E&Y dissects biotech's toughest challenges

If you just focus on the $25 billion raised by biotech companies last year, you'd assume that the industry had fully recovered from the market crunch that hit in 2008 and 2009. But then Ernst & Young's Glen Giovannetti did a little extra figuring, subtracting the debt financings by mature companies that had helped swell that figure. That left a painful 20 percent decline in what the big accounting firm calls "innovation capital."

Considering that 2010 was a full year removed from the global economic crisis, Giovannetti tells FierceBiotech, you're left with a picture of yet another "challenging" year for the biotech industry.

In their annual global biotech report, Beyond Borders, E&Y highlighted a series of trends that will make life harder for up-and-coming biotechs. Upfront payments are down, says Giovannetti. In the absence of a strong demand for IPOs, more established developers tend to have the upper hand in deal talks. And last year saw a continued slip in buyouts, adding further pressure as biotechs continued to either hold the line of R&D spending or tightened their belts a little more.

Not that there wasn't a silver lining or two to report.

Back in 2009, Ernst & Young declared, the industry had finally tipped the scales on profitability. And as more drugs gained approval and biotechs continued to mature, that trend improved in 2010.

Development pacts are running strong, even if the upfronts that pharma pays out aren't as sweet.

Pharma companies "definitely want to do more risk sharing," says the high-profile analyst, which is a gentle way of saying that they aren't keen about forking over huge sums when the contracts are signed. But they also don't want to push so hard on the terms that they jeopardize their partner's' chances of success. Nevertheless, overall, it's still a buyer's market, he adds, particularly if you factor in the tough environment for IPOs that currently exists.

"Certainly if there were more funding options (biotech companies) would be in a stronger position to negotiate better deal terms," says Giovannetti. "It decreased on the M&A side for the third straight year, which continues to be surprising to me. All the signs indicate that there would be more M&A."

In an interview with Reuters, Giovannetti went on to define the sweet spot for biotech buyouts as the $1 billion to $5 billion range. "There are not many targets above $10 billion," Giovannetti said. "I think there is an interesting space between $10 and $20 billion, which is a pretty sizeable deal, but it's different than $20 billion and above."

"The number of deals are down on the alliance side," he tells FierceBiotech, though that may not be a long-term trend. Deals are still the lifeblood of the industry. Pharma needs them," but with consolidation among the pharmas and plenty of "portfolio rationalization" underway in the pipeline, there are fewer buyers in the market for any given program.

Will there be a turnaround in '11?

"That motivation is there," he says, "but it still feels like the pace is not significantly higher than what we saw last year. Most of the money is going to a concentrated set of the companies, it's not being spread around like peanut butter."

That's all part of the 80/20 rule at work right now in biotech. The top tier of companies, the 20%, which are better established have access to capital and are generally operating on stable ground. The majority, though, have to convince investors that their company can handle the heavy risk of developing new drugs as well as identifying new drugs that payers will pay for.

"Investors are trying to assess risk. You have scientific risk" and developers try to distinguish their products. "Will regulators see that and approve a drug based on the data," he asks, or will there be more trials and more cost, along with the further uncertainty of reimbursement risk.

"A product needs to be differentiated" if a developer expects to get the reimbursement needed to compensate them for the risk they endured. "Understand what is in your portfolio. Can you explain to potential partners, with as much clarity as possible, how the product fits in?" asks Giovannetti. That competency will differentiate the 20%; "the haves from have nots."

There's another long-term trend that disturbs the analyst. Back in 2009 when E&Y crunched the numbers on the biotech industry, two thirds of the companies had scaled back on R&D spending. In 2010, the split was close to 50-50, but even then there was a marginal-1%-decline in R&D spending.

"It's not as pronounced as last year," he adds, but it's clear that developers are still placing bets on leading assets and reducing spending on earlier-stage products as they wait on partners.

Bottom line: "Capital remains scarce. There's a premium on operating as efficiently as possible with the capital available. Everyone is looking for more efficiency." - John Carroll (twitter | email)