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Last week’s big news in the pharmaceutical industry was the official patent expiration of Pfizer’s (PFE) block buster drug Lipitor. While this came as no surprise, an important sidebar article was published earlier this year through Reuters that touched on an issue that will have far reaching consequences for Big Pharma and by extension the smaller biotech industry. Pfizer has announced that it is lowering its 2012 research and development spending budget by as much as 24%. That is up to $2 Billion less in spending and it ushers in an era where big is not necessarily better in terms of filling the pipeline with new compounds that may eventually become successful growth engines for the company. Other industry standard bearers such as Astra Zeneca (AZN) and Glaxo Smith Kline (GSK) have also made similar announcements and the reception on Wall Street has generally been positive. Only Merck (MRK) was willing to buck the trend with an announcement that it would refuse to lower R & D spending while summarily withdrawing its long term profit forecast. The market response: a quick down draft in the share price.

It seems that mega block buster drugs have become more elusive and throwing more money at R & D departments has been met with diminishing returns over the past decade. As Pfizer’s President of Research and Development Mikael Dolsten was quoted, "I'm not convinced that more is necessarily better." Other market participants have validated this notion of doing more with less, as was revealed in a recent Forbes article whose title says it all, “Fear, Apathy, And Bureaucracy: Why We Won't Have Another Lipitor.” Big Pharma’s size precludes it from becoming what it once was: scrappy, nimble, less risk averse and quite frankly, less bureaucratic. New discoveries that eventually coalesce to create new compounds require the aforementioned attributes on the part of development teams. This is where things start to get interesting. It seems the creative front of the drug discovery business is being shifted to laser focused and nimble teams at the smaller biotech firms that have the will, flexibility- and sometimes the capital- to create new drugs. Big Pharma knows it truly cannot easily create something with less, so it is choosing to shift more would be R & D dollars to smaller biotech firms. If you think about it, if Pfizer has $2 billion less to spend on traditional discovery methods, it can easily engage in promising tie-ups and joint ventures with its more creative counterparts in biotech.

For those tie-ups that are met with initial success, a company like Pfizer can then either acquire the company or engage in benchmark agreements that enable it to do what it does best: groom the new drug for commercialization and ultimately distribution. It is a symbiotic relationship that serves both masters- the biotech’s get funding with prospects for a possible liquidity event (as would occur with a sale for example) and the lumbering pharmaceuticals with their well-oiled commercialization processes can bring the product to the markets. This is the best chance for getting promising drugs in the hands of the medical community where they can ultimately benefit consumers.

I think most of us would like to see major breakthroughs in combating heart disease, cancer and other nefarious maladies that afflict us. As the dearth of new discoveries by Big Pharma in the past decade has shown us, it is the entrepreneurial biotech companies that may have a better chance for success in the development of promising new drugs. The following maxim can be applied to most any industry- the innovation occurs in the hands of the nimble and those willing to take risks. It is no accident that Facebook was not the creation of Microsoft, IBM or Time Warner. The same goes with biotech- some of the most promising compounds will be created from focused development teams however, unlike the social media or internet industry, they will also require more upfront investment and the willing support of larger partners- hence the tie-ups with Big Pharma.

Follow the Money: Biotech Tie-ups with Big Pharma

Biotech Company Domicile Market Cap Partnerships
Amira Pharmaceuticals (Private) San Diego, CA (Private) Glaxo Smith Kline (GSK)
Isis Pharmaceuticals (ISIS) Carlsbad, CA $711 Million Glaxo Smith Kline, Genzyme Corporation (GENZ)
Lpath Incorporated (LPTN) San Diego, CA $61 Million Pfizer
Amylin Pharmaceuticals (AMLN) San Diego, CA $1.53 Billion Elli Lilly (LLY), Biocon (BIOCON-BO), Takeda Pharmaceuticals (OTCPK:TKPYY)

A case in point is Pfizer’s agreement with Lpath Incorporated. Lpath is one of a number of biotech firms that have sprung up in the San Diego Area and it seems to be a poster child for the aforementioned trends. Lpath is engaged in the discovery and development of lipidomic-based therapeutic antibodies. That is a mouthful to be sure, but for the investment community essentially they have created drugs such as iSONEP (used in the treatment of the most debilitating version of macular degeneration, glaucoma) and ASONEP which has shown promise in the treatment of various forms of cancer. Pfizer’s $14 Million investment in Lpath represents a veritable drop in the bucket relative to its R&D budget, but it is a big deal for an aggressive biotech looking to make its mark and earn the right to achieve even more significant milestone payouts as it goes through the clinical trial process and beyond. The potential market for the application of new drugs derived from of Lpath’s 50+ awarded and pending patents would give a company like Pfizer a leg up on the opportunity to create new engines for growth. Of course it must multiply these tie-ups many times over with other promising firms and competition among the major’s is fierce for the most sought after development prospects at the smaller biotech’s.

Like any growth industry it helps to have an identifiable locale where start-ups can proliferate, share ideas and become a magnet for capital. The San Diego area is quickly becoming a biotech hub with the reputation for aggregating some of the greatest biotech talent in the U.S. Close to major research universities, that terrific weather and the mother ship of successful biotech companies, Amgen (AMGN) the region now wields over 400 companies focused on the development of new potential breakthroughs in the health sciences. As Big Pharma engages in this shift towards less in house R&D and more investment in the smaller biotech companies, this region is in a unique position to capture billions in future investment. It might be harder to see that now with many firms struggling to capture funding, but the industry is notorious for its tendency to move in cycles and right now only the most promising firms are attracting capital.

Many of the nascent biotech companies exist in a sort of stealth mode and it often takes years of research experience to gain traction in the most promising frontiers of the health sciences. The early years are for “patient money” and this is why it has become more difficult to get venture funding from the traditional venture capital communities who often want a shorter bridge to a liquidity event. It becomes paramount to engage the larger pharmaceutical companies who understand the process, timeframes and the risks associated with backing the biotech’s. The most promising biotech firms have been engaged in research for many years. Lpath was formed in 1997. Other promising firms such as Amira Pharmaceuticals, another San Diego based firm formed in 2005, are shorter lived but have core teams that have worked together for years.

Will a company like Pfizer be able to find the next Lipitor as its tie-ups start to bear fruit in coming years? While the firm wouldn’t eschew another blockbuster like Lipitor, Pfizer probably doesn’t expect- or for that matter want- to rely on one drug making such an impact on the bottom line. A diversity of “singles and doubles” emanating from such tie-ups as with Pfizer and Lpath would provide for a steadier and ultimately more sustainable path to growth. It sort of analogous to having that one stock in your portfolio that makes up for most of the gains- it’s great that it was wildly successful, but one hit wonders are rarely the road to riches because they are so hard to duplicate. So it will likely be with Big Pharma as it mines the Lpath’s of the biotech community to attain that Holy Grail for its shareholders: a stable and more predictable path to profits. And for investors who try to pick the winners in the biotech space, there are fortunes to be made. Just be sure to pick the right ones- not an exact science to be sure, but the nature of the tie-ups with Big Pharma are a clue to where the future lies.

Source: Biotechs To Benefit From Strategy Shift By Big Pharma