How Small Biotechs Should Protect Their Interests During Mergers and Acquisitions

Strategic alliances and partnering deals were a big biotech news story during 2006—with deal values setting an all time record of over $23 billion for the year. The strategic partnering trend continues during 2007 and in this column we present some frequently asked questions and answers about the merger and acquisition (M&A) activity in the life sciences sector.

Q: Which have been the more significant deals in the year 2007?

A: The Merck/Sirna deal continues to be an especially impressive one to consider, not only because of its size ($1.1 billion), but also because of the generous premium Merck paid to purchase early-stage, platform technology—a premium of 102%. Until recently, big pharma has been shopping for late-stage products with robust clinical validation. In this case, Merck paid over $1 billion to obtain—and to prevent others from accessing—Sirna's RNA interference (RNAi)/gene silencing technology that Merck perceived as a strategic long-term opportunity. Sirna had a significant intellectual property (IP) portfolio in RNAi-based therapeutics that complemented Merck's internal research capabilities and this clearly was a major factor in Merck's willingness to acquire the company at such a large premium.

Sergio Garcia

Another interesting development is big biotech moving aggressively to acquire companies and technologies that they perceive as critical to future shareholder value. Amgen, for example, has acquired five companies in the past three years. The M&A deal was Amgen's acquisition of Avidia for $380 million. Avidia was an early-stage company with a portfolio of human therapeutic proteins known as avimer proteins. Avidia's patented technology was regarded as very attractive because it had potential application in a wide range of disease areas, including inflammation, oncology, and neurology.

And we're seeing mid-cap biotech companies becoming good targets for acquisition. Back in 2006, Amgen acquired Abgenix for $2.2 billion and Genentech acquired Tanox last year for $919 million. This year, of course, AstraZeneca's $15.6-billion acquisition of MedImmune has received a lot of attention, given that MedImmune at that time was the sixth largest biotech company. Although MedImmune is a successful company, it had struggled recently to meet investor expectations. This transaction demonstrates how big pharma continues to see M&A as a quick path toward building out a broader pipeline in biologics.

Q: What's driving the volume of strategic transactions and M&A deals?

A: Obviously, the tough IPO market has been a primary driver of biotech's activity in M&A. Many of the companies that have chosen the IPO path are struggling to maintain their offering price; and we're seeing more and more companies trading well below it. Additionally, the rising cost to bring a new drug to market is forcing venture capital (VC) investors to seek alternatives to IPOs, such as M&A, so they can recover their investments in early-stage biotech companies.

Another interesting development is the leverage emerging biotech companies have when dealing with larger biopharmaceutical or pharmaceutical companies. Big pharma has a lot of cash right now, but drug development pipelines continue to look anemic. What is more, pharmaceutical companies have a significant number of blockbuster drugs facing patent expiration. Pharmaceutical companies need innovative technologies and products, which is precisely what emerging biotech companies can provide. This shifts the relationship between the companies and allows the biotech company to negotiate a more attractive deal for itself.

Q: Why are mergers and acquisitions an increasingly attractive exit strategy for companies?

A: It's a good question because it raises the issue of why management at biotech companies appear to be so willing to sell their companies at an early stage. Historically, management teams at early-stage biotech companies were perceived as individuals who built companies toward late-stage development and ultimately commercialization, not people who are interested in selling off companies in M&A transactions. Today, however, biotech executives need to be prepared to assess all strategic opportunities available to the company, including an early M&A exit. With appropriate deal terms, an M&A transaction may in many cases serve as the optimal vehicle to ensure that promising drugs or technologies have a real chance to be fully developed, approved, and brought to market.

Q: How can an early-stage company best preserve its M&A options?

A: One of the most important things a company can do to preserve its M&A options is to preserve its intellectual property (IP) rights. In any M&A transaction, the acquiring company will seek to engage in detailed IP due diligence. Diligence will involve, at minimum, a review of the company's IP protection, its patent prosecution strategy, patent ownership, and freedom to operate issues (i.e., ensuring the product or technology doesn't infringe on the rights of a third party). Any transfer of rights to or from third parties would also be closely investigated, so early-stage companies need to assess whether a potential licensing deal might unduly encumber its lead programs or the value of its IP. Of course, every deal executed by an emerging biotech company potentially can encumber future transactions, including an M&A deal. Licensing early is a tradeoff between bringing in cash (in the form of upfront fees or milestone payments) and giving up rights that future buyers might deem important.

Q: How should small biotech companies approach collaboration deals with large pharma?

A: First, the smaller biotech company should build collaboration into the negotiations early if it believes it must retain control of its product's development and to gain shared control of the entire research program. For example, in the 2006 collaboration between InterMune and Roche, InterMune controlled the initial research development for its hepatitis C virus (HCV) lead candidate, ITMN-191, by exclusively conducting the Phase 1 clinical trial. After completion of Phase 1 trials, the HCV research program would transition into a co-development plan, subject to guidance and approval by the governance committees established by Roche and InterMune.

Second, the smaller biotech company may seek to leverage its innovative technologies and know-how to push for balanced sharing of responsibilities for co-developing and co-promoting the product. The larger company can provide most of the needed development infrastructure and clinical development expertise and the smaller company can learn much about these activities; the responsiblities and governance aspects of the relationship are shared.

The Roche–InterMune deal also illustrates that smaller companies are receiving an equal share of profits in the co-development territory, even if they fund less than half of the development costs. For ITMN-191, Roche agreed to fund 67% of the global development costs, but both companies will share profits on a 50–50 basis in the US.

Q: What rights should a small biotech seek to retain in co-development and co-promotion deals?

A: One trend worth noting is for smaller biotech companies to retain the right to opt-out of co-development or co-commercialization of the product. For instance, InterMune retained the one-time right to opt-out of either co-development or co-promotion of ITMN-191 in its agreement with Roche. Typically, if a company chooses to opt-out of the co-development of the product, it can retain its co-promotion option and receive royalties. InterMune's additional opt-out rights are evidence of the smaller biotech's growing leverage in collaboration agreements with large pharma.

Q: How can a company best navigate the complexities of all the tactical options—strategic partnering, collaborations, licensing, another financing round and M&A?

A: Clearly understanding the financial risks and benefits of all options is the first step. However, other factors must be considered—how much control is the company willing to cede? What decision-making responsibilities are most important to the company and the long-term success of the drug or technology? What areas of expertise does the company have and where is it lacking?

Today's deal-making environment offers many options for life sciences companies. Companies need to fully understand the options—and the risks and rewards—related to strategic alliances and M&A so they can make the best decisions to preserve long-term enterprise value and also to enhance the probability of success.

Sergio Garcia is co chair of the life sciences group, and partner, corporate and intellectual property group, at Fenwick & West LLP, San Francisco, CA, 415.875.2366, sgarcia@fenwick.com