Licensing

Historically, the big pharmaceutical companies (Big Pharma) have sought to feed their marketing machines by manufacturing blockbuster drugs—chemical-based, one-type-fits-all products that treat chronic conditions such as heart disease or arthritis. This approach has yielded recurring revenue streams from large patient populations. In contrast, biotechnology companies typically have created protein-based drugs,or biologics, to treat acute or niche conditions and diseases. With few exceptions (such as the biotech giant Amgen), biotech companies have foregone doing the marketing and sales of their drugs themselves, and have, instead, relied on others to perform their marketing and sales functions.

Sometimes Big Pharma's blockbuster drugs have been accompanied by blockbuster risks. A one-type-fits-all approach may be hazardous, in that a single drug taken by many users may inevitably result in harmful side effects in some patients. These side effects can adversely affect not only the physical health of the patients but the economic health of the manufacturer, as well. For example, although Merck's drug Vioxx brought great relief to many, some patients experienced heart attacks and strokes. As a result, Merck must now contend with 600 lawsuits and settlements that some speculate could reach $20 billion — a figure equal to nearly one year's revenue for the company.¹ If that figure seems unimaginable, consider that as of December 31, 2004, Wyeth had paid and reserved a total of $21.1 billion to settle litigation over the FenPhen diet drug it introduced in the 1990s, a drug which also caused heart problems in some patients.²

In the future, Big Pharma may migrate from one-type-fits-all drugs to more personalized medications. As a result of the personalized nature of these therapeutics, side effects may be reduced and efficacy may be increased. Biotech companies, because they are accustomed to providing personalized niche therapeutics, will become increasingly important as alliance partners for the big pharmaceutical firms. A move from blockbuster drugs to more personalized medicines and niche therapeutics will require reexamination of the Big Pharma business model, as well as a reexamination of the business arrangements between Big Pharma and biotech companies.

Potential Drawbacks of Licensing and Development Deals

Today most business arrangements between Big Pharma and biotech companies are royalty and milestone-based licensing and development deals. There are, however, some potential drawbacks to that configuration for both Big Pharma and the biotech companies.

Drawbacks for Big Pharma

For Big Pharma, as the demand for new drugs increases, there is a substantial risk of overpayment for these drugs. The end value of a developed and commercialized drug may, in hindsight, be less valuable to a Big Pharma firm than aggregate milestone payments made to a biotech company and the continuing overhang of future royalty payments against future revenues. In addition, if a large pharmaceutical company shoulders development costs on its own, the risks of product efficacy, safety, and regulatory approval are borne inordinately by that company. Finally, after a new drug is launched, it may not perform in the marketplace as projected, or its manufacturing or marketing costs may be higher than anticipated.

Drawbacks for Biotech Companies

For a biotech company involved in a royalty and milestone-based licensing and development arrangement with a large pharmaceutical manufacturer, an important portion of the economic value chain is substantially absent. The biotech company can be relegated to its historical role of being a research and development company, receiving only royalties or sales milestone payments, while the pharmaceutical firm reaps large and ongoing revenues from the commercialization of the developed product. The biotech company in such an arrangement remains essentially an intellectual property (IP) platform company. In addition, venture capital and public markets place a higher valuation on companies that also participate in profits from commercialization. For these reasons, a biotech company would do well to pursue an arrangement in which it receives profits and not just royalties or sales milestone payments. An example of such a biotech company is Amgen, which has a large, active sales force to sell its products.

A Prototypical Deal

To better understand royalty and milestone-based licensing and development deals for drug development and commercialization, let's examine a prototypical example to illustrate a template commonly used today between biotech and Big Pharma companies.

In June 2003, GlaxoSmithKline signed a royalty and milestone-based licensing and development agreement with biotech company Pozen to develop and commercialize migraine therapeutics, combining triptans and NSAIDs under the brand name Trexima.³ The drugs to be developed were potentially very profitable because of the large market for migraine therapy. Migraines are a chronic affliction that may start in the teen years and extend into adulthood, and 28 million Americans suffer from migraine headaches.⁴

The agreement between GlaxoSmithKline and Pozen was a late-stage deal, signed during Phase II clinical trials that were showing a 50 percent improvement for sustained pain relief by the new drug over available treatments for migraines. By coming in at the late stage of drug development, Glaxo mitigated its risk of product performance and approval. Under the agreement, Pozen was responsible for drug development and associated costs, but Glaxo paid Pozen an upfront fee and an initial milestone payment that together totaled $25 million. Pozen can earn up to $55 million in additional development milestone payments if certain benchmarks are achieved in development and in regulatory submissions and approvals. Glaxo, meanwhile, has the exclusive right to sell the developed products in the US. Once the products move from development to commercialization, Pozen can earn up to $80 million in sales milestones payments if sales thresholds are met. In addition, Glaxo will pay Pozen an undisclosed royalty on sales.³

Alternative Approach: Cost and Profit Sharing

Let's look at an alternative approach, one in which the value exchanged between the parties is more directly related to drug development costs and the level of commercial success: cost sharing and profit sharing.

When the biotech firm Alnylam Pharmaceutical was founded in 2002, it was the first company to pursue the development of therapeutics using RNA interference (RNAi) to silence disease-causing genes that produce proteins that play harmful roles in disease. Alnylam's areas of research include age-related macular degeneration, respiratory syncytial virus (RSV), spinal cord injury, Parkinson's disease, and cystic fibrosis.⁵

In June 2004, Merck and Alnylam entered into a collaboration and license agreement to develop and commercialize RNAi therapeutics for ophthalmic diseases, in particular age-related macular degeneration, a condition that leads to severe deterioration of vision and may ultimately cause blindness.⁶ As was true for the Glaxo-Pozen medication mentioned above, there was a potentially large market for the drugs to be developed by Merck and Alnylam. The National Eye Institute estimates that more than 1.6 million Americans over 60 suffer from advanced age-related macular degeneration.⁷

The agreement between Merck and Alnylam was signed at the drug discovery stage before any clinical trials had commenced. The foundation for the agreement was cost sharing and profit sharing; except as noted below, costs and profits were to be split 50/50. As a result, the parties' interests were more closely aligned and intertwined throughout the process than was true in the Glaxo-Pozen arrangement. Merck was the lead commercialization party, responsible for developing the budget and preparing the commercialization plan; however, Alnylam would retain co-promotion rights in the US to sell commercialized products along with Merck.

Although the Merck-Alnylam deal revolves around cost sharing and profit sharing, Alnylam will still receive milestone payments (at seemingly lower levels than are customary) as development benchmarks are achieved. This may be because Alnylam does not have the monetary means of a larger biotech company to fully fund its share of costs without some subsidization. While the parties have chosen not to credit these milestone payments as advances against Alnylam's right to receive future profit payments, such a provision could be utilized by others in other deals.

One attractive feature of such a cost-and-profit-sharing arrangement is its flexibility to accommodate change. The deal contains safety valves and exceptions to the full cost-and-profit-sharing arrangement. These are: (1) a party may elect to reduce the level of shared expenses from 50/50, provided that the profit-sharing level is correspondingly reduced, (2) a party may opt out of development costs for a specific product; if the other party continues in the development and commercialization of that product at its own expense, the continuing party will pay a royalty to the other party, rather than share costs and profits, with respect to that product, and (3) Merck will pay Alnylam royalties on product sold outside of the US.⁶

Conclusion

While many royalty and milestone-based licensing and development deals lead to successful drug development and commercialization, the question always remains whether the risks and rewards allocated on the front end of the deal achieve a balanced exchange of value on the back end — one that best serves the interests of both parties and the long-term health of the $500 billion pharmaceutical industry. Now may be the time for biotech companies to grab a larger slice of the economic pie by participating in profits derived from the commercialization of their intellectual property and developed products. Now, too, may be the time for Big Pharma to encourage biotech companies to underwrite a portion of product development costs.

Of course, the ability of biotech companies to share costs and profits requires that they have the capital to invest in product development. The present environment is very encouraging and bodes well for a wider adoption of cost sharing and profit sharing deals between large pharmaceutical firms and biotech companies. According to a healthcare report by Jefferies & Co., private biotech companies raised nearly $4.2 billion in 2004, and public biotech companies raised $4.1 billion, up almost 50 percent in each category over 2003.¹

In the absence of the pharmaceutical industry more widely embracing "cost and profit sharing deals" over "royalty and milestone deals" in drug development and commercialization, some in Big Pharma may conclude that industry demand for new products has driven or will drive "royalty and milestone deals" too high. If that occurs, more large pharmaceutical firms may seek to purchase entire biotech companies. M

REFERENCES

1. Abrams, SL. Searching for a Cure. Investment Dealers Digest. 2005 March 28.

2. Wyeth Reports Results for the 2004 Fourth Quarter and Full Year [press release]. Madison, NJ: Wyeth. 2005 January 31. Available at: http://www.wyeth.com/news/Pressed_and_Released/pr01_31_2005_06_43_17.asp

3. Product Development and Commercialization Agreement, June 11, 2003, between Pozen, Inc and Glaxo Group Ltd (dba GlaxoSmithKline). Filed with Securities and Exchange Commission. 2003 August 12, as Exhibit 10.1 to Pozen, Inc's Form 10-Q.

4. Headache News, 2000, July. Nearly 28 million Americans have migraine, and one in four US households have at least one migraine sufferer. American Council for Headache Education Website. Available at: http://www.achenet.org/news/older/072000.php.

5. Therapeutic programs. Alnylam Pharmaceuticals Website.Available at http://www.alnylam.com/therapeutic-programs/programs.asp.

6. Collaboration and License Agreement, 2004 June 29, between Merck & Co, Inc and Alnylam Pharmaceuticals, Inc. Filed with the Securities and Exchange Commission, 2004 August 12, as Exhibit 10.1 to Alnylam's Form 10-Q.

7. More Americans Facing Blindness Than Ever Before [press release]. Washington, DC: National Institutes of Health — National Eye Institute; 2002 March 20. Available at: http://www.nei.nih.gov/news/pressreleases/032002.asp.

Jeff Stewart, J.D., is president of the Georgia Nanotechnology Alliance, Inc. and a partner who chairs the Mergers & Acquisitions / Strategic Alliances Practice and co-chairs the Nano-Biotechnology Practice at Arnall Golden Gregory LLP, 171 17th Street NW, Suite 2100, Atlanta, Georgia 30363, 404.873.8670, jeff.stewart@agg.com