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Biotechs are spending less on drug discovery

By Robert Weisman
Globe Staff / June 14, 2011

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US biotechnology companies raised 15 percent more in investment funding last year than in 2009, but “innovation capital’’ — the amount actually spent on drug discovery — declined by 20 percent, according to an Ernst & Young report set to be released today.

That’s because nearly half of biotechnology investment money last year was raised through debt financing deals by larger mature companies, which used it to buy back their own shares, boosting earnings and share prices. Meanwhile, the report said, start-ups and unprofitable smaller companies found it increasingly difficult to raise cash.

The findings, which will be presented Friday at a Cambridge meeting hosted by Biogen Idec Inc. and later this month at the global BIO trade conference in Washington, D.C., suggest that the industry’s investor-backed business model has come un der strain. One sign cited by the report: The number of drugs approved annually by federal regulators fell to 21 between 2005 and 2010, down from an average of 36 approved between 1996 and 2004.

“It’s a Darwinian process, and the good technology is still getting funded,’’ said Glen Giovannetti, global biotechnology leader in the Boston office of Ernst & Young, the accounting and advisory firm. “But I worry about what’s being lost. There may be some very interesting technologies that are not being funded. I worry that innovation could be delayed.’’

Ernst & Young’s report points to an acceleration of two trends that began late in the last decade: an increase in the number of research alliances between big drug companies and young biotechs, and the rise of contingency-based payments from partners or buyers for companies that meet milestone targets. “Investors are willing to provide funding,’’ the report said, “but it is being doled out in smaller increments and it comes with more strings attached.’’

While the report surveys the state of the industry worldwide, many of the trends it cites are common in the Boston area biotechnology cluster, one of the nation’s largest.

Pharmaceutical giants such as Pfizer Inc., Novartis AG, and Sanofi SA have been expanding their research presence here over the past year in an effort to forge alliances with academic researchers and start-up companies in fields ranging from cancer to rare diseases. At the same time, milestone payments — such as the contingent value rights Sanofi used to sweeten its bid when it bought Cambridge’s Genzyme Corp. this spring — are becoming more popular. And start-ups have been looking to drug companies and other nontraditional funding sources.

The reasons are twofold. Kenneth I. Kaitin, director of the Tufts Center for the Study of Drug Development in Boston, said some venture capitalists have soured on biotechnology investments because their need to cash out in a relatively short time conflicts with the increasingly long time it takes to get a new drug on the market. At the same time, pharmaceutical companies — which are sitting on cash but are having limited success with their in-house research — are more eager than ever to strike partnerships with biotechs.

“Biotechs can’t do it the way they did it in the past, so they’re turning to Big Pharma for funding,’’ Kaitin said. “And what Big Pharma’s saying is we’ll cut the investors out of the equation so we can get access to the most promising [drug candidates] as quickly as possible. The biotechnology industry is being viewed as a potential provider of assets for drug companies as they cut back on their own research and development spending.’’

The trend is likely to continue because drug development programs are clouded by uncertainty, and venture capital firms have become more conservative, said John A. Gordon, partner at Burlington life sciences consulting firm Putnam Associates.

“Especially since the financial crisis, venture capitalists are looking for sure bets and more established business models where they know from the outset there’s going to be a good outcome,’’ Gordon said. “Early-stage biotech companies are the polar opposite of that.’’

Biotech financing data can also be misleading, the Ernst & Young report noted. Funding totaled $25 billion in 2010, it said, on par with funding levels before the 2008 market crash. But 20 percent of US companies raised more than 80 percent of that money, often using it for stock repurchasing programs that don’t advance drug research. The bottom 20 percent of biotech companies raised only 0.4 percent of the funding.

“Overall, capital investment is recovering,’’ Ernst & Young’s Giovannetti said. “But the increased selectivity by investors is more in evidence. Many companies are not in a position to access the capital markets as freely as they were before. If you’re between clinical milestones and you need to raise money, it can be a challenge.’’

Robert Weisman can be reached at weisman@globe.com.