoPro will likely receive FDA approval later this year, and another product called Panorex is proving significantly effective against colorectal cancer in Phase III clinical trials. Looking back, company officials say, Centocor wagered too heavily on the fully integrated pharmaceutical company, or FIPCO, strategy. Rather than form alliances with other companies to provide costly business capacities it did not possess, it moved instead to develop these in-house. "As it was preparing to launch Centoxin worldwide, the company decided to go with the FIPCO strategy," says Tim Cost, senior vice president of investor relations and strategic operations at Centocor. "It hired a full sales force, put in information-management systems to support them, built up the finance organization, created regional sales offices around the world--all without a product to sell yet, but getting itself ready. It got that infrastructure in place, took the employment levels up to 1,600 people, and took the negative cash flow up to in excess of $50 million a quarter. And then Centoxin did not get approved." Centocor's stock collapsed from $60 to $5, Cost says, and managers began a complete overhaul of the company in an effort to save it from bankruptcy. The burn rate was trimmed from $50 million a quarter to less than $50 million a year. The work force was scaled back from 1,600 to 500--but managers worked hard to protect the company's basic researchers. "We dismantled the entire sales and marketing organization," Cost says. "What we did was go back to what the company was founded on in 1979, which is that it's a discovery and development company that has good partnering strategies. While the Centoxin bombs were going off, we preserved the R&D and scientific core around ReoPro and pursued it. Now, we're coming to the end of this year with this drug that we are hopeful will be approved." Cost says that pursuing the FIPCO approach was a "very hopeful" strategy that nearly cost the company its existence. "You have to crawl, then you have to walk, and then you can run," Cost says. "The company found its way back to its original roots, which is discovery and development. That's what we do well--we find innovative products." Franklin Hoke The biotechnology industry's prospects for the coming year are strong, despite a harsh financing climate and continuing difficulties in shepherding drugs through clinical trials, according to a new report. The report's two authors, from the accounting and management-consulting firm of Ernst and Young, San Francisco, acknowledge that novel alliances and other creative business strategies will be required for companies to survive. But, sounding a note of optimism notably missing from other recent assessments, the two analysts predict the industry will prosper in 1995, largely because, in their view, biotechnology researchers are proving to be the most reliable source of innovative pharmacological agents. Biotech company executives also expect the industry to grow as a whole. At the same time, however, they say that something close to a shakeout in their industry is imminent. They assert that only a fraction of the current 1,300-plus biotechnology companies will persist as independent firms past the next few years. Many will be partially or totally merged into other biotechs or much-larger pharmaceutical corporations, or will be forced to limit their goals and cut their work forces substantially in order to survive. Some, they say, will fail entirely. The biotech officials do agree with the analysts that basic scientists are the core resource of the industry and will be somewhat protected in the expected restructuring. They add that the most promising ideas from academia will continue to be able to create a place for themselves within biotech, either through venture-capital-supported startups or licensing deals with existing companies. "Conventional wisdom is that we're going to take the 1,300 companies and shrink them down very dramatically because the capital markets are going to cause that to happen, and that we're going to go down to a list of 100 or 200 companies," says G. Stephen Burrill, one of the report's authors and a senior adviser for international life sciences and high-technology industry services at Ernst and Young. "We don't believe that's going to happen." "The biotechnology industry raised more capital in the last 12 months than in the 12 months previous, more capital by a substantial margin," contends Kenneth B. Lee, Jr., the second report author and Ernst and Young's national director of life sciences industry services. "The industry is doing quite well--albeit that there are some clinical [trials] difficulties. Public company product sales were $5.2 billion, which is a 20 percent increase in product sales over the previous year," in which sales totaled $4.3 billion. In the report, "Biotech '95: Reform, Restructure, Renewal," released in September, the analysts also note that discovery and development of new technologies continue to be well supported by the industry. They point to a 27 percent increase in spending for research and development by public companies from 1993 to 1994, from $3 billion to $3.8 billion, and predict further increases in the coming year. This rise in R&D spending, however, outpaced revenue growth significantly in 1994, leading to a 40 percent increase in net losses for public companies, from $1.5 billion to $2.1 billion. "This tremendous increase in the investment in R&D continues to drive overall industry losses," Lee says. By comparing companies' cash on hand to their spending rates, Lee and Burrill present a so-called survival index in the report--the number of months that companies have to spend themselves out of cash. For the median company, the average survival index dropped from 34 months in 1993 to 25 months this year. Still, the analysts say the industry is undervalued in the financial markets, and they expect investors to gain greater confidence in biotechnology this year. They base their assessment on a number of positive indicators, including the fact that more than 300 biotechnology products are now in some stage of clinical trials, with a number of them nearing Food and Drug Administration (FDA) approval. The biotechnology executives also see a relatively bright future for the industry overall, based largely on the continuing high productivity of industry researchers, reflected in the number of product candidates. They are less sanguine than the analysts, however, about how many firms will be able to negotiate the path to success. "I am personally extremely bullish on the future of biotechnology, but I am not saying 1,300 to 1,400 companies will be around as independent companies in five years," says Gabriel Schmergel, president and chief executive officer of Genetics Institute in Cambridge, Mass. "The industry is overpopulated. There are a lot of interesting and lucrative areas to work on, but there isn't room for 1,400 companies." Most observers of biotechnology agree that, however many companies may survive in the next few years, the industry is currently undergoing a major reorganization in response to financial pressures of different kinds. A key concept in this process is a business tactic-- referred to variously as the "virtual company" or "virtual integration" strategy--being adopted by an increasing number of biotechnology companies. In the virtual company, one or more of the stages in discovering, developing, producing, marketing, and distributing a drug may be performed by different firms. Each partner in this process may work for a fee or for a stake in the overall value of the product or its sponsoring company, or combinations of these. Complex hybrid businesses result as companies invest in each other's strengths. New types of industries are being created as the concept evolves. Clinical research organizations (CROs), for example, specialize in managing clinical trials for biotech and pharmaceutical companies (F. Hoke, The Scientist, Sept. 19, 1994, page 1). The virtual company approach is contrasted with the concept of a fully integrated pharmaceutical company, or FIPCO, approach. A company pursuing the FIPCO strategy seeks to own and control all aspects of the process of creating and selling a drug. According to Schmergel, the biotechnology companies that will succeed in the next few years fall at one end or the other of the business spectrum defined by these two strategies. At one end are perhaps a relative handful of companies with products on the market and sufficient capital in the bank to successfully pursue a FIPCO approach, although most of them also selectively engage other companies for distribution or other kinds of help. His own Genetics Institute is among these, Schmergel observes--although a measure of that financial security stems from the 60 percent acquisition in 1992 of the company by American Home Products, the pharmaceutical giant based in New York City. "At the other end of the spectrum, you have the high-quality, small research boutiques, usually concentrating on only one, very often specialized, technology platform," Schmergel says. "Of these companies, the ones that are, in fact, occupying a leading-edge position with a particular project or in a particular technology niche and that resist the temptation to add unnecessary infrastructure--to do that, they have to, at the appropriate time, arrange partnerships to aid them with clinical development or marketing--will be able to provide an excellent return for the shareholders." Between these extremes are companies that have built up an infrastructure that may prove to be a liability in the current economic environment, according to Schmergel. "It's in the middle that you get squeezed most brutally," he says. "These are companies that had a strategy to be broad-based, built up the infrastructure, and then one thing or another went wrong--whether it's a patent issue, a delay of a clinical trial, or a negative FDA reaction." A classic case study of the risk such a company runs is Centocor Inc., headquartered in Malvern, Pa. The widely publicized failure of the company's Centoxin product to gain FDA approval in 1993 nearly destroyed Centocor. The company saved itself through a combination of sharp spending cuts and a return to the firm's core scientific strengths. Today, with several products doing well in clinical trials or nearing FDA approval, Centocor is once again among the leaders in its industry (see accompanying story). Some biotechnology companies with existing infrastructure investments that may not be fully occupied in manufacturing their own products increasingly are turning to the virtual-company approach as a way to maximize their assets. "Companies that may have already invested in infrastructure, in the bricks and mortar of a manufacturing plant and so on, are going to be looking for more active collaborations in the industry," says David L. Urdal, president of Immunex Manufacturing Corp., a division of Immunex Corp. in Seattle. Urdal notes that, in addition to the more commonly discussed difficulties for biotechnology companies in getting a product approved by FDA--such as demonstrating a compound's safety and efficacy through successful clinical trials--a company must also have an agency-licensed manufacturing facility ready to produce the drug. "In our industry, that means you have to make that investment before you know you have a product," Urdal says. "While we have products in our pipeline that are in clinical development, from the manufacturing and process development point of view, we have excess capacity that we could potentially sell to younger companies that could then hold off making a larger investment for a longer period of time." Such arrangements would, in turn, also help Immunex defray operating costs, Urdal says. Like other industry observers, Urdal predicts that the next several years of financial constraint may be difficult ones for some biotechnology companies. He notes, however, that the pharmaceutical industry is in the process of scaling back its research and development efforts and sees possible benefits to biotechnology in this situation. "The large pharmaceutical companies are cutting back, investing less in research," Urdal says. "That may be a boon to biotechnology, because many of these companies will be looking to biotechnology as the source of greater innovation than, perhaps, they have represented within their own groups." Biotechnology executives also say that, despite the difficult financing market, good ideas remain at a premium and can find support. "The interesting thing is that new startups are still being financed by venture capital--although less than before," says Schmergel. "Venture capitalists have become a lot more discriminating, but the best ideas still get funded." Tim Cost, senior vice president of investor relations and strategic operations at Centocor, notes that ReoPro, a drug that his company hopes will be approved before the end of the year, was originally developed by Barry Coller, a professor of medicine at Mount Sinai Medical Center in New York City. "We didn't discover that," Cost says. "Coller's a brilliant guy with a brilliant idea, and we'll be out looking for more. The value of [scientists'] ideas, their innovation, their ability to create technology, is going to be as highly valued as ever, if not more so."

Optimistic Report Predicts Rebound For Biotechnology

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Franklin Hoke

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October 1994

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