Milken Institute eyes strategies - pooling IP, donor bonds, ABS, futures - to cure biotech funding crisis

By Ronda Fears

Memphis, Oct. 12 - The Milken Institute, a think tank based in California, issued a detailed report Thursday with a host of recommendations to bridge the funding gap for early stage biotechs culminating from a series last fall to address the "crisis" and explore new channels for attracting capital.

"The experts and stakeholders who gathered at the Milken Institute's Financial Innovations Lab in late 2005 provided several innovative strategies to 'cure' the financing gap and offer new supplies of capital to drug development," the report stated.

"One recommendation was to perform a case study that brings together a set of transaction partners to facilitate a potential deal and help identify the incentives and challenges. Another proposal called for the creation of a simulated pool of patents and/or early stage drugs for review by a ratings agency and interested foundations so that the potential players would learn to identify incentives and stumbling blocks.

"Whether the solution is diversification and pooling, the use of foundations, enhanced D&O [directors and officers] insurance, advanced purchases, donor bonds, or a combination of strategies ... one thing remains clear: the current shortage of capital in the development of drug, medical device, and health care technology can be resolved through public-private partnerships. Financial technologies, innovative securitization, and structured finance can address capital needs in the realm of global health, human capital development, and broader economic growth."

State of funding affairs dismal

It is a sad irony, the report stated, that while immense potential exists to cure disease and improve health standards, public and private funding for research is in such rapid decline.

"Financing for the biotech industry in general has diminished for early, innovative projects. There is nearly no venture capital available for innovative ideas that lack significant clinical data," the report authors observe.

"The funding crisis occurs at the point of transition from preclinical to clinical-stage development. Very few sources of funding are available to support early stage work. In fact, most will not invest until the drug candidate has been exposed to humans in phase 1 safety trials. Others will wait until the results of rigorous phase 2 trials demonstrate efficacy."

While this strategy has been fairly effective in mitigation of risk, it has had a stifling effect on the biotech industry.

"Since 2004, NIH [National Institute of Health] research funding has remained static or decreased, based on adjusted dollars. In fact, the most recent budget cut of 2006 is steep enough to bring NIH R&D below the 2003 funding level in real terms, erasing the increases of previous years. Large pharmaceutical companies have come under increasing competitive and financial pressures, and have pulled back from early stage discovery and development," the report states.

"Industry trends, however, may not favor easy solutions. The average cost of bringing a new drug through development, clinical trials, and market launch has risen sharply, more than 7% per year for the past 15 years, and is reportedly more than $800 million today. And market launch is no guarantee of success: of products that reach the market, 70% fail to recoup their R&D investments."

In the current financial environment, good ideas with the potential to cure disease are nearly impossible to fund, the report observes, but the Milken sessions last fall came up with some concrete ideas: Reduce risk through pooling intellectual property; use foundation funds to enhance credit quality; use directors and officers liability insurance to enhance credit quality; tap into the emerging market for IP-backed securities; use advanced purchases to underwrite research; use donor bonds to underwrite research.

Lower risk with IP pooling

Reducing scientific risk through pooling intellectual property sounds like an obvious solution, but implementation in the financial markets requires new investment vehicles. Precedent exists, however, in the film industry, where investor syndicates finance pools of films. Similar vehicles could be used in the biotech industry, according to the Milken report.

"The probability is perhaps 15% that an innovation will translate into a commercially successful product. With the escalating price tag of drug development, it is not difficult to understand the origins of risk-aversion," the report states.

A lot can be learned from the film industry, however.

"Both drug development and film production use the same 'stage-gate' (expected value) valuation model, in which value increases as risk is resolved and the film is closer to returning revenues. In addition, both industries have a skewed value distribution, with a few immensely valuable outcomes and many outcomes of small or no value. More than 40% of films did not recover their costs at the box office in 2004, a success rate that is similar to biotechnology's," the report observes.

"Today JP Morgan is the lead investment banker for film syndication, reportedly holding 80% of the market. John Miller, head of the firm's entertainment group, has 25 years' experience with this kind of financing. Instead of financing a single film, he backs studio slates, packages of five to 15 films, because his quantitative models predict that only three out of 10 films will do well, and that one out of 10 will hit the jackpot - results that are very similar to those of drug development."

Improving credit quality key

Before exploring new means of financing, credit quality is a major concern among investors so biotechs have to find a way to improve their ratings.

"Much of the focus for financial solutions was on securitization, a financial instrument strongly supported by Milken Institute research and defined as the pooling of assets that can be sold as a security (or some other means of structured finance)," the report states.

"If there is a way, for example, to estimate the value of royalties over time from a portfolio of patents relevant to a particular disease group or medical problem, then the portfolio could be turned into a marketable security, which would in turn provide capital to accelerate research."

The use of foundation funds could enhance credit quality and attract potential investors, and another avenue is directors and officers liability insurance.

"A diversified pool of drugs under development for Alzheimer's disease may have only moderate scientific risk, but nonetheless too much financial risk to qualify as an investment-grade vehicle. Instead, a foundation focused on Alzheimer's could provide the financial guarantees that raise the credit quality of the pool, opening up the investment to a significantly larger group, the report stated.

Glenn Yago, director of capital studies at Milken, suggested two alternative roles for foundations - playing the role of credit enhancers so that debt and equity capital are raised more cheaply, and facilitating the sharing of research for a specific disease.

Derivatives, PIPEs attractive

Tapping into the emerging market for intellectual property-backed securities also could be accomplished through more established routes of financing in the biotech industry, such as PIPES, in addition to incorporating the biotech industry into other routes of established financing for other industries, such as asset-backed loans and debt securitizations.

"Several presenters [at the Milken conferences] were active participants in the emerging market for intellectual property based lending. This is a growing segment of the asset-backed securitization market. Although the intellectual property in drug development is protected by patents, intellectual property protected by copyrights and trademarks has dominated the market to date," the study said.

"Several participants wondered if asset-backed or IP-secured financing actually could play a role in funding drug discovery, given industry practices. It seemed that lenders were willing to make loans for successful drugs, but not for drugs that faced significant scientific and commercial risks. One participant suggested that if the loan-to-value ratio was 25% and an early stage drug prospect is worth $3 million to $4 million, then a loan of $1 million or less might be possible. This does not reduce the need to raise significant equity capital; nor would the debt funding be sufficient to close the phase 2 funding gap."

But it would be seed money perhaps, and IP equity derivatives such as PIPEs could fill the gap.

"The rise of captive intellectual property holding companies and private investment in public equity (PIPES) suggests that it would be possible to create instruments indexed to IP value, much of which is captured in enterprise value," the report states.

One example given was the partnership between Bayer Healthcare AG and the Global Alliance for TB Drug Development.

Donor bonds, futures available

There also could be instruments similar to existing futures contracts customized to the biotech industry, such as donor bonds and funding from customers and downstream partners.

"Just as credit card companies use future customer repayments as the collateral for borrowing, donors could sell bonds whose payments are met by future gifts," the report stated.

As of May 2006, eight European governments had already signed on to this promising securitization approach, issuing bonds worth $4 billion for massive immunization programs in Africa and Asia, and offering future donor pledges as collateral, according to Milken.

In a sort of futures contract, advanced purchases from customers and marketing partners could be tapped.

"The industry has been moving toward this innovation in the monetization of future sales [through advanced customer-financed purchases]. In effect, it is the trade of upfront R&D funding in exchange for a share of future royalties," the report stated. "In June 2005, Great Britain took the concept further, with the announcement of plans to purchase 200 to 300 million doses of a malaria vaccine, thus ensuring a market if a vaccine is developed."

Equity investments from a strategic or downstream value-chain partner is a common practice of later-stage biotechs that partner with large pharmaceutical companies, and involves the trade of upfront R&D funding in exchange for a share of future royalties or other economic interest.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.