How Can You Make Money in Biotech If Only One In Ten Companies Turns A Profit?
Originally published 9/16/2016
It’s that time of year when we can finally sit down to enjoy the long awaited knock down, drag out battle of some national heavyweights. No, I’m not talking about Clinton vs. Trump; that fight may be too painful to watch. I’m talking about the upcoming clash between two battle-tested opponents. This fight pits lobbyists representing “Usurious” insurance companies against those for “Greedy” biotech and pharma firms. In the battle of Goliath vs. Goliath, the razor arrows have been sharpened and the lines in the sand have already been drawn.
“Rather than actually engaging around a tangible solution, it’s not surprising that the pharmaceutical industry would choose to launch another PR campaign that will do little to address the root of the problem - which is their own egregious pricing,” said Clare Krusing, spokesperson for the insurers’ trade group America’s Health Insurance Plans. This was in response to Jim Greenwood, the CEO of industry trade group BIO, who threw down the gauntlet when he said, “We’re not going to let our industry be tarnished by insurance practices that burden patients with unaffordable costs.” He followed this up with a call for supporters to emphasize that developing drugs is long, hard, and expensive work: “We will remind elected officials that, despite the rhetoric on drug prices, just 1 out of 10 biotech companies actually turns a profit.” That’s a pretty bold statement, with no evidence presented to back up this claim.
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Drug industry representatives, like most politicians, often skate around the truth. False claims that I’ve recently challenged include the one that drug costs, as a percentage of health care costs, haven’t changed in decades, as well as the astounding assertion that only two out of ten drugs actually earns back its development costs. This time, however, I am inclined to believe the number being cited (and I suspect it could actually be much worse than that). What’s missing here, of course, is context. Why would astute investors put money into an industry where the vast majority of companies don’t actually turn a profit? Are they hoping to just get lucky? After all, even 1 in 10 odds are a whole lot better than the astronomical ones available in the mega-millions lottery jackpot.
Most lay people reading these numbers have no understanding of the economics of this industry. What industry representatives aren’t explaining is that a very high percentage of biotech companies aren’t trying to turn a profit. That’s not their business model. These aren’t restaurants, laundromats, or hair salons where the principals stake their money and risk going broke if enough customers don’t come through the door and spend some money. Biotech companies like income, but it’s not their raison d’etre. Their primary focus is on generating enough data that they can spin into a compelling story that will cause some Big Pharma/Biotech company to swallow them whole. Their business model is to get acquired. That’s when the angel investors, venture capitalists, company founders, and (to a much lesser extent) the rank and file make the big money. Having their stock go public can be a nice outcome, but it’s not required. The “old fashioned” notion (dating back to the 1990s and earlier) of becoming a vertically integrated biopharmaceutical company has, for the most part, gone the way of the Intel 80486 processor chip and the Apple Newton.
Part of the challenge in analyzing this “only one in ten” assertion is defining exactly what a biotech company is. These come in many flavors, and the business models associated with them can be quite different. The most well known companies are the drug developers, but there are also medical device firms, diagnostic companies, and businesses that supply products and services to biotech companies that enable them to achieve success. Think DNA sequencing companies, for example. Financially, the drug development companies have the longest and most expensive path towards achieving financial success. Developing these other products is significantly less expensive, and as a result can allow the companies that develop them to become profitable in a much shorter timeframe.
The greater Seattle area, where I live, has about 115 biotech drug developers (see my list here). How many of them are actually making money? Companies that haven’t gone public (which is the vast majority of them) are pretty much resigned to losing money. Sure, they’ll have the occasional quarter where they sign some tie-up with Big Pharma that pumps in millions of dollars. The next quarter, however, they will be back to hemorrhaging cash. For the purposes of this analysis, I focused on publicly traded companies that are actually based here, not merely satellite sites of industry behemoths (we have branches of Bristol-Myers Squibb, Celgene, Genzyme, Gilead, and Novo Nordisk). I’ve divided up the publicly traded companies into two groups: those with no marketed products, and those that are selling drugs.
Financials for Eight Publicly Traded Biotechs with No Marketed Products
Acucela loses money. It actually was profitable in 2011, 2012, and 2013 due to revenues from collaborations. However, it lost nearly $27M in 2015. Its stock is publicly traded in Japan.
Alder Biopharmaceuticals recorded no revenues in 2015, and lost nearly $86M last year.
Atossa Genetics works on breast cancer and is trying to develop microcatheters as well as drugs. It lost nearly $13M in 2015.
Cascadian Therapeutics (formerly Oncothyreon) lost nearly $33M in 2015.
Immune Design Corp. lost $39M in 2015.
Juno loses money big time, but is also has a much bigger piggy bank than any other area biotech. Despite (or maybe because of) the large amount of money in the company vault, it still lost $239M in 2015.
OncoGenex lost $16.8M in 2015. The company is in serious trouble with the recent phase III clinical failure of it’s experimental drug custirsen for castration-resistant prostate cancer. This follows the clinical failure of another drug, apatorsen, last year.
PhaseRx only began trading on NASDAQ in the second quarter of 2016. Its reported financial results for the first half of 2016 show it lost $13M during that period.
Are companies that actually sell drugs profitable? Let’s take a look:
The largest (in terms of headcount) local biotech is Seattle Genetics. It rakes in a lot of money from its pioneering drug Adcetris (which earned $226M last year). However, it still manages to lose money, with a net loss in 2015 of $120.5M.
CTI Biotherapeutics lost $116M on revenues of $16.1M in 2015, and sales of it's only product, Pixuri, accounted for just $3.5M of that income. CTI Biopharma has a net cumulative loss over its 24 years in business of just over $2B (no, that’s not a typo, it really is billions).
Omeros is Washington states fastest-growing public company. According to the Puget Sound Business Journal, the company’s revenues increased by nearly 745 percent between 2013 and 2015. However, even with this revenue growth, the company is still losing money ($12.6M in the second quarter of 2016). Revenues from its sole product Omidria were only $10M in this same time period, which was 3 times as much as the company earned during the same quarter last year. It lost a total of $75M in 2015.
Finally, there’s Aptevo Therapeutics, a recent spin out from Emergent Biosolutions, which purchased local biotech Trubion in Oct. 2010. It actually sells four revenue-generating products (acquired from the parent company; these were not developed by Trubion) and it began trading as its own stock on August 1, 2016. As it is essentially a new company, no financial data are yet available. According to Stacey Jurchison (Senior Director, Investor Relations & Corporate Communications), these drugs generated about $28M in revenue in 2015. However, this income will only partially offset R&D and other expenses, and the company is expecting to lose money this year.
My conclusion: Despite the large number of companies, there appear to be no profitable drug developing biotechs in Seattle.
How about non-drug developing biotechs? Let’s take a look at their financials:
BioLife Solutions, a company that supplies materials to biotechs that enable them to successfully ship biological samples, hit record revenues this past quarter (even if they were only $2M). However, it lost $4.2M in 2015.
Halosource, a water purification company with a biocidal process, lost $11.5M in 2015.
IsoRay, which makes brachytherapy products, lost about $3.7M in 2015.
NanoString Technologies, which makes tools used by life science companies, had nearly $63M in revenue in 2015, but still lost $45.6M for the year.
Finally, Adaptive Biotechologies, a Fortune magazine Unicorn, works in the immunosequencing space, and is said to be valued at $1B. However, it’s privately held and financials are not available. The company has raised more than $400M from investors, sells a diagnostic kit for cancer patients, but is likely not profitable.
Second conclusion: there may be no profitable biotechs in Seattle, period. The “one in ten” profitable companies must be based somewhere else.
Biotech is a very tough business (and that’s putting aside the science/medicine component, which can be even more difficult than the business part of the equation). Let’s do some back of the envelope calculations based on some widely circulated numbers. On average, it reportedly takes $2.6B and 10 to 12 years to bring a drug to market. Now, of that $2.6B number, nearly half of that figure is the “time value of money”, not actual spending. So let’s cut the number in half. This means a biotech would need to spend about $108M per year to achieve a single drug launch. If it doesn’t bring in that much money, it’ll be running at a financial loss. That’s a lot of income for a startup with no drugs to sell and not a lot of other ways to bring in money. And having drugs to sell, as illustrated above, is no panacea for profitability. Non-profitable biotechs can employ lots of people in high paying jobs; their failure to turn a profit is just one small aspect of the overall landscape.
Here’s the key concept: biotech companies can be highly profitable to invest in, even if they never turn a profit and lose tens of millions of dollars a year. Here are some recent examples:
Daiichi Sankyo bought Plexxkion for up to $935M to get its melanoma drug Zelboraf.
Amgen bought Onyx for $10.4B to gain the rights to its multiple myeloma drug Kyprolis.
Abbvie’s bought Pharmacyclics for $21B in 2015 to take control of its cancer drug Imbruvica.
These deals that worked out well for the investors in the acquired company, as well as the acquirer. However, not all deals go that way:
GSK bought Sirtis for $720M in 2008, then shut it down almost five years later with no drugs brought to market.
Bristol-Myers Squibb bought Inhibitex for $2.5B in 2012, then wrote off $1.8B of this investment in less than a year. It abandoned the hepatitis C medicine it had spent so much to acquire due to safety concerns that arose during clinical trials.
BioMarin paid $680M to gain the rights to the Duchenne muscular dystrophy treatment drisapersen from Prosensa, but the investment ended up being a complete write off. Despite this disastrous investment, BioMarin has a market cap in the neighborhood of $15B, pulled in $890M last year from sales of its rare disease drugs, and its stock price has climbed 460 percent in the past ten years. It also made Forbes 2016 list of the world’s ten most innovative companies. Even with these stellar numbers, the company lost $172M in 2015. It anticipates that it will finally book a profit from operations next year.
One more example where the fate of the acquisition is looking shaky, but the final word is not in yet: AbbVie’s $9.8B acquisition (for $5.8B in cash, with another $4B in milestone payments) of Stemcentrx. Early clinical data on its lead drug, Rova-T, have been less than impressive.
It’s these types of acquisitions that many biotech investors live for, not drug sale revenues at some distant point in the future. BioMarin also illustrates that investing in established biotechs with big sales, but that are still losing money, can be financially rewarding. Good biotech investments mirror Sam Spade’s description of the Maltese Falcon; they are “the stuff that dreams are made of.”
Expect more defensive posturing from BIO and PhRMA during the election season as they look for sympathy from voters. The drug lobby will continue its well-orchestrated campaign highlighting how drugs save lives, and how they provide tremendous “value” to American health care consumers. Spending by lobbyists on behalf of Big Pharma/Big Bio this fall is expected to dwarf the money (reportedly some $20M) health insurance companies spent in 1993-1994 to defeat Hillary Clinton’s healthcare reform efforts with their “Harry and Louise” ad campaign. Numbers being tossed around have been pegged at hundreds of millions of dollars. Look forward to health insurance industry lobbyists also putting big bucks behind a fall campaign to convince us that they aren’t the bad guys in the continuing contretemps over drug pricing.
No matter who wins the election, expect the loser in this “Goliath vs. Goliath” battle to be consumers. The list prices of all brand name medicines sold in the US were raised more than 14 percent in 2015. However, a report by IMS health revealed that net drug prices (after rebates) increased by only 2.8 percent in 2015. This raises two interesting questions: why do drug companies raise prices so much if they are just going to give back most of that money via rebates? This is likely tied in to the financial shenanigans used by companies (like Mylan) to drive executive compensation. And doesn’t this increase the burden on the poor and uninsured, who are the least able to take advantage of these rebates? If you’re betting in this election, put your money on the fact that drug prices are likely to climb by a similar amount next year. The more things change, the more they stay the same.
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