Medicine has a tradition of external innovation that predates much pharmaceutical CVC activity. It is perhaps best illustrated by the number of revenue-generating drugs with origins outside the vendor’s own research and development operation, often building on the input of government-funded research and expertise from universities. Development in many cases started with a smaller developer bought by big pharma further down the line, with venture capital supporting the earliest stages of design.
Data compiled for Global Corporate Venturing shows that of the biggest revenue-generating drugs reported on an individual basis by the industry’s 15 largest companies in 2017, almost half – 49.3% – are known to have been sourced from external channels.
Our study indicates external innovation is responsible for an even larger slice of reported revenues for those drugs, accounting for $168.3bn of a total $279.8bn, or 60.1%, of their annual turnover.
Grey areas
However, it is difficult to draw a conclusive picture, given the potential for overlap between the internal and external dynamics of innovation.
Collaborative programs between corporates, for instance, are counted as external in this dataset as they often include intellectual property (IP) from outside the company. Conversely, medicines partly based on expired patents – therapies only carry exclusivity for a limited number of years – have been tagged as internal projects, in light of the protected IP coming from within the firm.
Take two inhalable solutions sold by Teva Pharmaceutical Industries, Qvar and ProAir, which treat reversible obstructive airway disease and asthma respectively. Both formulations build on inventions by David Jack of GlaxoSmithKline’s internal R&D team in the 1960s and 1970s. Jack’s innovations have long since lost exclusivity.
Another handful of assets were difficult to classify because the external contribution is likely to have required vast internal R&D resources to convert into a clinical-grade product.
For the sake of argument, these grey areas have been included as internal projects. The nature of pharmaceutical discovery, with its multitude of potential compounds, high cost-burden and persistent risk of failure, means molecules first synthesised by external researchers may have fundamentally changed by the end of the development process.
One case worth contemplating is Pfizer’s Xeljanz medication for moderate-to-severe rheumatoid arthritis. Xeljanz works by exploiting the Jak3 protein first discovered by John O’Shea of US government research agency National Institutes of Health (NIH) in the early 1990s, and NIH partnered Pfizer to conduct further research into the protein in 1996.
But Pfizer argues the drug is its own innovation, having poured more than $1bn into internal R&D for the project by 2013. In its view, O’Shea’s contribution was already available in the public domain, and the cooperation agreement failed to yield patentable IP.
Innovation is indispensable
It is clear, however, that external innovation has matured into an indispensable resource for the industry. Pharma corporates have always looked beyond internal R&D for ideas, but many external actors have greatly increased their role over time.
Drug development is now awash with venture capital, with the cumulative amount of VC poured into early-stage bio-pharmaceutical companies globally topping more than $4bn during both the first and second quarter of 2018, according to Evaluate Group.
Many corporates now operate open innovation programs directly connecting internal expertise with third-party partners, and universities have also strengthened their hand with increasingly sophisticated tech transfer and collaboration departments.
Thomas Verhoeven, a president’s fellow for pharmaceutical development and partnerships at Purdue University, who spent a total of 34 years as senior vice-president for R&D at Merck & Co and Eli Lilly, said: “Historically, the interaction between universities and corporates was based on establishing a relationship that enabled a firm to access talented recruits. Sponsored research projects were primarily with individual faculty members, rarely rising to a strategic interaction at an institutional level.
“In recent times, as research universities have organised themselves to conduct interdisciplinary research, pharmaceutical firms are realising the value of being able to tap into the strength of an entire university research ecosystem. So, we are beginning to see a shift toward institution-to-institution interaction with the type of sponsored research becoming more strategic, longer term and less tactical.”
It is perhaps surprising then that the corporate venturing divisions of most major pharmaceutical companies date back only to the turn of the 21st century, though some may have previously made corporate investments and participated as an investor in independent VC funds.
JJDC, the corporate venturing division of Johnson & Johnson, has a longer history than most. It was launched in 1973 and is now under the Johnson & Johnson Innovation–JJDC banner.
GlaxoSmithKline was also ahead of the curve with the launch of its independent SR One venture capital fund in 1985, but most other active pharma CVC initiatives are at least a decade younger. Eli Lilly formed its Lilly Ventures division in 2002, for example, while Pfizer and Amgen followed suit two years later with Pfizer Ventures and Amgen Ventures respectively.
Taking the lead
And yet the momentum behind pharmaceutical CVC is now seemingly unstoppable. Total capital raised in pharma deals backed by healthcare corporates so far this year has not only surpassed 2017’s total, but has also broken the previous record of $5.5bn invested in 2015, according to GCV Analytics.
All the 15 largest pharmaceutical companies by revenue have now made corporate investments, and all but a few operate at least one pharma CVC fund or subsidiary.
Speaking to Bloomberg last month, William Janeway, veteran investor and managing director of Warburg Pincus, observed that profit-led VCs had effectively built up biotech in the 1970s and 1980s on the back of government agency funding. Verhoeven added that VCs had enabled nascent biotech opportunities to be derisked and connected to the industry, at a time when major firms were perhaps intimidated by a mismatch in risk compared with internal R&D projects.
But pharma corporates are now leading the charge, reaping the benefits of an exceptional record over the past two decades.
Biotech-focused venture capital firm Atlas Ventures saw the number of its rounds featuring corporate investors soar from 5% in 2000 to almost 75% in deals backed by its 2013 fund. In 2016, trade body the Association of the British Pharmaceutical Industry found 60% of financing rounds for UK-based pharma companies featured CVC involvement.
Better still, the industry has a knack of picking winners. Atlas cited data from PricewaterhouseCoopers and US trade body the National Venture Capital Association showing that CVCs featured as equity holders in 60% and 40% of biotech M&As and IPOs respectively between 2001 and 2015, despite backing only 23% of total dealflow in the sector, outperforming the wider CVC average.
One theory advanced in a 2016 Wharton School at University of Pennsylvania study argues CVC-backed biotech companies achieve greater innovation in terms of scientific and patenting output thanks in part to the corporate’s expertise, infrastructure and resources. Investment consortia with corporate involvement were also shown to be twice as good at turning around so-called “innovation laggards” into leaders within a four-year post-investment period.
The research was conducted by Gary Dushnitsky, a senior fellow at Wharton’s Mack Institute for Innovation Management, and Elisa Alvarez-Garrido, assistant professor at University of South Carolina’s department of international business. However, VCs continue to play an integral role in biotech development, notably by fulfilling support roles in embryonic biotech businesses that corporates may find difficult to provide.
Deal focus
Top-drawer pharmaceutical deals featuring corporates from May 2017 to April 2018 included a $1.1bn round for Switzerland-based drug developer Roivant led by the SoftBank Vision Fund that featured investors including drug maker Dexxon Pharmaceuticals. While the round is evidence of SoftBank and other non-healthcare corporate investors marking pharmaceuticals in a bid to build diverse portfolios, the supply of capital from healthcare firms in major deals has also been robust.
Pfizer and Gilead Sciences both took part in a $300m series A round for immuno-oncology debutant Allogene Therapeutics in April 2018, for instance, a mere six months before securing an exit with Allogene’s near-$373m initial public offering.
Novo backed a $270m round for rare disease therapy developer Harmony Biosciences in October 2017, while regenerative medicine business Celularity secured $250m from backers including Celgene, United Therapeutics and Sorrento Therapeutics in February this year.
Hippocrates, Greek antiquity’s father of medicine, was famously quoted as saying his field reflected a love for humanity, and it is the same essential dynamic that pushes the industry to find answers. Drugs targeting diseases with unmet medical needs and novel approaches to drug development account for a substantial share of deals, and many feature more than one corporate investor from the healthcare segment.
One recent example is US-based RNA drug developer Ribometrix, which generated $30m in a series A round last month featuring subsidiaries of drug makers Merck Group, AbbVie, Amgen and Mitsubishi Tanabe Pharma, as well as of genomics technology provider Illumina. The company’s pipeline targets disease-causing RNA molecules rather than proteins in the hope of improving the treatment of a wide range of conditions.
Barbara Dalton, vice-president for venture capital and worldwide business development at Pfizer, said the collaborative approach contrasted with CVC investment in medical devices, where in general there was greater competition between corporates and fewer venturing groups.
She said: “If you are a device company looking for a strategic investor, you are probably only looking for one because you do not want to set up that competitive situation at board level, whereas in the therapeutic space you will find companies with three or four pharma corporate VCs round the table – it is not an issue there.”
Thanks to trends such as the rise of digital health products, there is greater competition and overlap for healthcare venturing dollars than in previous years. However, pharmaceutical companies have consistently accounted for the most CVC-backed healthcare rounds since GCV Analytics began tracking data in 2011. The segment racked up 149 deals last year against 117 for medical devices and diagnostics, and 64 for healthcare IT and administration.
The blended approach
Pharma has also proven particularly adept at blending corporate venturing activity with other sources of innovation.
Given the price tag of drug development, in-house research will always play a crucial role for the industry, though the nature of that role is evolving. Corporate venturing’s advantage lies in complementing R&D operations and business development, by introducing valuable ideas and contacts from outside the corporate’s own structures.
Scott Brun, head of AbbVie’s Ventures division and vice-president of the firm’s corporate strategy office, said AbbVie was increasing activity in each part of the innovation dynamic – in CVC, R&D and M&A. He named two recent CVC investees, Alector and Morphic Therapeutic, as examples that led AbbVie to preclinical business development deals targeting neurodegenerative diseases and fibrosis-related conditions respectively.
Pfizer’s Dalton said: “What I like to do is have corporate venture investments early in the process of funding and growing a new company, and at the right time bring them to the attention of my Pfizer business development colleagues for a transaction, and then make sure the companies we are starting or helping can get off the ground.
“We will have a partnership with the parent through a business development transaction at the right time. And that right time differs among the corporations. Some corporations will do deals before compounds have entered the clinic and others want to see phase 1 or 2 data before they partner them. So it depends on what they are looking for.”
Pharma’s venturing methods have changed over the past 15 years alongside changes in internal R&D, according to Mark Wilson, principal at Strategic Technology Bioconsulting, who co-authored a report on the subject alongside Tim Minshall, the Dr John Taylor professor of innovation at University of Cambridge.
Many pharma investors now participate in so-called hybrid CVC initiatives, which allow them to engage with VC funds that grant a degree of investment control or privileged access rights. Hybrid fund investment in early-stage pharma and biotech businesses was equal to approximately 25% of funding supplied through standard CVC operations in 2017, according to the report, up from below 15% in 2006.
Examples include Medicxi Ventures 1, a $230m vehicle focused on Europe whose limited partners include Johnson & Johnson Innovation–JJDC and GlaxoSmithKline.
Hybrid strategies also help pharma corporates and biotech VCs pool their resources to the benefit of driving emerging therapies. For example, Atlas’s ninth and 10th funds, backed by Novartis and Amgen, provide the corporates with a closer look at Atlas’s startup formation activities.
Wilson said the emergence of hybrid CVC was the latest development in pharma’s shifting approach to externalisation, which has moved from strategic alliances to option-based deals and then to biotech acquisitions aligned with specific preferences. He also noted pharma corporates often now aim to minimise expenditure until portfolio companies reach proof-of-concept stage.
Conclusion
Pharmaceutical companies are the largest contributor to CVC in the healthcare segment, itself consistently ranked as the second-largest CVC sector by GCV Analytics. The industry’s approach to CVC is therefore complex, with companies adopting tactics for a myriad reasons.
This should be little surprise, not least because each firm’s drug development strategy is fundamentally different. Some emphasise marketing medications in specific therapeutic areas, for instance, and companies may choose to prioritise either strategic or financial goals.
But pharma’s impressive exit record is a vindication of its approach, to the point where corporate involvement has become a reliable predictor of innovative potential. Wider lessons could be drawn from the achievement, which stems in part from a collaborative environment in which corporates, VCs and other agents of external innovation feel comfortable working with each other.