UK Biotech: time for bold and affirmative action

pharmafile | January 22, 2009 | Feature | Research and Development, Sales and Marketing |  BTG, Chris Collins, Christopher Evans, Neuropharm, Plethora, UK, biotech, pharma, strategy 

Biotech leaders in the UK say the cash-stricken industry has reached ‘breaking point’, and have made an unprecedented plea for state funding. Twenty-two prominent figures from the sector say a major cash injection is the only hope for its survival, and have asked Gordon Brown and business secretary Lord Mandelson for £500 million.

Investor Sir Christopher Evans and Nomura Code Securities chief executive Chris Collins are leading the group, and argue in the following article that government-industry partnerships would encourage private investors and secure UK biotech’s future.

The UK has been a leading light in the biotech field for the past 20 years, second only to the USA. However, the size and value of the UK industry has been falling disappointingly over the last five years.

But its scale is still considerable and if this data is added to those of the larger pharmaceutical industry, the combination makes up one of the UK’s largest industrial sectors.

Success stories in UK biotech

Although the UK has been criticised for its sparse commercialisation of intellectual property and its inability to grow biotech companies to scale, there have been significant successes over the last ten years such as Celltech, Chiroscience, Powderject and Neutec Pharma.

Speciality pharma company Shire is a prime example of a highly profitable global company, spearheaded in the UK. Merging with seven companies over a ten-year period, Shire has shown rapid expansion, growing in value to over £4.4bn before moving out of the UK to Dublin in 2008.

Smaller niche-companies such as Vectura, Ark Therapeutics, Renovo, Abcam and Neuropharm are considered to have strong growth potential. A number of important strategic mergers are also in the offing, with UK-based BTG and Protherics recently announcing their intention to merge to create one of the largest biopharma organisations in the UK for some time.

The latest progress report presented to the Bioindustry Association in 2006 by consultants Critical I suggests the UK market has successfully consolidated a number of the smaller, privately held and loss-making companies and is now benefiting from a more mature industry compared with other European countries. But none of these consolidations have raised sufficient capital to build a new, healthier fast growth business.

However, the report also stresses the significant barriers facing companies wishing to prosper in the UK. Many of the most successful and best-funded organisations have to turn to the US for final-stage funding whilst others have simply sold themselves to non-UK corporates. This is evidenced by the recent buy outs of PowderMed to Pfizer for $200m, Cambridge-based Acambis by Sanofi Pasteur for £276m, UK-based cancer specialist Piramed by Roche of Switzerland for $185m this year and Zeneus Pharma for $360m to Cephalon USA.

Many consider a sell-out to foreign buyers, particularly in the US, to be a pragmatic and successful exit strategy, providing timely dividends to investors. However, it is unlikely to result in profits being recycled back into UK development projects and may also lead to job losses and stimulate a migration of talent as well as intellectual property out of the UK. For example, all of the British managers of Zeneus remained in the USA to later form EUSA Pharma and did not return to Britain.

Additionally, developing economies are also channeling significant funding into their biotech industries, attracting UK expertise overseas. The Singapore government, for example, planned biotech funding of $8bn over five years.

How we’ve reached crisis point

Despite its world-leading science base, the UK biotech industry has been unable to capitalise on its scientific excellence or on the strength of London as a world leading financial capital.

There is a general consensus that the UK biotechnology industry is now sub-optimal and there are several reasons for this failure which have been described on many occasions in many reports. Some are being addressed while the single biggest issue – finance – is being ignored.

Of paramount importance is the development of a properly focused government led ‘action plan’ to help transform the beleaguered UK biotech sector with the help of strong financial and vocal support from government.

The state of the UK industry was underlined emphatically by the recent ‘wargame’ exercise carried out by the Bioscience Futures Forum. Two teams, one from the UK and one from the US, were challenged to create a virtual biotech enterprise of value £1bn or more, each working within the prevailing American and British commercial environments. The objective was to create full and fair value for their stakeholders. While the US succeeded in its aims to build such value, the UK team failed.

The war-game concluded with cross sector stakeholders voting overwhelmingly in support of the view that UK biotech faced a strategic threat due to major financing challenges at all levels.

Biotech industry structure

The basic structure and business model of the UK industry is seriously flawed and this became apparent as early as 2003 when the last serious financial drought took hold: The UK biotech never recovered from this but just limped on.

Many companies raised small sums of cash in 2003/04 only allowing them to conduct sub-optimal clinical trials and today we are seeing the poor results of this under investment.

The House of Commons Trade and Industry Select Committee Report on the UK Biotechnology Industry, 2002/2003 stated: “There is also the danger of making it too easy to start new firms. Germany would appear to be a good example of this. Not only have too many companies been formed for the private capital sector to sustain, companies have been formed that probably should not have been, with technology with little commercial viability and without the levels of necessary management and expertise in place”.

This early stage structure had been supported pre-2001 by easy access to large volumes of soft capital to create an unrealistic market. Too many companies which had poor management and fundamentals and unrealistic expectations of success were created and somehow sustained, for too long. Too much focus was put on early stage companies to the neglect of the maturing development stage businesses.

Of course there will always, and should always be early stage companies. Governments have traditionally focused funding at this start-up level believing the more companies created, the more chance of an eventual big British success. However, the UK is suffering desperately from a lack of more mature commercially focused companies creating genuine products and services that generate significant revenues.

Industry management and governance

“The perception among certain people is that biotechnology management is a lifestyle choice – you can get a very large salary, you are not delivering and you are failing on your business model”, Karl Keegan, head of Research (UK) global sector, and head of life sciences, Canaccord Adams.

Because biotech companies have been able to access small amounts of capital so freely, they have not, on a sufficiently regular basis, had to deal with the basic pressures faced by other commercial enterprises namely generating cash flow, making a return and reducing the payback period.

Top level, experienced management have largely shunned the sector as they can see insufficient cash is available in the UK sector to enable the best companies to do a proper job. There have been instances where UK management have managed to build sizeable companies including ones such as Powderject, Nutec, CAT, Zeneus, Domantis and Piramed. But they and their investors did not go on to take their companies to a higher level, opting instead for sale and exit to foreign organisations.

By contrast, their US counterparts show greater ambition, and the successful ones are characterised by having taken their own products to market. This success has undoubtedly been achieved by greater capital available to them in the US.

The UK industry has also suffered its mix of management, with too much emphasis on academia and research qualifications and too little on true commercial acumen and business experience.

This disappointing management profile has coloured the whole sector and those few good companies with experienced commercially focused managers have also been tarnished in the ensuing mess created by all the others. This has resulted in the sector becoming considerably less attractive to investors of any size.

Investors have also not been sufficiently rigorous or methodical in their investment approach. This has been compounded, post investment, by their inability or unwillingness to hold management teams to account on performance.

In the world of private company investing, syndication politics and a desire not to be diluted often weighs more heavily on investment decision-making than furthering the fundamentals of the business. The result is an imbalance in capital allocation such that large pools of capital are not available for good new companies, as original investors commit funds to their existing companies in order to protect the capital they have already invested. There just isn’t enough true venture capital available to do the job properly.

Professional advisers have also been overly subjective and optimistic. Over the past decade many companies have been floated on AIM which could not live up to their prospectus, and were in reality too immature to flourish unless given large volumes of capital – something that never seems to materialise here in the UK.

Market failure

The flow of capital has been diverse and largely indiscriminate and given life to a plethora of small sub-optimal, poorly managed businesses in the UK. The capital has come from a wide range of sources including venture capitalists and a cadre of others which are less aggressive and with less commercial bent such as government, grant-funding bodies and high net worth individuals.

In the UK, very large amounts of government capital have rightly gone to fund university-led research, but the evidence now suggests there have been precious few university spin-outs that have gone on to become substantial commercial enterprises in the UK: Renovo and Oxford BioMedica are amongst some of the better UK spin outs.

Nearly all of America’s most successful biotech companies have achieved their status using institutional capital raised primarily from the excellent quoted NASDAQ exchange.

In the UK the last eight years have been an unmitigated disaster, with pitiful amounts of cash raised on the AIM, with even the main market offering no chance of real product success and deliverables, and no liquidity on the stock markets for investors.

Traditionally, analysis of the UK biotechnology industry has concentrated on two pinch points:

1. The relatively poor availability of true venture capital when compared to the USA; and

2. The responsibility of government to provide increasing levels of cash in the form of R&D incentives

Both of these initiative sets have led to a concentration on boosting the supply side of the industry – i.e. the creation and sustainment of more and more small companies without the capability or cash to take products through clinical development in an internationally regulated environment.

What has been ignored almost entirely is the necessity to grow bigger, profitable businesses and to stimulate the demand side of the industry – i.e. the expansion of the customer base in the UK and therefore of revenues to these companies.

Although the method of calculation varies, a company’s value is always a function of its ability to generate future cash flows. An investor makes its decision to take a stake in a company based on its expectation of a return according to the value that attributes to its company’s share of future, profitable revenues in its market place – i.e. value.

The industry’s failure to generate revenues significantly in excess of its invested capital is one of the causes of its present parlous state.

That failure has led to the existence of two addressable issues – one that deals with the history of failure and the other that promises hope for the future:

1. Deal with the current inventory of sub-optimal businesses with little or no hope of creating incremental value; and

2. Deal with a sense of pathos resulting in little or no appetite by venture capitalists or City institutions to re-enter the sector leaving it devoid of that vital component of success: cash.

Both of the above issues are capable of being remedied. The question that now needs to be addressed in UK biotech as a matter of real urgency is: What measures can be devised and implemented immediately that will deliver the seismic change necessary for the industry to survive, improve and go on to fulfil its potential?

Biotech as part of medical sciences

The structure of Britain’s so-called biotech industry needs to change as do the business models and funding strategies.

Biotechnology itself desperately needs to be put into context, particularly in the UK where in truth biotech is really a segment, rather than a sector of a much larger industry, that of medical sciences.

Medical sciences is a broader term that more accurately reflects the true range of activities of companies in the UK biotech sector. It encompasses companies developing new diagnostics, medical devices, speciality pharmaceuticals, medical and healthcare services, surgical technology, aesthetics and wellness products and services. Biotech, of course, has an important role to play within the medical sciences sector where the focus is predominantly on development of new therapeutics.

There are very few comprehensive statistics on the metrics of the UK medical sciences sector, but it is almost certainly vastly bigger and more productive and profitable that just the biotech segment. But like the biotech segment, the whole medical sciences industry sector is now being starved of cash investment.

To achieve in Britain the sort of results being achieved in the USA, realistic business models need to be encouraged from the outset and with proper critical mass financing and support from private and public financiers alike.

Britain’s stock market now houses only a few very promising young companies today. For example, Neuropharm has a strong and experienced board and management team. It has a pipeline of low-risk orphan drug projects and the FDA appears to be positively encouraging and accelerating Neuropharm’s excellent lead formulation for Autism. Ark Therapeutics is on the verge of getting the first gene based medicine approval and both the EMEA and FDA are involved with progressing its breakthrough biologics in brain cancer and kidney failure.

These businesses could grow substantial sales and profits from their existing pipelines and, using their capital base, go and acquire more later stage projects (as did Shire in its earlier days) and build Britain more truly successful £1bn speciality pharma companies. But are British investors really prepared to do this? What Neuropharm and Ark don’t need is totally inadequate drip feed money.

All investors would then benefit from this. Examples of new and exciting private companies include EUSA Pharma and Decon Sciences and the likes of these will shun the British stock markets.

The sector-wide challenge is to find a way to enable the growth of the real gems to take place. Firstly, the very best companies will only formulate a bold, long term visionary business plan if they genuinely believe it could be funded and supported for several years without management’s time being chipped away every year through drip feed financings. So the solution here is multi-faceted and requires a number of things to happen in sequence if we are to unblock the road to £1bn success for British medical companies.

Solutions for seismic change

There is widespread consensus in the industry that fundamental and decisive steps need to be taken to effect the change necessary to secure Britain’s place of second to the USA in the biotech world rankings. Many accept that Britain has possibly lost this position already to Canada and, if things carry on as they are, will soon be overtaken by other European countries.

The numerous bodies, groups and working parties that have assessed and examined the industry over the last 10 years have made many recommendations which in broad terms should be supported and are not addressed again in this document.

However, the signatories to this document believe there is an urgent need for further unprecedented measures. These measures cannot be delivered by the industry alone in the UK and would require significant involvement from the government.

The government’s role is to act as an important ‘financial catalyst’ and to ensure substantial national focus during the next three to five years where the industry will encounter very serious difficulties.

Recommendations

The establishment, as a matter of urgency, of a national biomedical public-private partnership that will truly galvanise the UK biotechnology sector. This would herald a new and productive era, delivering world-class results in terms of medical developments and commercialisation, along with significant financial returns – all to the overall benefit of the UK.

These initiatives will offer an excellent opportunity for venture capitalists and financial institutions (including the big pharma players who are becoming increasingly dependent on the innovative products being developed by small biotech companies) to pull together with the UK Government and provide this critical mass of financing.

This partnership should focus primarily on three new initiatives:

1. The creation of a National BioMedical Consolidation Fund

2. The creation of a National Super Growth Biomedical Fund

3. The creation of a national co-ordinated initiative to stimulate revenues for UK medical science companies

National Biomedical Consolidation Fund

The National Biomedical Consolidation Fund would encourage the hundreds of small, cash poor, sub-optimal medical science companies in the UK to link up with one or more other sub-optimal businesses and pool their scientific assets, talent, customers, revenues, management resources and cash assets. Once they have agreed their new vision and business plan then they would present their case to the new fund.

The fund needs to be a minimum of £50m. No such fund exists, or has ever existed, anywhere in the UK or Europe. This quantity of capital will never naturally pool here in the UK from the British VC community unless it is led by a substantial government commitment with a national focus to build these new consolidated businesses here on British soil.

A fund of this magnitude could create 20-30 new, enlarged and high quality medical science ventures from the existing pool of hundreds of sub-optimal British companies.

The success of each new business that receives funding would become obvious within one year and the operations and commercial success would be of sufficient quantum to revitalise the flagging biomedical industry and stimulate more co-investment from venture and institutional sources of capital from around the world not just the UK.

Fund structure and management

The fund should be established as a public-private equal partnership. It is estimated the fund should need to be at least £500m in size with 50% public funding and 50% from the private venture capital community.

It is important to stress that public funding would not be grant funding but the government becoming a significant investor in the sector – it would receive a return on its investment pari passu with the private investors.

Companies applying for funding would need to articulate a clear and detailed vision for the proposed new and enlarged business, and why it would grow to become a successful and sustainable, international medical science business creating real wealth in the UK.

The new, consolidated plans would be presented in detail by the proposed management team to the fund managers and investment committee of the consolidation fund. These fund boards and committees would be made up of highly experienced industry experts, venture capital professionals, financial practitioners and representatives appointed by the government.

The fund board would carry out extensive due diligence and scientific, commercial and financial analysis of any proposal it feels could merit a serious investment. The size and essence of this fund would be such that the successful proposal could receive between £10m-£45m of capital to properly establish the new business venture.

The new consolidation proposals would, of course, be expected to demonstrate a clear path to successful organic growth as well as a continued roll up plan of more consolidations. In this way, each of the successful investments would rapidly increase its critical mass, its revenues, profits and product pipeline whilst consolidating British medical assets. Significant emphasis will be placed on ensuring only the very best chief executives and boards are put in place to steer each business towards its agreed goals.

To date, Britain has had limited success with consolidation within the industry. While in the past companies were reluctant to merge as they had sufficient cash resources to go it alone, today most companies have insufficient cash to even properly pay advisers fees, let alone survive a consolidation process.

They would stand little chance of obtaining fresh capital for their proposed enlarged new entity from a capital market that has completely turned its back on medical science in the UK.

The creation of such a substantial fund, that will inevitably back consolidation of hundreds of different medical assets, offers an excellent opportunity for big pharma companies to invest and get involved in rejuvenating and preserving this crucial industry that feeds their weakening pipelines.

This is why a new national initiative to create a substantial consolidation fund is absolutely crucial to the survival and future of the UK biomedical sector.

National Super Growth Biomedical Fund

This fund should be established to assess, and invest substantial amounts in, high growth individual companies which are the brightest UK prospects.

Over the last 20 years only two of the UK’s oldest medical science companies – Shire Pharma and Celltech – managed to pass the £1bn capitalisation milestone. Both achieved this status through multiple acquisitions of revenue generating assets and with substantial capital raisings and share issues.

Other successful biotech companies from the nineties era, such as Chiroscience, Powderject, Cambridge Antibody Technology and Nutec Pharma, were also contenders for high growth and value but were all sold off before they could attain this status. In recent years we have seen the premature but successful sale to big pharma of our youngest and most promising UK biotechs such as Piramed and Domantis.

In these cases investors felt they ought to take the cash on offer because there was no alternative available i.e. no chance of building large and successful public companies through substantial fundraisings either privately or publicly.

Analysis of the current crop of UK biotech companies such as Vectura, Antisoma, Ark, BTG/Protherics etc, shows they are barely capitalised above £100m and the UK does not have any £500m prospects let alone anything near the £bn mark.

Below the £100m radar are some younger and ambitious companies such as Plethora, Renovo, Neuropharm and Decon Sciences. Unfortunately none of these businesses will ever hit their true potential using the UK financial markets, and will never rival their US counterparts without easy access to the scale of capital needed to acquire synergistic businesses and assets from around the world. Relying on just organic growth with sporadic, piecemeal and often agonisingly painful fund raisings will not produce the £1bn medical science companies we need here in the UK. What can we do to catalyse the formation of these flagships?

Fund structure and management

A National Super Growth Fund would again need to be of the order of £500m-£750m. It would be 50/50 public/private matching funds and, again, managed by the very best venture capital and private equity professionals available. This fund would probably select less than ten existing and promising medical businesses to back.

Those companies would be required to present exceptional propositions for growth to the fund’s board and in return they could receive substantial equity investment of the order of £50m-£100m. Only sums of this order will allow these companies to take products through late stage clinical development to marketing authorisation or to undertake acquisition growth to achieve critical mass. The executive management and boards of these chosen few companies would have to be quite exceptional.

The fund could also arrange additional debt financing of £25m-£40m per business. Finally, the high profile and quality of this fund’s board and investment committee and the depth of commercial due diligence actioned prior to any investment would comfortably attract significant co-investment from third parties if required eg a further £20m-£50m per business could easily be arranged once a target company has been properly assessed.

In summary, an ambitious British medical science company could attract a substantial and unprecedented package of capital investment from the fund ranging from £50m- £200m to set about a rapid growth and acquisition strategy to build the multi-billion pound international successes Britain so badly craves.

With this magnitude of backing, Britain’s beleaguered biomedical companies would have a source of capital to finally compete with US counterparts and certainly should outstrip their European and Asian rivals. Nothing on this scale has ever been tried before in Britain or Europe: it is time for bold and affirmative actions.

A co-ordinated drive to stimulate revenues

The industry has made some very noble proposals for government support with a view to improving companies’ cash flow:

1. Provision of R&D set offs against National Insurance and PAYE payments to eliminate the cancellation of grants by payroll taxes

2. Availability of SME tax relief on both revenue and capital expenditure and ‘independence’ restrictions to be lifted where the control involves a dominant venture investor

3. Modification of SBRI-Small Business Research Initiative to copy the US model with a strong bias to ‘proofs of concept’ against valid test with an overall objective to raise the game and improve the chance of success

4. Creation of Young Innovative Enterprise status to provide tax and financial incentives

5. Measures to mitigate the impact of the change to Capital Gains Tax, including suggestions to remove entirely CGT for early-stage, high-risk investments

6. Co-funding of clinical trials by the government and NHS; and

7. Raising the bar on revenue thresholds for Pharmaceutical Price Regulation Schemes from £1m to £10m to facilitate revenue generation from the NHS.

While these and other measures are to be supported, further wide-ranging measures are required to fundamentally improve the generation of revenues within the UK. Action should be taken to create a public sector commitment to buy innovative goods and services from the indigenous UK medical sciences industry.

The only way to significantly increase the value of the British biomedical industry is to effect a quantum increase in its revenues. This is proven by the much more valuable US industry which generates substantially greater revenues on an industry-wide and individual company basis. As the Americans show time and time again, shifting a business from a passive science-based culture to an aggressive sales-based one is the only path to value growth.

The nature of healthcare in the UK makes the government by far the largest customer – the annual NHS drugs bill is £11bn alone. Unfortunately, unlike the USA, there is no requirement for the government to spend money on indigenous products and services from small and medium sized businesses.

The government should set aside at least 5% of its healthcare spend to be sourced from companies with a turnover of less than £100m. This would add significant value to the medical sciences sector and provide an increase in innovative solutions within the NHS.

Sourcing innovative solutions from small, early stage providers is likely to prove too difficult for the existing NHS procurement process. Instead the government could encourage large pharmaceutical companies to source 5% or more of their NHS contracts from domestic innovators.

This encouragement should come in two forms – stick and carrot. The stick should be created by embedding local sourcing requirements into official tenders and the carrot should come from real tax incentives granted for incorporating local content.

Conclusion

Over the last 20 years, the UK has built a reputation of excellence in the biomedical arena and is often ranked second to the United States.

It would be a catastrophe for any government if the UK was to surrender this eminent position to Canada, China or even Germany and France. There is now evidence we have started sliding down the league table.

Clearly the UK venture capital sector does not possess the financial firepower to tackle on its own the challenges the biotech industry is facing. Government intervention is required and it must happen soon. However, government support is not being sought to prop up a struggling industry.

Government support needed as outlined in this document would be in the form of genuine investment with a view to delivering significant financial return to the government and taxpayer while protecting and growing one of its most prized industries.

If the government were to embrace these initiatives on the scale outlined here, it will effect fundamental change in the biotech sector and enable it to create wealth, jobs and contribute towards building a truly high tech, high value economy in Britain. Only then will UK biotech finally realise its full potential on the world stage.

This is an extract from the report The UK Biotechnology Sector – Recommendations For The Survival And Transformation Of The Industry.