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Big
Pharma, Small Biotech - Who Needs Who? |
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 Sometimes
picking a small cap stock is about the numbers and certainty. Other
times there's a little philosophy to it. I think both
are important. Today we've got some philosophical answers to questions
many of you have been voicing about biotech R&D company CEL-SCI Corporation
(AMEX: CVM).
This
isn't
going to be a primer of CEL-SCI's merits. If you're not familiar with the
company I strongly encourage you to go back through our extensive
coverage of the company. It's really a fascinating story.
If
you want the bare minimum to get you rolling, here you go - CEL-SCI
is working on a cancer therapy that appears to have enormous promise.
The drug is called Multikine, and its use as a head and neck cancer treatment
is on the verge of entering Phase III testing (the final stage before the
FDA makes an approval decision).
A passive
interest in this biotech outfit may never have even prompted today's questions.
Some of you, like myself, have noticed the same thing I did shortly after
I became the editor of this newsletter...why doesn't CEL-SCI have or
even seem to be interested in a major pharmaceutical sponsor to help them
get to their endpoint? Not having one seems to be a major liability.
We
will try to answer the question in full, but first let's really set the
stage with some mind-boggling numbers.
Did
you know that over 30% of big pharma's (Bayer, Merck, Glaxo, Pfizer, etc.)
revenues are derived from licensed products?
 The
bottom line is most major pharmas need small biotech and drug developers
badly. Why? Two simple reasons. First, like I said above, licensed
drugs account for 30% of all drug revenues. Second, the R&D labs at
the major outfits can't or won't do groundbreaking work. They just
don't innovate. If major pharmaceutical names were unable to sell the drugs
created by the tiny R&D outfits who are actually doing the 'breakthrough'
work, all the Glaxos and Mercks of the world would be proverbially dead
in the water.
Fine,
but why would a biotech with a cutting edge drug need help from a major
manufacturer? You already know the answer - money. Big pharma
has it and little biotech needs it.
The
symbiotic relationship has been in place for years, and it looks like it
will be in place for years to come... or does it? We'll come back
to that in a second.
There's
a price to pay for major funding though, and sometimes it's a big price.
Metaphorically speaking, it's about the same as selling your soul to the
devil.
To
qualify for the cash a licensor (the owner/developer of a drug) usually
ends up getting a mere fraction of the sales dollars generated by the licensee.
How much you ask? My research turned up all kinds of numbers. The range
seemed to be anywhere between 5% and 50%, with 15% being my ballpark average.
Granted, the licensee incurs the selling, marketing, and sometimes manufacturing
expenses as part of the process. A mere 15% of sales though? Geez.
That
15% assumes a drug is approved and ready to sell. Earlier stage
pharmaceuticals (pre-clinical) the royalty may be worth only 2% to 3% as
it requires more upfront funding. Sponsors of drugs in clinical trials
(Phase II and Phase III) will usually pay licensing fees of 3% to 4%. This
still means they may require some additional funding but it's not as much.
Fully-approved drugs may net a royalty of 5% to 10%...and 15% on the high
end.
The
next question is why don't the smaller biotech developers tell big pharma
to take a hike? The standard answer for years has been 'because
the little developers need the marketing prowess and funding of the major
pharma names'. And for years that was true. As the globe recently has
gotten much smaller though, and as small biotechs have become more fiscally
independent, guess what's been happening? Little R&D outfits need less
and less of big pharma's help.
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CEL-SCI's
Independence - Good For The Bottom Line |
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So
what's any of this got to do with CEL-SCI? Though only an educated guess,
there are two ideas I can't personally refute...
1)
CEL-SCI doesn't need sponsor funding. CEL-SCI has managed to raise
money for years via funding efforts. (Fortunately they don't need much.)
So, what could a major pharmaceutical company do for them they can't do
for themselves?
2)
CEL-SCI doesn't need/want the marketing power of a major name. By foregoing
capital assistance from a big company, CEL-SCI is in a position to eat
a bigger piece of the pie by marketing the drug themselves. The licensee
almost always makes out better than the licensee when it comes to pharma.
Avoid licensing altogether, and you reap all the reward for yourself.
 Now
with that being said, know that CEL-SCI has four minor licensing agreements
in select Asian countries. I think they're minor marketing rights deals
though, and not significant in terms of the total dollars in question.
Here's
the core of the whole matter as I see it...does CEL-SCI really need
a major ally selling Multikine, or can they do it themselves? I really
think that's the pivotal question.
To
the best of my knowledge, and from what I can surmise from my conversations
with the company's people so far, CEL-SCI thinks they can do it themselves.
I don't disagree. There are only about 1500 head and neck surgeons in the
U.S., and around 2500 in Europe. Getting Multikine in front of the right
people isn't going to be any more difficult for CEL-SCI than it would be
for J&J or Bristol-Myers. It could be accomplished with a relatively
small sales force. Besides, if Multikine works in Phase III as well as
it did on Phase II, I think it may end up selling itself.
Some
of you have also (thoughtfully) asked what's to prevent an outright
buyout of the company? That's actually an interesting question because
it's a legitimate concern. My answer is - and I'm saying this with 100%
seriousness - these same major drug companies have their proverbial
heads in the sand.
The
pharmaceutical outfits in a position to make an acquisition are also the
same companies unwilling to risk any real dollars on their own R&D.
Why would they risk owning someone else's R&D if it's not bearing
revenue yet?
Yes,
milestone funding payments are made all the time to the smaller biotech
companies. Look closely though - those deals are only sought out
by big pharma if (1) the potential payback is enormous and/or (2) the funder
has every reason to believe that drug will actually get to the market.
The
irony behind a biotech buyout (as opposed to a licensing deal) is this
- the closer a drug gets to the market, the more expensive the developing
company becomes. By waiting for a 'more sure thing', big pharma often misses
the opportunity to buy a target company. I believe that's why you see more
licensing than acquisitions and that's why a CEL-SCI buyout is the least
of my worries. Based on its future potential, I feel CEL-SCI is
worth every bit of it's current market cap of $70.7 million. Major pharma
companies can't get past the idea of 'future potential'.
So
here's the 'philosophy' promised above - about CEL-SCI and pharmaceuticals
in general. The major pharmaceutical companies need biotech R&D
companies a heck of a lot more than biotech outfits need the major pharmaceutical
companies. Yet, far more often than not, the major pharma names end
up winning most of the reward (i.e. revenues and profits) of the
hard work and breakthroughs created by someone else.
 In
all fairness to the major pharmaceutical names, without their money, sometimes
important (and profitable) drugs would have never been brought to the market
at
all. So, a tiny under-funded biotech company has to do what it has
to do. If that's the way it has to be, then so be it.
But
what if the tiny biotech company can get a drug to the market without any
help from a major drug company? Then their destiny - and 100% of
the drug's earnings - are in their own hands.
I have
a feeling the old school ways are being replaced as R&D biotechs realize
this (which has implications for investors beyond CEL-SCI). I feel
as more and more biotech companies figure out how to avoid bad deals, large-cap
pharma will really struggle to stay competitive.
The
upside for investors (small cap investors in particular) is this...when
a major drug company sells a 'breakthrough' drug the results may
or may not trickle down into their stock price because of so many other
things the stock price reflects. When a small company owns and controls
the drug in question, its success wholly impacts the company's books...and
the stock's trading level.
Two
opposing examples come to mind...Celgene (NASDAQ:
CELG), and ImClone (NASDAQ:
IMCL).
About
a decade ago, when their shares were trading at a split-adjusted 81 cents,
Celgene had an opportunity to relinquish some of their marketing rights.
Though it may have helped sales initially, they chose not to. Today, those
shares are worth $69.96.
Back
in 2001, the infamous ImClone agreed to allow Bristol-Myers Squibb (NYSE:
BMY) to offer Erbitux, which has since been approved by the FDA
for certain cancers. Shares have traveled from a peak of $73.55 just after
the partnership was forged to the current level of $46.15. While there's
some history with the Martha Stewart flap, I don't think that's actually
determining the current valuation.
Does
every licensing decision turn out like these? No, of course not. But
for investors, too many do.
My
internal bottom line is simple - I'm thrilled CEL-SCI hasn't been seeking
out any partnerships with a major pharma name, particularly
because I don't think they need it at this point. I'm equally thrilled
that any future profits will be all theirs. Lastly, I'm thrilled Multikine
is in Phase III. Knowing everything you know now the clincher is this tidbit...66%
of drugs in Phase III trial are eventually granted the FDA's final approval.
Good
odds, meaningful sales potential, and complete control of how the drug
is marketed. That's not a bad situation for CVM owners to be in. You can
bet my next small cap pharmaceutical-development investment will look pretty
similar to CEL-SCI's model.
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Got comments, questions or suggestions?
Send 'em on over: Email
the Editor
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or inquiry, please send it to our physical address:
TGR Group, LLC
4653 Carmel Mtn Rd Suite 308 #402
San Diego, CA 92130 |
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