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PHARMACEUTICAL LICENSING STRATEGIES Best practices in deal-making, valuations and strategic management By Steven Seget

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Page 1: PHARMACEUTICAL LICENSING

PHARMACEUTICAL LICENSING STRATEGIES Best practices in deal-making, valuations and strategic management

By Steven Seget

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ii

Steven Seget

Steven Seget is Principal at Delphi Pharma, and provides independent strategic

consulting services to the pharmaceutical and biotechnology industries. Steven

previously managed the strategic healthcare consulting function at Datamonitor and has

an MBA from the London Business School. [email protected]

Delphi Pharma provides strategic, financial and market–based solutions to clients,

focusing primarily on the portfolio management, business development and licensing

functions. Delphi Pharma combines an extensive research network, applied analytical

expertise and an established track record to deliver high value results and measurable

impact to its clients. www.delphipharma.com

Copyright © 2006 Business Insights Ltd

This Management Report is published by Business Insights Ltd. All rights reserved. Reproduction or redistribution of this Management Report in any form for any purpose is expressly prohibited without the prior consent of Business Insights Ltd.

The views expressed in this Management Report are those of the publisher, not of Reuters. Reuters accepts no liability for the accuracy or completeness of the information, advice or comment contained in this Management Report nor for any actions taken in reliance thereon.

While information, advice or comment is believed to be correct at the time of publication, no responsibility can be accepted by Business Insights Ltd for its completeness or accuracy.

REUTERS and dotted and sphere logos are the house trade marks of Reuters Limited in more than 25 countries world-wide.

Printed and bound in Great Britain by FPC Greenaway. Ormolu House, Crimscott Street, London SE1 5TE. www.greenaways.com

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Table of Contents

Pharmaceutical Licensing Strategies

Executive Summary 10

Introducing pharmaceutical licensing 10 Licensing trends 10 Licensing process 12 Licensing valuations 13 Licensing best practices 14

Chapter 1 Introducing pharmaceutical licensing 16

Summary 16 Introduction 17 The age of the partnership 17 Definitions 19 Report outline 20

Chapter 2 Licensing trends 22

Summary 22 Introduction 23 Headline deal trends 23 Licensing deal partners 27 Licensing deal types 32 Licensing deal subjects 36

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Chapter 3 Licensing process 42

Summary 42 Introduction 43 A complex process 43 In-licensing versus out-licensing 45 Licensing strategy 47 Opportunity identification 49 In-licensing 50 Out-licensing 52 Licensing evaluations 56 General portfolio management 57 Applications for licensing evaluations 59 Deal-making and agreement 60 Key elements of a pharmaceutical license agreement 60 Post-deal management and analysis 61 Alliance management 62 Using outside agencies 64

Chapter 4 Licensing valuations 70

Summary 70 Introduction 71 Valuing deals 71 Current best practices 73 Deal-making valuation model 76 Model inputs 77 Evaluation modeling 82 Model outputs 88 Model refinements 91

Chapter 5 Licensing best practices 100

Summary 100 Introduction 101 Top licensing deals of the 21st century 101 Genentech-Roche 101 Idenix-Novartis 102 Millennium-Ortho Biotech 102

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AstraZeneca-AtheroGenics 103 Preferred licensing partners 104 Leading in-licensing companies 104 Novartis 105 Leading out-licensing companies 107 Cephalon 107 Recommendations for the future 109 Licensing trends 109 Licensing process 109 Licensing valuations 110 Licensing best practices 110

Chapter 6 Appendix 112

Primary research survey 112 Sources 115 Index 116

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List of Figures Figure 2.1: Number and average value of top 10 pharmaceutical company licensing deals, 2001-

2005 24 Figure 2.2: Expected change in number of licensing deals during 2006 25 Figure 2.3: Expected change in average value of licensing deals during 2006 26 Figure 2.4: Number of top 10 pharmaceutical company licensing deals by partner, 2001-2005 28 Figure 2.5: Number of top 10 biotech company licensing deals by partner, 2001-2005 30 Figure 2.6: Number of biotech out-licensing deals by partner, 2001-2005 31 Figure 2.7: Number of top 10 pharmaceutical company licensing deals by deal type, 2001-2005 33 Figure 2.8: Number of top 10 biotech company licensing deals by deal type, 2001-2005 35 Figure 2.9: Proportion of product-based licensing deals by therapy area, 2001-2005 36 Figure 2.10: Number of product-based licensing deals by therapy area, 2001-2005 37 Figure 2.11: Number of R&D licensing deals by development stage, 2001-2005 38 Figure 2.12: Number of biotech R&D licensing deals by development stage, 2001-2005 39 Figure 3.13: Expected change in number of potential partners chasing each licensing deal during

2006 44 Figure 3.14: Expected change in the length of time required to complete a licensing deal during

2006 44 Figure 3.15: The pharmaceutical licensing process 46 Figure 3.16: Parties involved in identifying potential licensing opportunities, 2006 65 Figure 3.17: Parties involved in conducting due diligence for potential licensing opportunities, 2006

66 Figure 3.18: Parties involved in the valuation and negotiation of potential licensing deals, 2006 67 Figure 4.19: Information shared between partners during licensing negotiations, 2006 74 Figure 4.20: Valuation techniques used in determining optimal licensing deal terms, 2006 75 Figure 4.21: R&D costs by phase, 2000 78 Figure 4.22: R&D lead times by phase, 2000 79 Figure 4.23: R&D success probabilities by phase, 2000 80 Figure 4.24: Drug market diffusion curve – product lifecycle 81 Figure 4.25: Likelihood of outcomes for new phase I, phase II and phase III drugs 85 Figure 4.26: Expected real values (non-discounted) for new phase I, phase II and phase III drugs 86 Figure 4.27: Discounted expected real values for new phase I, phase II and phase III drugs 87 Figure 4.28: Discounted expected real values for new phase I, phase II and phase III drugs

(adjusted for lower R&D cost inflation) 88 Figure 4.29: Deal outcomes for out-licensor 89 Figure 4.30: Deal outcomes for in-licensor 89 Figure 4.31: Share of expected deal outcomes by partner 90 Figure 4.32: R&D costs by phase by therapy area, 2000 92 Figure 4.33: R&D lead times by phase by therapy area, 2000 93 Figure 4.34: R&D success probabilities by phase by therapy area, 2000 94 Figure 4.35: Peak sales and year of peak sales by therapy area, 2000 94 Figure 4.36: Discounted value of sales by therapy area, 2000 95 Figure 5.37: In-licensing partner of choice, 2006 104 Figure 5.38: Business development and licensing department, Novartis 106 Figure 5.39: Licensing process at Novartis 106 Figure 5.40: Out-licensing partner of choice, 2006 107 Figure 6.41: Licensing trends survey respondents by company focus 112

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Figure 6.42: Licensing trends survey respondents by functional responsibility 113 Figure 6.43: Licensing trends survey respondents by licensing responsibility 114

List of Tables Table 4.1: R&D cost by phase and peak sales, 2006 (expressed in 2006 dollars) 83

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Executive Summary

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Executive Summary

Introducing pharmaceutical licensing

With falling R&D productivity and continued healthcare cost containment and

generic competition pushing down the returns available for successfully launched

products, only those companies able to complement internal efforts with a strong

partnering strategy will be able to remain competitive over the next five-to-ten

years.

Since Eli Lilly and Genentech forged the first truly ‘strategic’ licensing agreement

almost 30 years ago (Humulin, 1978), the licensing deal has been a fundamental

part of every pharmaceutical and biotechnology company’s strategy.

The pharmaceutical industry remains one of the most risky industries in the world,

with the licensing agreement providing the best safeguard for managing, or at least

sharing, some of the inherent risks involved with pharmaceutical R&D.

Given its relative infancy, the strategic alliance – one that involves some level of

ongoing collaboration between partners – has grown in frequency, value and

complexity over the past 20 years or so.

Licensing trends

A pharmaceutical company’s limited resources to manage inter-company

relationships and collaborative projects places an upper limit to the number of

different agreements that can formed each year. However, there has been a

consistent increase in average deal values between 2002 and 2005, likely to be the

result of deal sizes increasing to include multiple development compounds. It

appears that the leading pharmaceutical companies have determined that the size

and quality of the deal is more important than signing a greater number of deals.

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2001 was at the height of the ‘golden age’ for biotechnology, where company

valuations were high and every pharmaceutical company wanted to access their

technologies. However, a period of rationalization in the following three years saw

the leading pharmaceutical companies turn away from risky biotechnology

companies and back to more traditional, but relatively less risky, pharmaceutical

partners. However, 2005 saw a shift in licensing activity by partner, with leading

pharmaceutical companies significantly increasing licensing activity with biotech

partners at the expense of intra-pharmaceutical deals.

As with deal numbers and deal values, the proportion of relationship-based

alliances was also high in 2001, before falling and steadily increasing to a new peak

in 2005. Again, these trends appear to confirm the leading pharmaceutical

companies’ new found confidence in committing to long-term alliances.

The greatest growth in product-based pharmaceutical licensing over the past four

years has been in agreements involving cancer therapies. Many biotech approaches,

including monoclonal antibodies and growth factors, have their most valuable

applications in the treatment of cancer.

Licensing agreements in later stages, particularly in phase II, appear to be driving

growth in licensing activity over the past five years. This trend is consistent with

the increased maturity of the biotech sector and the emergence of biotech

companies with the resources and capabilities to develop lead drugs to later stages

of clinical development before seeking a pharmaceutical partner.

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Licensing process

Growth in the number of companies involved in chasing each licensing agreement

will lead to increased pressure on licensing lead times, requiring greater levels of

resources to be committed to the identification and evaluation of potential

opportunities and partners.

Deal failure is often the result of one or more partners not clearly identifying their

strategic aims for a licensing deal. Pharmaceutical companies must not enter into an

agreement without having determined that the licensing opportunity satisfies a real

and valuable objective for the company.

Having a clear understanding of what you can and cannot offer potential partners is

critical in order not to over promise or waste time negotiating over the wrong deal

with the wrong partner.

Many small, but ambitious biotechnology companies have managed to do a good

job with the preparation of presentation materials and the identification of target

licensing partners only to make a bad job of establishing a first contact with the

company and failing to make any further progress.

If you are a small biotech looking to agree a blockbuster late-stage licensing

agreement with a top 10 pharmaceutical company you can either spend money on a

good lawyer now to negotiate and agree a favorable contract or spend double the

money later down the line having to continually defend claims from your eventual

licensing partner.

Biotech companies look towards specialist agencies and key investors, such as

venture capitalists, in order to support the licensing process. Pharmaceutical

companies appear to have greater levels of licensing resources and expertise in-

house, with the majority completing the entire licensing process without outside

help.

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Licensing valuations

According to a survey of 142 licensing executives, pharmaceutical companies are

more likely than biotech companies to share financial evaluations during licensing

negotiations, with more than 80% of companies sharing at least a single point

financial projection and almost 50% sharing a more detailed probabilistic

evaluation.

The most common evaluation technique used in determining optimal deal terms is a

discounted cash flow net present value (NPV) calculation, which is used in more

than 70% of companies according to surveyed licensing executives.

A deal-making valuation model is one used specifically to agree licensing terms

between partners. While the approach might be similar to that used to provide

recommendations for selecting the most valuable licensing opportunities to pursue

the outputs of the model are quite different.

If the inputs into the valuation model cannot be agreed upon by both licensing

parties then the outputs of the exercise will not provide any common ground for

negotiation. Similarly, if the modeling approach and any assumption are not clear

and defendable then the effective use of the evaluation model for negotiation will

be limited.

The first test as to whether two companies are going to be successful in

collaborating together as part of a strategic licensing agreement is whether or not

they are able to negotiate an agreement based on significant common ground. If

two companies are unable to agree upon the true value of the licensing asset and

subsequently on the fair distribution of risks, returns and responsibilities then there

is little hope that they will be able to reach a satisfactory conclusion once the real

work of implementing a licensing deal begins.

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Licensing best practices

With no two drugs or partnerships the same, there are no hard-and-fast rules for

successful pharmaceutical licensing. Lessons can be learned by looking at the

leading deals and deal-makers, but the application of best practices must always be

directed by the specifics of the deal, rather than reverting to a list of generalized

benchmarks.

The leading strategic pharmaceutical licensing deal, mentioned by the greatest

number of surveyed licensing executives, is the ongoing relationship between

Roche and Genentech. Over the course of the 16 year relationship Roche has

acquired non-US marketing rights to a range of Genentech products, including

Rituxan (rituximab) in 1995, Herceptin (trastuzumab) in 1998 and Avastin

(bevacizumab) in 2003.

Novartis was considered to be the in-licensing partner of choice in 2006. The

company has worked hard to position itself as a preferred licensing partner,

employing a structured process providing a quick evaluation of opportunities and

the early involvement of senior management to expedite decision-making. As part

of this standard review process, Novartis employs a single gateway for all

opportunities allowing for improved coordination and contact management.

Cephalon was considered to be the out-licensing partner of choice in 2006.

Cephalon’s licensing model of acquiring rights to marketed products in order to

generate revenues cash flow to help fund the development of in-house products

appears to have worked well. More importantly, as an out-licensor, the company

has been willing to share promotional rights for its lead products, particularly in the

US and Japan, in order to maximize the returns from its internal assets.

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CHAPTER 1

Introducing pharmaceutical licensing

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Chapter 1 Introducing pharmaceutical licensing

Summary

With falling R&D productivity and continued healthcare cost containment and generic competition pushing down the returns available for successfully launched products, only those companies able to complement internal efforts with a strong partnering strategy will be able to remain competitive over the next five-to-ten years.

Since Eli Lilly and Genentech forged the first truly ‘strategic’ licensing agreement almost 30 years ago (Humulin, 1978), the licensing deal has been a fundamental part of every pharmaceutical and biotechnology company’s strategy.

The pharmaceutical industry remains one of the most risky industries in the world, with the licensing agreement providing the best safeguard for managing, or at least sharing, some of the inherent risks involved with pharmaceutical R&D.

Given its relative infancy, the strategic alliance – one that involves some level of ongoing collaboration between partners – has grown in frequency, value and complexity over the past 20 years or so.

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Introduction

Pharmaceutical licensing strategies: Best practices in deal-making, valuations and

strategic management provides a detailed analysis of licensing strategies in the

pharmaceutical and biotechnology industries. The report draws upon deal-making trend

data, primary research survey results and a profile of best practices in pharmaceutical

licensing in order to present a set of actionable recommendations for optimizing deal-

making. With falling R&D productivity and continued healthcare cost containment and

generic competition pushing down the returns available for successfully launched

products, only those companies able to complement internal efforts with a strong

partnering strategy will be able to remain competitive over the next five-to-ten years.

The age of the partnership

The purpose of this report is to provide a strategic perspective on the increasingly

important area of pharmaceutical licensing. Questions the report attempts to answer

include:

Why is licensing important in the pharmaceutical and biotechnology industries?

What are the recent trends in pharmaceutical licensing activity?

What are best practices in developing a robust licensing process?

What can be done to optimize licensing deal values through collaborative

evaluations?

What does it take to become a partner of choice?

What lessons can be drawn from the key successful deals formed over the past 10

years?

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In order to answer these questions the report brings together research and analysis from

multiple sources. Leading deal-tracking databases including MedTRACK and

Recombinant Capital provide licensing trend data. A survey of 142 senior licensing

executives drawn from across the pharmaceutical and biotechnology industries

provides a real-time assessment of current licensing processes, practices and

expectations regarding future deal-making trends. Finally, company profiles and

licensing case studies provide a detailed insight into successful licensing strategies and

best practices.

Ever since Eli Lilly and Genentech forged the first truly ‘strategic’ licensing agreement

almost 30 years ago for recombinant insulin (Humulin, 1978), the licensing deal has

been a fundamental part of every pharmaceutical and biotechnology company’s

strategy. Licensing has been used to provide a more flexible mechanism through which

R&D, sales and marketing and, most important of all, revenue and income streams can

be balanced over time. The biotechnology industry could not exist on venture capital

alone, and the pharmaceutical industry would be in a sorry state without the

breakthrough innovations licensed from biotech companies. The pharmaceutical

industry remains one of the most risky industries in the world, with the licensing

agreement providing the best safeguard for managing, or at least sharing, some of the

inherent risks involved with pharmaceutical R&D.

The strategic alliance – one that involves some level of ongoing collaboration between

partners – has grown in frequency, value and complexity over the past 20 years or so.

Much of the growth in pharmaceutical licensing is linked to the emergence and

development of the biotechnology industry, with deal-making activity broadly tracking

funding levels and valuations for biotechnology companies. An illustration of the rise

in value and complexity of strategic licensing is provided by the 2001 agreement for

Erbitux between Bristol-Myers Squibb and ImClone Systems. Nothing illustrates the

importance, value and complexity of pharmaceutical licensing better than a story that

starts with a headline value of US$2 billion and concludes with an initial non-

approvable letter from the Food and Drug Administration (FDA), a rewrite of the

licensing contract and, as a sub-plot, jail time for one the key protagonists.

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Definitions

The term ‘strategic pharmaceutical licensing’ presents many questions regarding scope

and interpretation. In order to avoid confusion the following definitions of key terms

can be applied throughout the remainder of the report:

License – an agreement between two or more parties relating to the ownership of

intellectual property (IP) rights, and in particular those rights pertaining to a

technology, development compound or marketed product;

Pharmaceutical license – an agreement as above that involves IP rights relating to a

pharmaceutical technology, development compound or marketed product. For the

purposes of this report a pharmaceutical license is used as an umbrella term to

include IP relating to both pharmaceutical and biotechnology products and

technologies;

Strategic license – an agreement as above that also involves an ongoing

collaboration between partners, such as a co-development or co-commercialization

agreement;

Licensing – the act of forming a license, relating either to process or ongoing

activity in forming licenses;

Deal-making – see licensing above;

In-licensing – the act of acquiring the rights to a technology or product;

In-licensor – the company acquiring rights to a technology or product;

Out-licensing – the act of divesting the rights to a technology or product;

Out-licensor – the company divesting rights to a technology or product.

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Report outline

The report has been divided into four key sections. The licensing trends chapter

presents an overview of recent trends in pharmaceutical licensing and details industry

expectations for future deal-making. The licensing process chapter provides a practical

guide to pharmaceutical licensing and sets out the different phases involved in optimal

deal-making for both in- and out-licensors. The licensing valuations chapter outlines a

simple licensing valuation model based on independent sources to support negotiation

and deal-making efforts between prospective partners. Finally, the licensing best

practices chapter presents a set of detailed cases studies for successful licensing deals

and leading licensing partners in order to provide key lessons for optimizing strategic

pharmaceutical licensing.

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CHAPTER 2

Licensing trends

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Chapter 2 Licensing trends

Summary

A pharmaceutical company’s limited resources to manage inter-company relationships and collaborative projects places an upper limit to the number of different agreements that can formed each year. However, there has been a consistent increase in average deal values between 2002 and 2005, likely to be the result of deal sizes increasing to include multiple development compounds. It appears that the leading pharmaceutical companies have determined that the size and quality of the deal is more important than signing a greater number of deals.

2001 was at the height of the ‘golden age’ for biotechnology, where company valuations were high and every pharmaceutical company wanted to access their technologies. However, a period of rationalization in the following three years saw the leading pharmaceutical companies turn away from risky biotechnology companies and back to more traditional, but relatively less risky, pharmaceutical partners. However, 2005 saw a shift in licensing activity by partner, with leading pharmaceutical companies significantly increasing licensing activity with biotech partners at the expense of intra-pharmaceutical deals.

As with deal numbers and deal values, the proportion of relationship-based alliances was also high in 2001, before falling and steadily increasing to a new peak in 2005. Again, these trends appear to confirm the leading pharmaceutical companies’ new found confidence in committing to long-term alliances.

The greatest growth in product-based pharmaceutical licensing over the past four years has been in agreements involving cancer therapies. Many biotech approaches, including monoclonal antibodies and growth factors, have their most valuable applications in the treatment of cancer.

Licensing agreements in later stages, particularly in phase II, appear to be driving growth in licensing activity over the past five years. This trend is consistent with the increased maturity of the biotech sector and the emergence of biotech companies with the resources and capabilities to develop lead drugs to later stages of clinical development before seeking a pharmaceutical partner.

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Introduction

Pharmaceutical licensing has undergone significant changes over the past 20-30 years.

Trends in deal-making activity have shown an increase in the value and number of

licensing agreements, while the types of company involved, stage of development of

the deal subject and complexity of the agreement have also changed significantly.

Today’s strategic licensing deals are more valuable, numerous and complex than ever

before, and as a consequence companies must build competences in the licensing field

in order to support these trends.

Headline deal trends

The number and average value of licensing deals involving the top 10 pharmaceutical

companies both increased between 2001 and 2005, as shown in Figure 2.1. The top 10

companies were considered to be those with the highest pharmaceutical product sales

in 2005 (Pfizer, Sanofi-Aventis, GlaxoSmithKline, AstraZeneca, Johnson & Johnson,

Roche, Merck & Co., Novartis, Wyeth and Bristol-Myers Squibb), with all licensing

activity for companies acquired by the top 10 companies between 2001 and 2005

consolidated over the period.

Average deal values for the top 10 pharmaceutical companies have risen consistently

between 2002 and 2005. Average deal values are based on the headline deal values

released by partnering companies at the time of signing an agreement. As a result these

deal values often refer to the maximum potential deal value and usually exclude any

royalty payments to be paid once a drug is brought to market.

The number of licensing deals involving top 10 pharmaceutical companies has both

increased and decreased at different periods between 2001 and 2005. While licensing

activity in 2005 is the highest it has been over the five years, similar peaks were

reached in 2001 and 2003.

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Figure 2.1: Number and average value of top 10 pharmaceutical company licensing deals, 2001-2005

300285

297273

304

172149

170187

266

0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005

Num

ber

of d

eals

0

50

100

150

200

250

300

350

Average deal value ($ m

illion)

Number of deals Average deal value ($ million)

Source: MedTRACK Deals & Alliances database Business Insights Ltd

By looking at an analysis of the top 10 pharmaceutical companies only, we can see that

the number of licensing deals that have been signed by any one company appears to

have reached a plateau between 2001 and 2005. While an average of 30 deals per

company is significantly more than would have been seen 20 or even 10 years ago,

licensing activity in the leading companies appears to have reached a natural limit. A

company’s limited resources and abilities to manage inter-company relationships and

collaborative projects places an upper limit on the number of different agreements that

can formed each year. However, it is noticeable that there has been a consistent

increase in average deal values between 2002 and 2005. This is likely to be the result

of deal sizes increasing to include multiple development compounds. It appears that the

leading pharmaceutical companies have determined that the size and quality of the deal

is more important than driving increases in the number of deals. As a result, the same

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number of licensing partners are providing a greater level of licensing value over a

greater number of licensed compounds.

Around two thirds of the 142 licensing executives surveyed for this report considered

the number of pharmaceutical licensing deals likely to increase during 2006, as shown

in Figure 2.2. This increase in licensing agreements was considered likely to be higher

in the biotechnology industry than in the pharmaceutical industry. It appears that there

is significant room for growth in licensing activity in the pharmaceutical and

biotechnology markets, but growth will be primarily driven by smaller companies

building up their licensing capabilities and increasing their deal-making activity to the

levels found in established pharmaceutical and biotech companies.

Figure 2.2: Expected change in number of licensing deals during 2006

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Pharma Biotech Other Overall

Pro

port

ion

of s

urve

y re

spon

dent

s

Increasesignificantly

Increasesomewhat

Stay roughlythe same

Decreasesomewhat

Decreasesignificantly

Source: Business Insights Licensing Trends Survey, 2006 Business Insights Ltd

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The slowest level of growth in licensing activity is expected in specialty, drug delivery,

generics and diagnostic companies. These companies are either well-established

licensors, such as specialty and drug delivery companies, or are in industry sectors

where licensing plays a less important role, such as generics and diagnostic products.

Around 60% of surveyed licensing executives expect average deal values to increase in

2006, as shown in Figure 2.3. Again, the likely increase is considered to be higher for

biotech companies than for pharmaceutical companies. Only a very small percentage of

survey respondents (just over 10%) expect deal values to decrease in 2006. Trends in

increased average deal values found over the past four years appear set to be continued

in the near future.

Figure 2.3: Expected change in average value of licensing deals during 2006

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Pharma Biotech Other Overall

Pro

port

ion

of s

urve

y re

spon

dent

s

Increasesignificantly

Increasesomewhat

Stay roughlythe same

Decreasesomewhat

Decreasesignificantly

Source: Licensing trends survey, 2006 Business Insights Ltd

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Alongside increases in industry deal numbers and headline values, it also appears that

pharmaceutical licensing deals are becoming more complex. In 2004, GlaxoSmithKline

and Theravance signed a multi-compound, multi-therapy area deal that involved

sophisticated financial put and call options on Theravance shares in support of the

biotech company’s imminent initial public offering (IPO). Other deals involving major

equity stakes and multiple, cross-portfolio compounds include the 2003 agreement

between Novartis and Idenix and the landmark agreement between Genentech and

Roche, first signed in 1990 and revised in 1995. Sliding royalty rates, contingent equity

valuations and complex territorial and market splits for co-developed and co-promoted

compounds are fast becoming the norm. Those companies not able to negotiate their

way through these sophisticated deal terms will quickly find themselves on the wrong

end of a bad deal.

Licensing deal partners

Between 2001 and 2005 it appears that the leading pharmaceutical companies have

returned back to the biotech industry as a source for licensing. 2001 was at the height

of the ‘golden age’ for biotechnology, where company valuations were high and every

pharmaceutical company wanted to access their technologies. However, a period of

rationalization in the following three years saw the leading pharmaceutical companies

turn away from the more risky biotechnology companies and back to more traditional,

but relatively less risky, pharmaceutical partners. However, as shown in Figure 2.4,

2005 saw a shift in licensing activity by partner, with leading pharmaceutical

companies significantly increasing licensing activity with biotech partners at the

expense of intra-pharmaceutical company deals.

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Figure 2.4: Number of top 10 pharmaceutical company licensing deals by partner, 2001-2005

50 63 63 51 57

115106 106

100

157

135 116 128122

90

0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005

Num

ber

of to

p 10

pha

rma

licen

sing

dea

ls

Pharma

Biotech

Other

16.7%22.1% 21.2% 18.7% 18.8%

38.3%37.2% 35.7% 36.6%

51.6%

45.0% 40.7% 43.1% 44.7%

29.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Prop

ortio

n of

top

10 p

harm

a lic

ensi

ng d

eals

Pharma

Biotech

Other

Source: MedTRACK Deals & Alliances database Business Insights Ltd

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Over the last five years the biotechnology industry has matured to become a tried and

tested source for good science and collaborative development. This has been helped

along by a period of consolidation in the industry to allow stronger biotech companies

to emerge with full pipelines and robust development capabilities. Both pharmaceutical

and biotech companies stand to benefit as a result of increased licensing activity

between the two – with pharmaceutical companies gaining access to innovative and

valuable compounds and biotech companies receiving improved deal values and long-

term collaborative partners.

Taking a look from the other side of the industry, the trends for the top 10 biotech

companies based on total 2005 revenues (Amgen, Genentech, Genzyme, Serono, CSL,

Biogen Idec, Gilead, Chiron, MedImmune and Cephalon) appear to closely mimic

those found in leading pharmaceutical companies. As was the case for the top 10

pharmaceutical companies, licensing activity for the top 10 biotech companies in 2005

saw an increase in the number of deals signed with other biotechnology companies.

Interestingly, it appears that the leading biotechnology companies are not behind the

increase in pharmaceutical-biotech licensing found for the top 10 pharmaceutical

companies, with the number of deals between leading biotech companies and

pharmaceutical companies decreasing consistently between 2003 and 2005, as shown

in Figure 2.5. It is clear that leading pharmaceutical and biotechnology companies are

much less likely to partner amongst themselves than they are to partner with smaller

companies that represent less of a strategic, competitive threat.

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Figure 2.5: Number of top 10 biotech company licensing deals by partner, 2001-2005

8 11 8 918

41 3432 33

48

30 35 4232

26

0

10

20

30

40

50

60

70

80

90

100

2001 2002 2003 2004 2005

Num

ber o

f top

10

biot

ech

licen

sing

dea

ls

Pharma

Biotech

Other

10.1% 13.8% 9.8% 12.2%19.6%

51.9% 42.5%39.0%

44.6%

52.2%

38.0%43.8%

51.2%43.2%

28.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Pro

port

ion

of to

p 10

bio

tech

lice

nsin

g de

als

Pharma

Biotech

Other

Source: MedTRACK Deals & Alliances database Business Insights Ltd

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31

As a proportion of all biotech out-licensing deals, other biotech partners continue to

provide just over 60% of all licensing partners, as shown in Figure 2.6. This proportion

has been on the increase over the previous two years, and is consistent with the figures

for leading biotech companies in Figure 2.5. However, with trends in licensing activity

for the top 10 pharmaceutical companies showing an increase in the number of deals

signed between leading pharmaceutical companies and biotech companies it appears

that the growth in biotech licensing is greater for intra-biotech deals than for pharma-

biotech deals. It is also evident that smaller pharmaceutical companies are not yet fully

embracing the renewed interest in biotech licensing found in their larger contempories.

Figure 2.6: Number of biotech out-licensing deals by partner, 2001-2005

41.7% 41.4% 44.7% 43.1% 39.4%

58.3% 58.6% 55.3% 56.9% 60.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Pro

port

ion

of b

iote

ch o

ut-li

cens

ing

part

ners

Biotech

Pharma

Source: Recombinant Capital, Analyst’s Notebook Business Insights Ltd

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Licensing deal types

In order to better understand trends in pharmaceutical licensing agreements signed over

the past five years three key categorizations were used:

License/acquisition – including all agreements that involve a simple transaction

involving intellectual property (IP) rights;

R&D/S&M – including all agreements involving a transactional exchange of IP

rights and some exchange of expertise and know-how;

Collaboration – including all agreements involving a significant, ongoing

relationship, either in R&D or marketing and sales.

For the top 10 pharmaceutical companies, there has been a move away from simple

licensing/acquisition deals towards more relationship-based alliances involving

collaborative R&D and sales and marketing, as shown in Figure 2.7. As with deal

numbers and deal values, the proportion of relationship-based alliances was also high

in 2001, before falling and steadily increasing to a new peak in 2005. Again, these

trends appear to confirm the leading pharmaceutical companies’ new found confidence

in committing to long-term alliances. The smaller number of simple

license/acquisitions in 2005 is also representative of a down-turn in pharmaceutical

mergers and acquisitions, which are often followed by portfolio consolidation and the

divestment of overlapping products/compounds.

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Figure 2.7: Number of top 10 pharmaceutical company licensing deals by deal type, 2001-2005

5634 44

2040

7491 83

8873

7968

95

87 86

9192

75

78105

0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005

Num

ber

of to

p 10

pha

rma

licen

sing

dea

ls

Collaboration

R&D/ S&M

License/acquisition

Others

18.7%11.9% 14.8%

7.3%13.2%

24.7%31.9% 27.9%

32.2% 24.0%

26.3% 23.9%32.0%

31.9%28.3%

30.3% 32.3%25.3% 28.6%

34.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Pro

port

ion

of to

p 10

pha

rma

licen

sing

dea

ls

Collaboration

R&D/ S&M

License/acquisition

Others

Source: MedTRACK Deals & Alliances database Business Insights Ltd

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For the top 10 biotech companies, the five-year trend towards relationship licenses is

similar to that found for the leading pharmaceutical companies. As shown in Figure

2.8, the leading biotech companies have increased the number of R&D/S&M

agreements at the expense of simple license/acquisition agreements. Interestingly, the

number of collaborative agreements has remained relatively unchanged between 2001

and 2005 – likely to be a function of big biotech turning to smaller biotech to drive

growth in their licensing activity over the past five years. Big biotech have grown to

reach a critical mass and can now avoid having to sign collaborative out-licensing

agreements in order to bring their drugs to market. At the same time, the leading

biotech companies have increased R&D/S&M licensing activity, particularly with other

smaller biotech companies, in order to fill their pipelines and maintain a throughput in

R&D.

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Figure 2.8: Number of top 10 biotech company licensing deals by deal type, 2001-2005

158 11 15

29

2324 15

21

2417 30

20

30

26 2520

28

26

0

10

20

30

40

50

60

70

80

90

100

2001 2002 2003 2004 2005

Num

ber o

f top

10

biot

ech

licen

sing

dea

ls

Collaboration

R&D/ S&M

License/acquisition

Others

18.8%9.8%

14.9% 16.3%

36.7%

28.8%

29.3% 20.3% 22.8%

30.4%21.3% 36.6%

27.0%

32.6%

32.9% 31.3%24.4%

37.8%28.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Prop

ortio

n of

top

10 b

iote

ch li

cens

ing

deal

s

Collaboration

R&D/ S&M

License/acquisition

Others

Source: MedTRACK Deals & Alliances database Business Insights Ltd

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Licensing deal subjects

More than 20% of all product-based pharmaceutical licensing agreements signed

between 2001 and 2005 involved cancer indications, as shown in Figure 2.9.

Agreements involving infections and central nervous system (CNS) indications

accounted for approximately 14% each, followed by cardiovascular and circulatory

system indications and autoimmune and inflammation indications.

Figure 2.9: Proportion of product-based licensing deals by therapy area, 2001-2005

20.5%

13.9%

13.8%

8.4%

7.6%

6.7%

6.2%

5.2%

4.0%

3.7%

Cancer

Infections

Central Nervous System

Cardiovascular and Circulatory System

Autoimmune and Inflammation

Metabolic/ Endocrinology

Dermatology

Respiratory and Pulmonary System

Digestive System

Blood and Lymphatic System

Proportion of product-based licensing agreements, 2001-2005

Source: MedTRACK Deals & Alliances database Business Insights Ltd

The greatest level of growth in product-based pharmaceutical licensing over the past

four years has been in agreements involving cancer therapies, as shown in Figure 2.10.

As a share of all product-based licensing, cancer indications have grown to the levels

found in 2001, closely matching trends found for biotech licensing in general. Many

biotech approaches in monoclonal antibodies and growth factors have their most

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valuable applications in the treatment of cancer. Other areas of licensing growth can be

found in infections and autoimmune and inflammation indications, particularly in 2005.

Leading therapy areas with more disappointing licensing growth rates include CNS and

cardiovascular and circulatory system. With pharmaceutical licensing often involving

agreements for the most successful R&D projects available, deal trends by therapy area

provide a good indication of current and future R&D trends. It appears clear that we are

likely to see some significant growth in the number of late stage cancer therapies

coming through the pipeline, with more disappointing growth rates anticipated for CNS

and cardiovascular and circulatory system therapies.

Figure 2.10: Number of product-based licensing deals by therapy area, 2001-2005

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

2001 2002 2003 2004 2005

Prop

ortio

n of

pro

duct

-bas

ed li

cens

ing

deal

s

CancerInfectionsCentral Nervous SystemAutoimmune and InflammationCardiovascular and Circulatory System

Source: MedTRACK Deals & Alliances database Business Insights Ltd

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By stage of development, there has been some recent movement towards pre-clinical

licensing in 2005, as shown in Figure 2.11. More generally, there has been trend in

licensing activity from phase II to phase I licensing over the period 2001 and 2005. The

general share of R&D licensing for phase III compounds has remained relatively

unchanged over the five-year period at around 20%.

Figure 2.11: Number of R&D licensing deals by development stage, 2001-2005

19.4% 19.7% 23.7% 20.2%28.3%

16.2% 17.8%19.5%

20.5%

18.0%

42.6% 39.4%38.3%

37.2%34.5%

21.8% 23.2% 18.5% 22.0% 19.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Pro

port

ion

of R

&D

licen

sing

dea

ls Phase III

Phase II

Phase I

Pre Clinical

Source: MedTRACK Deals & Alliances database Business Insights Ltd

Looking at biotech R&D licensing deals specifically, there appears to have been a

significant trend towards later stage deals between 2001 and 2005, as shown in Figure

2.12. For biotech R&D licensing deals, the proportion of agreements signed in phase II

or later has grown from less than 20% in 2001 to almost 30% in 2005. Licensing

agreements in later stages, particularly in phase II, appear to be driving growth in

licensing activity over the past five years. This trend is consistent with the maturing of

the biotech sector and the emergence of biotech companies with the resources and

capabilities to develop lead drugs to later stages of clinical development before seeking

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a pharmaceutical partner. As a consequence of this trend, the value of licensing deals

will inevitably increase as the risk involved with compounds found at later stages of

development is reduced. The increased number of licensing candidates available at

later stages of clinical development also helps to explain the stagnant growth in the

number of agreements been signed by major companies. It is now possible for

pharmaceutical companies to limit risk by in-licensing a single phase II compound

rather than licensing two phase I compounds or a handful of preclinical opportunities.

It appears that the biotech industry is better prepared to bear the costs of unsuccessful

early stage compounds alone in order to share higher rewards with its partners for

successful compounds in later stages of development.

Figure 2.12: Number of biotech R&D licensing deals by development stage, 2001-2005

73.2%66.0% 63.7%

56.9% 59.0%

7.4%10.5%

9.9%13.1% 11.7%

19.4% 23.5% 26.4% 30.0% 29.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2002 2003 2004 2005

Prop

ortio

n of

R&D

lice

nsin

g de

als

Phase IIand above

Preclinical/Phase I

Research

Source: Recombinant Capital, Analyst’s Notebook Business Insights Ltd

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CHAPTER 3

Licensing process

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Chapter 3 Licensing process

Summary

Growth in the number of companies involved in chasing each licensing agreement will lead to increased pressure on licensing lead times, requiring greater levels of resources to be committed to the identification and evaluation of potential opportunities and partners.

Deal failure is often the result of one or more partners not clearly identifying their strategic aims for a licensing deal. Pharmaceutical companies must not enter into an agreement without having determined that the licensing opportunity satisfies a real and valuable objective for the company.

Having a clear understanding of what you can and cannot offer potential partners is critical in order not to over promise or waste time negotiating over the wrong deal with the wrong partner.

Many small, but ambitious biotechnology companies have managed to do a good job with the preparation of presentation materials and the identification of target licensing partners only to make a bad job of establishing a first contact with the company and failing to make any further progress.

If you are a small biotech looking to agree a blockbuster late-stage licensing agreement with a top 10 pharmaceutical company you can either spend money on a good lawyer now to negotiate and agree a favorable contract or spend double the money later down the line having to continually defend claims from your eventual licensing partner.

Biotech companies look towards specialist agencies and key investors, such as venture capitalists, in order to support the licensing process. Pharmaceutical companies appear to have greater levels of licensing resources and expertise in-house, with the majority completing the entire licensing process without outside help.

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Introduction

The pharmaceutical licensing process is both lengthy and complex. Whether

approaching licensing in order to acquire or divest intellectual property, there are five

key steps that must be completed on the way to agreeing a successful licensing deal.

Pharmaceutical companies must determine a clear licensing strategy, identify

appropriate opportunities, evaluate those opportunities, negotiate favorable terms and

then ensure agreements are successfully implemented and managed.

A complex process

Pharmaceutical licensing is a complex process involving the identification and

valuation of multiple potential opportunities and partners. More than 75% of surveyed

licensing executives expect the number of potential partners chasing each licensing

deal to increase in 2006, as shown in Figure 3.13. Growth in the number of companies

involved in chasing each licensing agreement will lead to increased pressure on

licensing lead times, with greater levels of resources required for the identification and

evaluation of potential opportunities and partners. With more companies chasing each

deal, in-licensing companies will inevitably have to expand their initial opportunity

screening numbers in order to maintain the same levels of successful deals at the end of

the process. As shown in Figure 3.14, more than 25% of surveyed licensing executives

expect the average time taken to complete the licensing process to increase in 2006,

with less than 20% expecting the time to decrease.

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Figure 3.13: Expected change in number of potential partners chasing each licensing deal during 2006

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Pharma Biotech Other Overall

Pro

port

ion

of s

urve

y re

spon

dent

s

Increasesignificantly

Increasesomewhat

Stay roughlythe same

Decreasesomewhat

Decreasesignificantly

Source: Licensing trends survey, 2006 Business Insights Ltd

Figure 3.14: Expected change in the length of time required to complete a licensing deal during 2006

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Pharma Biotech Other Overall

Prop

ortio

n of

sur

vey

resp

onde

nts

Increasesignificantly

Increasesomewhat

Stay roughlythe same

Decreasesomewhat

Decreasesignificantly

Source: Licensing trends survey, 2006 Business Insights Ltd

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In-licensing versus out-licensing

While in-licensing or inward licensing is a very different proposition to out-licensing or

outward licensing, the key stages through which companies must progress as part of the

licensing process are similar. As shown in Figure 3.15, the licensing process always

begins with a review of strategy. Setting out the strategic aims for licensing is essential

in determining the direction and value benchmarks for subsequent phases of the

process. Identifying opportunities means slightly different things to the in- and out-

licensor, but involves a similar process of identifying and reviewing potential

compounds/ technologies (for the in-licensor) or potential partners (for the out-

licensor) in order to begin approaching and evaluating those opportunities.

Licensing valuations provide both a selection and deal structuring tool. Once a list of

possible opportunities has been identified, some degree of evaluation must be

undertaken in order to begin prioritizing those of greatest value in order to determine

which opportunities should be pursued further or require more detailed scrutiny. Good

licensing valuations also provide an essential input into the deal-making and agreement

stage of the licensing process, helping to structure terms and values in order to reach a

satisfactory agreement between licensing partners. Finally, it is important not to forget

that the licensing process does not stop once signatures are added to a contract. The

real hard work begins when agreements are being implemented and when problems

arise that require solutions. In order to make sure all previous phases of the licensing

process help to endorse good post-deal relations between licensing partners, it is

important that deal outcomes are regularly fed-back to those charged with the

responsibility for earlier phases of the licensing process. Licensing is an iterative

process, whereby each deal provides lessons to inform better deal-making in the future.

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Figure 3.15: The pharmaceutical licensing process

Licensingstrategy

Post-deal managementand analysis

Deal-making andagreement

Licensingevaluations

Opportunityidentification

What are our limitations?What are our needs?

What could be donebetter next time?

What are my target/ acceptable risks, returns

and responsibilities?

What is the value?What is the value to us?

What have I got?Who will value it?

Where are the gaps?What can we offer?

What could be donebetter next time?

What are my target/ acceptable risks, returns

and responsibilities?

What is the value?What is the value to us?

What do we need?Where will we find it?

In-licensing Out-licensing

Licensingstrategy

Post-deal managementand analysis

Deal-making andagreement

Licensingevaluations

Opportunityidentification

What are our limitations?What are our needs?

What could be donebetter next time?

What are my target/ acceptable risks, returns

and responsibilities?

What is the value?What is the value to us?

What have I got?Who will value it?

Where are the gaps?What can we offer?

What could be donebetter next time?

What are my target/ acceptable risks, returns

and responsibilities?

What is the value?What is the value to us?

What do we need?Where will we find it?

In-licensing Out-licensing

Source: Author’s research and analysis Business Insights Ltd

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Licensing strategy

Deal failure is often the fault of one or more partners not clearly identifying their

strategic aims from a licensing deal. This does not mean that all deals have to be led by

top-down strategic management, nor does it mean that there is no room for

opportunistic deal-making that arises out of serendipity, rather than rigorous strategic

evaluations. However, companies must not enter into an agreement without having

determined that the licensing opportunity satisfies a real and valuable set of objectives

for the company, which from a portfolio perspective represents a sound investment

when compared with the strategic alternatives.

Licensing presents an integral part of today’s corporate strategy for pharmaceutical

companies. Drug development is a long-term game that involves significant rewards,

but only after undertaking costly investments over a long time period with a great risk

of failure. In the current pharmaceutical environment, where investors require returns

in both the long and short term, but where much of the ‘low hanging fruit’ for drug

discovery and development has been exploited, licensing provides companies, large

and small, with ways to limit costs and risk and bring about new products or revenue

streams more quickly.

Portfolio management will continue to be the catalyst for building a balanced portfolio

and maintaining strategic alignment across therapy areas, geographies and time-scales.

However, licensing has emerged as an effective tool for establishing alignment,

particularly where changes and adjustments are required over a short time period. The

unforeseen failure of a key product in phase III trials is difficult to compensate for with

an injection of R&D investment into a given therapy area. However, the in-licensing of

a similar late stage project or the out-licensing of the failed project for development in

other indications or by a company with lower ‘success’ thresholds provide real

compensatory actions that serve to balance the strategic aims of the company over a

short time period.

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Formulating a good licensing strategy is really a process of determining where you are

as a company today and where you would like to be in the future. The difference

between the two serves as a set of objectives for future licensing activity. Key areas of

analysis involve:

Therapy area and physician profiles – understanding in which areas a company has

strengths and deficiencies based on the current portfolio and pipeline of new drugs;

Resources and financing – determining the excess or shortfall in the amount of

money and resource capacity available compared with the amount required;

R&D pipeline – entering new indication or supporting new brands with follow-up

drugs by accessing either additional marketing expertise or additional products in

specific markets;

Geographical coverage – maximizing the sales of key products across geographies,

particularly those in which companies have no established in-house sales force;

Drug delivery/ line extensions – partnering with drug delivery companies in order

to enhance the formulation of a product in order to extend its life-cycle;

R&D technology platforms – understanding current R&D capabilities and the

potential productivity benefit of novel platforms, such as proteomics or

nanotechnology.

Once a strategic review has been completed, the resulting licensing strategy needs to be

presented to and agreed upon by senior management. The licensing strategy serves two

purposes: it provides internal clarity on what needs to be done, but also provides

potential partners with the reassurance that the company is committed to a clear

strategy and is unlikely to under-resource either the licensing process or post-deal

implementation.

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Having a clear understanding of what you can and cannot offer potential partners is

critical in order not to over promise or waste time negotiating the wrong deal with the

wrong partner.

Opportunity identification

Pharmaceutical licensing is best understood using the analogy of a dating agency.

There are two key functions to perform – the presentation of yourself as a potential

partner and the selection of appropriate profiles of potential partners. No matter how

much effort is put into these two functions, the process for identifying licensing

opportunities is not an exact science and is therefore fraught with inflated expectations

and considerable disappointment. As with personal dating, pharmaceutical licensing

suffers from an unfortunate externality resulting from the inflation of expectations and

disappointment, which is that a highly skeptical opportunity screening process has

emerged.

As in the ‘market for lemons’ – a microeconomics paper written by Nobel laureate

George Akerlof about the market for second hand cars – if you cannot easily determine

whether an opportunity or partner is a good one you inevitably assume it is a bad one.

As such companies looking to present their compounds as good licensing opportunities

or themselves as good licensing partners must find new ways to credibly elevate

themselves above the mass of potential opportunities available for scrutiny. Saying you

are young, attractive and blonde but not attaching a photo will not work in attracting a

partner today. Companies need to demonstrate their strengths rather than simply listing

them as a proof of suitability.

The process of opportunity identification is somewhat different for in-licensing and

out-licensing.

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In-licensing

Companies looking to identify potential compounds/technologies for in-licensing must

first determine an appropriate set of search criteria with which to produce a manageable

list of potential opportunities. Having determined an agreed licensing strategy, broad

criteria regarding specific market sectors, geographies and development stages will

already provide the focus for the opportunity search. However, refinement of this list

will take into account a more targeted set of criteria including:

Do we have the required R&D capabilities for this product?

Do we have the required sales and marketing capabilities for this product?

Is the product likely to be made available for licensing?

Are we likely to be considered to be an attractive partner for this product?

A full list of search criteria – once an initial selection has been limited to the required

therapy area, geographies and development stages – are used to eliminate specific

opportunities. These would include the following:

Specific therapeutic classes and indications;

Geographic availability;

Development stage and expected launch dates;

Maximum and minimum projected sales performance;

Key performance objectives (once-a-day dosing, low side effects etc);

Risk profile (first in class, reformulation etc).

Identifying potential opportunities can involve significant research, but should be

carried out in a logical way using the criteria identified above. Sales and marketing

data, available from IMS Health or through other aggregators of product sales

information provides a useful tool for identifying potential opportunities.

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Given that a high proportion of licensing occurs for development compounds, some of

the best research sources for licensing opportunities are R&D databases such as

LifeScience Analytics’ MedTRACK, Informa’s PharmaProjects, ADIS R&D Insight

and IMS Health’s R&D Focus. Each has the ability to refine searches by indication,

technology, development stage and company. In this way, a short list of suitable targets

that meet these criteria can be formed. More detailed profiles for key drugs are also

found in a number of the main databases which can further refine choices around sales

projections and the likely risk involved with further development.

Aside from the desk research involving sales- and R&D-based database querying, the

main source for identifying potential opportunities is the old-fashioned route of

networking. There are a number of well-organized licensing network events and a

number of websites, such as Pharmalicensing, that are now providing networking short

cuts in order to pass-on details of available opportunities to potentially interested

parties. It is still the major responsibility of any licensing or business development

manager to form networks through which information about potential opportunities can

quickly be shared. Above and beyond the direct networks between licensing and

business development managers, there are significant roles to play for R&D managers

and regional marketing teams. R&D managers, in particular, are exposed to many new

developments and opportunities in the various therapy area-focused conferences and

industry journals. These can often provide excellent sources for identifying new

opportunities or for fleshing-out an early evaluation of a potential opportunity using the

most up-to-date information.

In order to reduce the broad list of potential licensing opportunities to a more

manageable size, a process of prioritization must be applied. A formal review stage is

undertaken using a series of licensing opportunity profiles. These profiles present the

relevant product information alongside status details for each of the key selection

criteria. These standardized profiles then form the basis for a formal discussion

regarding potential strategic fit, value and prioritization. As mentioned earlier, any

determination of opportunity value must include an introspective look at whether you

as a company can offer sufficient value to the partner to make it a valuable opportunity

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to them too. The prioritization of opportunities must include a realistic determination as

to the likely success of subsequent deal negotiations. A licensing opportunity profile

for a development compound should include the following:

Drug name (brand/ chemical);

Originator/owner;

Planned indication(s);

Intellectual property status;

Abstract (history, mechanism of action, potential competitive benefits etc);

Development status (global/ regional);

Market profile (size, key players etc);

Clinical profile (patient size, clinical targets etc).

Out-licensing

For out-licensing, companies must look to both identify and present their own

opportunities (compounds/technologies) as well as identify partnership opportunities

with other companies. Before preparing presentational material for a licensing

opportunity, a company looking to out-license must determine when and how to go

about it. Determining when to license a compound involves the consideration of many

factors such as how much risk and financial burden is the company able to bear and

how well equipped is that company to continue further development of a compound

alone. Deciding how to out-license a compound is often subject to the decision over

when to out-license. Licensing at an early stage of clinical development may involve

some element of co-development, but is unlikely to include the co-commercialization

of the compound once it reaches the market. However, a late stage compound in phase

III development is likely to yield significant returns for the out-licensor and include

both co-development and co-commercialization rights. Other types of ‘transactional’

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licensing with limited collaboration often occur in early stage development or involve

products been divested as part of post-merger anti-trust actions etc.

Having loosely determined the optimal window for licensing and the type of deal been

sought, a team of qualified staff need to be brought together to draft the presentational

licensing material or licensing prospectus. Usually this involves a non-confidential

dossier that can be provided to any and all interested parties, and a more detailed

confidential prospectus that is only shared after initial contact has been formed and the

appropriate confidentiality agreements have been signed.

The confidential prospectus will include all relevant data available to support the

product’s potential. For a development project this will focus on the expected clinical

profile, the associated regulatory risks and the status of patent claims. The main

sections to be included in the prospectus include:

Overview/summary – a one-to-two page summary presenting the key product

features and potential value;

Therapeutic rationale – an outline of the mechanism of action and how and why

this differs from other products;

Chemistry and pharmacy – an outline of the product’s chemistry including likely

formulations and manufacturing processes;

Intellectual process – a review of the current patent position, expiry dates and any

other intellectual property such as confidential information etc;

Experimental studies – a review of relevant data and observations from

experimental work, in vitro and in vivo studies and any comparative data;

Clinical development – an outline of clinical objectives, pharmacology and study

results including a detailed summary of completed pivotal studies;

Therapeutic potential – a review of the product’s commercial potential and how this

links with a significant market opportunity;

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Competitive potential – a detailed profile of the product’s expected dosing,

tolerance and efficacy for each indication, as well as likely launch dates.

A references and bibliography section is often included to help support some of the

claims made in the experimental data and clinical development sections and to provide

further references to papers not referenced within the core text of the prospectus.

The non-confidential brochure provides a more concise product summary (five-to-six

pages) aimed to encourage potentially suitable partners to make contact and find out

more information. A good non-confidential brochure would also provide enough

information to deter unsuitable partners from making contact and wasting time in

providing further information. Aside from brevity, there are two further differences

between the confidential prospectus and the non-confidential brochure. The first is that

some sensitive data may be removed from the latter document, replaced simply with

‘…more information is available under confidentiality’. The second difference is that

the wider audience exposed to the brief, non-confidential brochure will require a short

introduction to the company at large and not simply the product available for out-

licensing. The brochure should include a company section that outlines scientific and

commercial competences as well as key contact details.

When preparing presentational materials for marketed products the key difference is

the addition of more significant therapeutic and competitive potential sections. Market

data will already be available and this will be reflected in a more robust commercial

evaluation for the product in current or future potential markets.

The licensing brochure and prospectus form the primary mechanism for presenting a

potential out-licensing opportunity to potential partners. The second licensing

opportunity process involves the active identification of potential partners.

The first filter for identifying potential partners is to look for activity in the product’s

target market sectors. Who is currently marketing, developing or in-licensing products

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for the target therapy sector or physician group? Secondary considerations involve

understanding which companies are strong in targeted regional markets, such as the

US, Europe and Japan. The final, but often the most important screening, is

determining the closeness of fit between the licensing opportunity and the potential

licensing partner’s portfolio and pipeline strategy. Would the product add something of

value? Would the out-licensing partner be able to add something of value? Ideally, this

process should provide around 20 companies to actively target as preferred partners.

These potential partners must be contacted very carefully, as the wrong sort of

introduction with the wrong message to the wrong person may prove disastrous to

future communications and potential negotiations. Identifying opportunities includes

identifying the right approach to the right person within the short list of target

companies. Many small, but ambitious, biotechnology companies have managed to do

a good job with the preparation of presentation materials and the identification of target

licensing partners only to make a bad job of establishing a first contact with the

company and as a result fail to make any further progress.

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Licensing evaluations

Evaluating licensing opportunities can fast become an overly detailed and sophisticated

pursuit if the right parameters are not agreed beforehand. First of all, there are two

levels of valuation. The first involves a selection of the most appropriate and valuable

opportunities. For an in-licensor this is the most attractive product, compound or

technology, while for an out-licensor this is the most attractive partner. Once the

selection process is completed a second, more detailed evaluation supports negotiations

and deal-making. This deal-making evaluation is not covered in this section of the

report, but is presented in detail in the licensing valuations chapter.

Licensing evaluations for selecting appropriate opportunities to advance to a more

detailed stage of negotiation and deal-making are similar to those found as part of an

internal portfolio management process. Valuations need to be consistent and

transparent in order to provide the relative ranking and prioritization required. Like

portfolio management evaluations, the key trade-offs are to be found between

sophisticated financial models and more simple rating models that include strategic

elements such as portfolio fit and balance. Unlike portfolio management evaluations,

potential licensing agreements involve an extra level of uncertainty, which is the

contractual relationship with a third party. Understanding the relative value of an

underlying licensed asset is not enough to make choices among different licensing

opportunities. Some expectation as to the likely deal terms available for a licensing

deal is required in order to compare opportunities. However, understanding a deal’s

potential terms and financial metrics at an early stage of opportunity assessment can be

difficult, particularly for complex licenses which might include multiple compounds.

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General portfolio management

Licensing evaluations need to provide relative values and rankings across all external

opportunities, but need not necessarily provide consistent measures across both in-

house and external opportunities. However, it is desirable in a robust portfolio

management process to include both internal and external potential projects in order to

arrive at optimal resource allocation decisions. Parameters set-up to aid decision-

making for internal projects and resources can easily be adapted for use in evaluating

external projects.

Portfolio evaluation approaches allow decision-makers to establish preferences across

projects by measuring them against the explicit objectives identified by senior

management. As a result, project evaluations must include measurable criteria to assess

the extent to which key objectives are likely to be satisfied. Identifying these value

criteria is a key part of the project evaluation framework. Once criteria have been

established, project evaluations can begin.

Project scoring approaches accommodate the fact that multiple criteria are often

required in order to select and prioritize pharmaceutical projects effectively. Different

scoring systems use different criteria, and include financial measures, strategic fit,

competitive advantage, market attractiveness, the degree to which projects leverage

core competencies, technical feasibility and risk versus return.

After a project has been scored against relevant criteria, a weighted score is calculated.

This relative superiority or attractiveness score is used as a proxy for the value of the

project. Once all projects have been evaluated, minimum threshold scores can be set in

order to select and prioritize the most attractive projects and eliminate those of

insufficient value.

Although project scoring is a key approach to project evaluation, and enables projects

to be evaluated with respect to a number of different dimensions, the project rankings

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derived from scoring can be misleading, which as a result can lead to sub-optimal

project prioritization and decision-making. Scoring systems provide a means of

capturing and quantifying project information in a consistent manner for future

decision-making, but as a basis for discussion rather than a decision in itself.

Pharmaceutical companies develop approaches to portfolio management in order to

allocate resources optimally with respect to both the minimization of risk and the

maximization of value across the portfolio. Different projects are associated with

different values and risk profiles. Although additional parameters can be incorporated,

the key role for project evaluations is to provide a critical assessment of value and risk

across the portfolio.

A broad range of different financial tools and evaluation techniques are available for

use in project valuation. Financial analysis is able to combine an evaluation of a

project’s value, risks and associated costs. However, financial approaches do not

represent a viable standalone approach to project evaluation. Portfolio decision-making

is characterized by the range of trade-offs made across different criteria, including

meeting unmet medical need while maximizing cash-flows, balancing short-term and

long-term performance, and protecting existing franchises alongside investments in

new technologies. It is clear that these trade-offs cannot be adequately captured by

project evaluations based solely on financial analysis. Instead, financial analysis must

be employed alongside a broader scoring methodology enabling non-financial

dimensions to be assessed and included in decision-making.

Although it is beyond the scope of this report, a 2005 Business Insights report,

Pharmaceutical Portfolio and Project Management, discusses a range of available

financial analysis tools and techniques, their application in project evaluation and their

relative strengths and weaknesses. Key financial approaches include:

Net present value (NPV);

Decision tree analysis and expected NPV (ENPV);

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Monte Carlo simulations;

Real options.

Applications for licensing evaluations

As mentioned previously, the key difference between an internal and external

opportunity is that a licensed compound’s agreement terms will determine how risks,

returns and responsibilities will be shared between parties. It is only by including an

evaluation of this package of contractual terms that a potential licensing opportunity

can be evaluated. Other complications for evaluating licensing opportunities include

the partnering risks brought about by third-party decision-makers and the limited

availability of data for generating evaluations for external opportunities.

As a check list, some of the key intellectual property (IP) licensing evaluation

questions include:

Who owns the IP rights (sole versus joint ownership, originator versus sub-license,

exclusive versus non-exclusive etc.)?

Is the patent in force and valid (have maintenance fees been paid, is claim

enforceable, are there any blocking patents etc.)?

What is the scope and length of the patent (how useful in preventing competitors,

how does regulatory progress affect legal and economic lifespan of patent etc.)?

In evaluating a licensing opportunity it is optimal to first value the asset and then apply

expected deal terms to bring about a company-specific value. As is shown in the

licensing valuations chapter, a number of different parameters affect compound

valuations. The costs, risks and returns associated with a compound all differ

depending on the stage of development and therapy area of the specific compound.

Further adjustments can be made if a specific peak sales figure can be forecast, while

company specific characteristics such as size and experience can also impact on values.

Consistent discount factors, applied for internal products, will allow for relative

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rankings for licensing opportunities. Finally, expected deal terms, with respect to

milestones, royalties, shared costs and responsibilities, can be applied in order to

determine valuations for each licensing opportunity. These values, along with other

more strategic considerations, provide the basis for selecting the opportunities of

greatest potential value to the company.

Deal-making and agreement

The valuations used as part of negotiations are outlined in more detail in the licensing

valuations chapter. However, agreeing a successful deal involves more than a robust

valuation and some persuasive negotiations. There are many pitfalls when agreeing

terms for a pharmaceutical licensing agreement, a number of which are detailed below.

Key elements of a pharmaceutical license agreement

The key sections of a pharmaceutical license agreement, such as preambles, recitals,

definitions, grant clauses, releases, reservations and improvements, read more like a

legal text book than a guide to pharmaceutical licensing. However, there are a number

of key considerations expressed in these legal terms that require due consideration.

The preambles identify the respective parties, guarantors and active date of the

agreement. Determining an early understanding as to which parties are signatures to the

agreements, particularly where local, regional and corporate representatives are

involved in early discussions, can save significant time and unnecessary confusion

during negotiations. Recitals memorialize the background of a relationship and

illustrate the importance of existing relationships and a reputation for successful

licensing.

Grant clauses relate specifically to what is being agreed. What is the technology,

product, field of use being licensed? What is the term of the agreement and over which

territories? Finally, what is the specific right being granted – to sell, to use, to import?

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Usually, grant clauses have been interrogated as part of an exchange of term sheets, but

it is important that negotiations over deal terms are founded on explicit grant clauses.

Improvements in licensing contracts play an important role, particularly where ongoing

relationships are anticipated. It is important that the ownership of any IP resulting from

collaboration is made clear and that each party understands their obligations relating to

protecting and promoting the licensed IP. It is particularly important that there is

agreement over the assignment of obligations relating to the enforcement and

protection of the licensed IP. If IP rights are challenged what happens to other terms of

the agreement, such as royalty payments etc?

In light of all the potential pitfalls outlined above, pharmaceutical licensing continues

to be one of the most complex and dynamic of legal pursuits. The good news is that

there are a number of well-prepared legal firms available to help pharmaceutical

companies negotiate their way through the complexities of the licensing agreement.

The bad news is that, like much adversarial law, often the company with the best

lawyer wins. If you are a small biotech looking to agree a blockbuster late-stage

licensing agreement with a top 10 pharmaceutical company you can either spend

money on a good lawyer now to negotiate and agree a favorable contract or spend

double the money later down the line having to continually defend claims from your

eventual licensing partner.

Post-deal management and analysis

The sign of a successful strategic licensing agreement is not in the agreement and

completion of the deal, but in the successful implementation of the deal terms over

time. Similarly, the sign of a successful deal is not in the quality of the eventual

product, over and above that which could have realistically been evaluated through due

diligence, but in the quality of the relationship between licensing partners. It is clear,

therefore, that much of the success in the licensing process actually occurs in the period

after making an agreement. As such, pharmaceutical companies must work hard to

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develop capabilities to help manage and support their alliances and collaborative

licensing relationships.

Alliance management

Alliance management is currently one of the hottest topics in pharmaceutical licensing.

Companies across the pharmaceutical and biotech industries have spent the last ten

years trying to determine whether it is a necessary capability and if so how it should be

organized. To date, the results show very different approaches to this critical issue.

Eli Lilly were among the first to publicly promote their alliance management

capabilities. Lilly established their Office of Alliance Management in 1998 as a

corporate executive function looking to develop Lilly’s alliance strategy and provide a

central point for alliance managers to learn and share experiences.

From an organizational perspective each Lilly alliance was assigned the following:

High-level alliance champion – vice president level or above responsible for

meeting the partner counterpart to discuss strategic and governance issues;

Operational alliance leader – responsible for day-to-day management of alliance

resources;

Alliance manager – responsible for providing a supportive and catalyst function,

liaising between Lilly and its alliance partner.

AstraZeneca launched a collaboration management program for alliances in 2003. The

collaboration management function is assigned with the responsibility for balancing

AstraZeneca’s perspective with the perspective of external partners. The function

provides a sense of continuity from deal-making through to implementation and is

positioned within the corporate licensing department.

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Alliance management responsibilities at Roche have been elevated to the senior

management level and are integrated into every stage of decision-making. Roche’s

global alliance management department combines key research, technical and

commercial functions into a single team to create and manage alliances more

effectively. Each partnership is assigned an alliance director who is charged with

providing a consistent company perspective across the due diligence, deal signing and

project execution phases.

The execution of alliances involves the management of two critical relationships. The

collaborative relationship between partnering companies helps to provide effective

alliance leadership, coordination and communication. However, the internal

relationship between the licensing team and all other relevant functional departments is

also a critical element in ensuring the successful implementation of each partner’s

licensing objectives.

Pharmaceutical alliances fail when significant confusion or disconnection exists

between groups within or between partnering companies. Internal groups must reach

agreement on alliance objectives and on each group’s respective roles in achieving

their objectives. Relevant functional teams must commit an appropriate share of their

resources to the partnership and internal efforts must be coordinated and integrated

both with the organization as a whole and with the efforts of the licensing partner.

The big test of alliance management capabilities is that when alliances fail for technical

reasons do partners come back for more?

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Using outside agencies

The pharmaceutical licensing process requires significant resources in order to be

completed successfully. Aside from the essential services provided by lawyers

mentioned earlier, a number of other outside agencies provide services that can help

complete the resource intensive or complex parts of the licensing process. Outside

agencies offering appropriate services in support of pharmaceutical licensing include:

Management consultants;

Other specialist consultancies, including licensing or drug/marketing forecasting

agencies;

Key investors, including venture capitalists and private equity funds for biotech;

Investment banks;

Accounting firms.

More than 50% of all surveyed licensing executives revealed that their companies

identify potential licensing opportunities without the help of a third party agency, as

shown in Figure 3.16. However, 70% of the biotech licensing executives relied on

outside help to support the identification of licensing opportunities, turning to

management and other consultancies, key investors and investment banks. The main

recourse for pharmaceutical companies, where less than 40% of companies rely on

outside help, are other specialist consultancies. These trends reveal the difference in

available information for potential in-licensors and out-licensors. It appears that

pharmaceutical companies, primarily comprised of potential in-licensors, are able to

identify potential opportunities without significant outside help, due in large part to the

promotional efforts of companies looking to out-license their compounds. For biotech

companies, who are predominantly involved in out-licensing, it appears they require

greater help in identifying potential partners for their technologies.

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Figure 3.16: Parties involved in identifying potential licensing opportunities, 2006

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Source: Licensing trends survey, 2006 Business Insights Ltd

More than 40% of the licensing executives surveyed for this report turned to third party

providers when conducting due diligence exercises as part the ongoing evaluation

efforts surrounding potential licensing opportunities. As shown in Figure 3.17, 60% of

biotech companies used outside agencies to support licensing due diligence, primarily

using specialist consultancies and accounting firms. As was the case for identifying

licensing opportunities, only a small proportion of pharmaceutical companies turn to

outside service providers to support their licensing due diligence.

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Figure 3.17: Parties involved in conducting due diligence for potential licensing opportunities, 2006

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Source: Licensing trends survey, 2006 Business Insights Ltd

More than 40% of surveyed licensing executives turned to third party service providers

to support the valuation and negotiation of potential licensing deals, as shown in Figure

3.18. Outside agencies were used by more than 50% of biotech companies to support

licensing valuations and negotiations. The main agencies used include specialist

consultancies and key investors, such as venture capitalists. Again, around two-thirds

of pharmaceutical companies were able to manage the valuation and negotiation of

potential licensing agreements internally without outside help.

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Figure 3.18: Parties involved in the valuation and negotiation of potential licensing deals, 2006

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Source: Licensing trends survey, 2006 Business Insights Ltd

Based on the results of a survey of 142 licensing executives it appears that around 60%

of biotech companies and 40% of pharmaceutical companies make use of outside

agencies in supporting the licensing process. Biotech companies look towards

specialist agencies and key investors, such as venture capitalists, in order to support the

identification of licensing opportunities, subsequent due diligence and the valuation

and negotiation of specific deals. Pharmaceutical companies appear to have greater

levels of in-house licensing resource and expertise, with the majority completing the

entire licensing process without outside help.

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CHAPTER 4

Licensing valuations

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Chapter 4 Licensing valuations

Summary

According to a survey of 142 licensing executives, pharmaceutical companies are more likely than biotech companies to share financial evaluations during licensing negotiations, with more than 80% of companies sharing at least a single point financial projection and almost 50% sharing a more detailed probabilistic evaluation.

The most common evaluation technique used in determining optimal deal terms is a discounted cash flow net present value (NPV) calculation, which is used in more than 70% of companies according to surveyed licensing executives.

A deal-making valuation model is one used specifically to agree licensing terms between partners. While the approach might be similar to that used to provide recommendations for selecting the most valuable licensing opportunities to pursue the outputs of the model are quite different.

If the inputs into the valuation model cannot be agreed upon by both licensing parties then the outputs of the exercise will not provide any common ground for negotiation. Similarly, if the modeling approach and any assumption are not clear and defendable then the effective use of the evaluation model for negotiation will be limited.

The first test as to whether two companies are going to be successful in collaborating together as part of a strategic licensing agreement is whether or not they are able to negotiate an agreement based on significant common ground. If two companies are unable to agree upon the true value of the licensing asset and subsequently on the fair distribution of risks, returns and responsibilities then there is little hope that they will be able to reach a satisfactory conclusion once the real work of implementing a licensing deal begins.

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Introduction

As mentioned in the licensing process chapter, there are two main reasons for

evaluating licensing opportunities. One is to support the optimal selection amongst

numerous opportunities and involves more simplistic and top-line valuations, often

referencing a range of strategic as well as financial measures. The second reason is to

support negotiations around reaching a licensing agreement and involves a more

detailed financial evaluation around which specific deal terms can be agreed. The

majority of this chapter will deal with the latter valuation, involving financial

projections for deal-making. However, much of the approach taken can be applied to

the financial element of valuations made for selecting appropriate licensing

opportunities to pursue.

Valuing deals

The valuation of a licensing opportunity is both an important and extremely difficult

task that usually falls under the responsibility of a licensing manager more suited to

making contacts and negotiations than to sitting in a dark room churning out financial

projections. The problem with tasks that are both important and difficult is that they

usually get handed over to specialists who neither understand the true importance of

the task nor are able to fully deliver against the objectives set for the task. Those

important objectives for a licensing valuation include:

Presenting an estimation of potential value for a deal;

Presenting an estimation of potential costs and risks associated with a deal;

Explaining in simple terms some of the interactions between risks and returns

inherent in the deal;

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Enabling the testing of different contract terms in order to see the impact for both

partners;

Building an independent and unbiased model for representing deal values;

Producing a financial estimate that can be explained and defended by all key

stakeholders.

It is the last two objectives mentioned above that represent the current challenge for

licensing executives, who often have a financial model produced for them by some

centralized financial or forecasting department. However, if a model cannot be shown

to be both fair and clear in representing values used in negotiations with a potential

licensing partner it does not provide a useful negotiation tool. It is important to make

the distinction here between a valuation model used as an active negotiation tool and

one that is used to set target and minimum acceptable deal terms.

Target and minimum acceptable deal terms are the established form of preparing

negotiation parameters for pharmaceutical licenses. Usually, both potential partners

produce their own separate valuation models, calculate target and minimum acceptable

terms and then begin negotiating. Valuations are not shared explicitly, and once

negotiations begin there is limited recourse to check new numbers against the valuation

model. The problems with this approach are two-fold. Firstly the negotiations become

needlessly adversarial. Often, there is much common ground between partners that

does not require significant negotiation based on upper targets set by each party.

Secondly, by taking separate approaches to valuing the deal, any discussion regarding

common value becomes obsolete. The ‘win-win deal’ approach is very difficult to

negotiate if one company values the deal at a distinctly different level than the other.

More and more pharmaceutical and biotech companies are beginning to move away

from the “sit around a table and argue over numbers approach” to try tackling

negotiations in slightly different way. The key to having more productive licensing

negotiations is to try to come about an agreement over the total deal value prior to

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negotiations. If this can be agreed upfront, then determining how that value is shared

between partners, along with costs, risks and responsibilities, is a much easier exercise

to embark upon.

The remainder of this chapter looks to set-out an approach to collaborative licensing

valuations that provides both parties with a clear way of expressing how deal terms

affect their share of deal values, costs and risks. The key to this approach is to use

independent and unbiased estimates for the major valuation parameters and to keep all

financial modeling at the simplest, most digestible level.

Current best practices

Current practices for the sharing of licensing valuations during negotiations differ by

the type of company involved, as shown in Figure 4.19. According to a survey of 142

licensing executives, pharmaceutical companies are more likely than biotech

companies to share financial evaluations during licensing negotiations, with more than

80% of companies sharing at least a single point financial projection and almost 50%

sharing a more detailed probabilistic evaluation. Around a third of all pharmaceutical

companies share detailed decision-models during negotiations with simulated outcomes

based on probabilistic parameters. For biotech companies, the picture is very different,

with more than 30% of all companies failing to share any evaluation data at all during

negotiations. A little over 10% of biotech companies divulge simulated decision-model

outcomes during licensing discussions with a potential partner. However, only a few

leading biotech companies are likely to be engaging in such sophisticated modeling

techniques and therefore most do not have this information to share. As can be seen in

Figure 4.20, only around 15% of biotech companies are engaged in simulation

modeling in determining optimal licensing deal terms.

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Figure 4.19: Information shared between partners during licensing negotiations, 2006

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A decision-modelsimulating outcomesfor both partners

A detailedprobabilistic forecastmodel

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No hard financialforecasts

Source: Licensing trends survey, 2006 Business Insights Ltd

The most common evaluation technique used in determining optimal deal terms is a

discounted cash flow net present value (NPV) calculation, which is used in more than

70% of companies according to surveyed licensing executives. The results shown in

Figure 4.20 provide the proportions of respondents from companies utilizing the

various evaluation approaches for licensing, with each separate technique able to be

applied alongside another. While the use of NPV calculations are applied in similar

proportions of companies in both the pharmaceutical and biotech segments, there are

some small differences when it comes to the use of more sophisticated approaches. The

uptake of ‘Monte Carlo’ simulations and real options is around 50% higher in

pharmaceutical companies than it is in biotech companies.

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Figure 4.20: Valuation techniques used in determining optimal licensing deal terms, 2006

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`Monte carlo'simulation models

Real option valuations

Source: Licensing trends survey, 2006 Business Insights Ltd

Interestingly, aside from the small difference in uptake of sophisticated modeling found

between biotech and pharmaceutical companies, the utilization of modeling techniques

to support licensing deal-making is similar. However, the sharing of this information

with a potential partner is far greater for pharmaceutical companies than it is for

biotech companies. This means that a greater proportion of biotech companies are

withholding valuation data from their partners than is the case for pharmaceutical

companies. The reason may be distrust between a biotech company and the often larger

pharmaceutical partner. As was mentioned earlier, the company able to hire the best

lawyer usually does disproportionately well during negotiations. One way to place a

check on this imbalance for the biotech company is undertake extra evaluation work

and keep it undisclosed in order to place a control on deal values as they evolve during

negotiations. A cynic might also add that it may be possible that the quality of these

biotech evaluations would not stand up to scrutiny from a more experienced licensing

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protagonist and are therefore shielded from any unwelcome criticism. Either way, there

is some work to be done for most companies, particularly those in the biotech segment,

in preparing useful licensing evaluations to support the licensing negotiation process.

Deal-making valuation model

A deal-making valuation model is one used specifically to agree licensing terms

between partners. While the approach might be similar to that used to provide

recommendations for selecting the most valuable licensing opportunities to pursue, the

outputs of the model are quite different.

As mentioned earlier in this chapter, the reason to invest time in building and using a

deal-making evaluation model is to help bring about a set of negotiated deal terms that

maximize deal values for each partner. A ‘win-win licensing deal’ is an overused

phrase in today’s pharmaceutical licensing lexicon, but the aim of every strategic

licensing deal must be to find a way of maximizing deal values for both partners. A

tough negotiator armed with an even tougher lawyer might be able to squeeze the last

cent of value to the benefit of their company, but a reputation for leaving nothing on

the table for their partners will have disastrous consequences on the company’s ability

to make deals in the future.

A deal-making valuation model must demonstrate two important qualities:

Independent and unbiased inputs;

Clear and defendable outputs.

If the inputs into the model cannot be agreed upon by both licensing parties then the

outputs of the exercise will not provide common ground for negotiation. Similarly, if

the modeling approach and any assumptions are not clear and defendable then the use

of the evaluation for negotiation will be limited. The first test as to whether two

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companies are likely to be successful in collaborating together as part of a strategic

licensing agreement is whether or not they are able to negotiate around common

ground during the deal-making process. If two companies are unable to agree upon the

true value of the licensing asset and on the fair distribution of risks, returns and

responsibilities then there is little hope that they will be able to reach a satisfactory

conclusion once the real work of implementing a deal begins.

Model inputs

The best starting point for any dealing-making valuation model is to begin with a

generic model based on independent industry inputs. Once this model has been

completed a number of additional adjustments to the model can agreed upon by both

licensing partners in order to bring about a more robust valuation of the licensed asset.

However, these adjustments need to be both agreed by each party and make a relative

reference to the generic inputs put together as part of the base model.

Given that most strategic pharmaceutical licensing agreements are formed during

R&D, specific inputs relating to the cost, lead time and risk associated with

pharmaceutical R&D must be determined. The industry numbers presented in Figure

4.21, Figure 4.22 and Figure 4.23 are taken from the Journal of Health Economics

article ‘The price of innovation: new estimates of drug development costs’ written by

Joseph A. DiMasi, Ronald W. Hansen and Henry G. Grabowski and published in 2003

(DiMasi, Hansen and Grabowski, 2003). The data was calculated using a random

selection of 68 new drugs drawn from a survey of 10 pharmaceutical firms. The article

gave a total pre-approved cost estimate of US$802 million in 2000 dollars, which takes

into account the cost of all the failed projects required in earlier stages to get one

successful product. This cost estimate has become widely established as the benchmark

for R&D development costs in the pharmaceutical industry and the article’s R&D data

are therefore considered to be a good estimate of cost, lead time and risk.

R&D out-of-pocket costs increase significantly as a product progresses through the

various phases of clinical development, as shown in Figure 4.21. Long term animal

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studies are considered to occur in parallel with phase I and phase II trials, being

completed before a drug begins phase III trials. Post approval trials relate to lifecycle

drug development including the development of a launched drug in new indications or

new formulations, as well as any necessary post approval regulatory trial requirements.

Figure 4.21: R&D costs by phase, 2000

15.2

86.3

140.0

23.5 5.2

0

20

40

60

80

100

120

140

160

Phase I Phase II Phase III Long-termanimal

Post approval

Cos

t (U

S$ m

illio

n, 2

000)

Source: DiMasi, Hansen and Grabowski (2003) Business Insights Ltd

As shown in Figure 4.22, the total lead time for a drug from entering human trials to

being approved for launch is approximately 90 months, or 7.5 years. The greatest

amount of development is spent in late stage phase III trials, but an additional 18

months are added once a marketing application is made before a drug receives final

approval. These figures are based primarily on receiving approval from the Food and

Drug Administration (FDA) in the US.

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Figure 4.22: R&D lead times by phase, 2000

12.3

33.8

18.2

26.0

0

5

10

15

20

25

30

35

40

Phase I Phase II Phase III Approval phase

Mea

n tim

e to

nex

t pha

se (m

onth

s)

Source: DiMasi, Hansen and Grabowski (2003) Business Insights Ltd

Figure 4.23 shows the average attrition rates for a typical pharmaceutical product as it

progresses through human testing and the approval stage. As would be expected, the

greatest level of attrition occurs before a drug enters expensive phase III trials. At a late

stage of clinical development only those drugs with the greatest chance of progressing

through the stage and eventually being approved for marketing are entered into phase

III trials.

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Figure 4.23: R&D success probabilities by phase, 2000

71.0% 68.5%

31.4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Phase II Phase III Approval

Prob

abili

ty o

f ent

erin

g ph

ase

(from

pre

viou

s)

Source: DiMasi, Hansen and Grabowski (2003) Business Insights Ltd

Alongside an analysis of R&D costs, lead times and risks, a drug valuation also

requires a determination of likely sales returns for a pharmaceutical product. There are

a number of different approaches to including sales forecasts for pharmaceutical drugs,

but perhaps the simplest is to use a peak sales number and then apply a diffusion curve

representing the likely uptake and eventual erosion of sales across the product

lifecycle. The drug market diffusion curve shown in Figure 4.24 has been adapted from

the Pharmacoeconomics article ‘Returns on research and development for 1990s new

drug introductions’ written by Henry Grabowski, John Vernon and Joseph A. DiMasi

published in 2002 (Grabowski, Vernon and DiMasi, 2002). The diffusion curve

assumes a 14 year post-launch patent life and peak sales occurring in year 10. It is

assumed that market sales erosion following loss of patent occurs at a rate of 50% per

annum. The article estimated mean average peaks sales for a pharmaceutical drug of

US$458 million in 2000 dollars. Mean average peak sales are skewed by the

disproportional impact of the small number of blockbuster drugs generating significant

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peak sales revenues, and as a result the mode (50th percentile) average peak sales are

much lower than the mean. When including the direct costs associated with sales, a

contribution margin of 45% is used in order to reflect both the cost of sales and direct

selling costs (amounting to 55% of total sales). In order to reflect the lead time

involved in marketing and sales, particularly around the launch period for a new drug,

the direct costs for sales were calculated as a proportion of sales expected in the

following two years. As a result, the very real scenario of investing significant

marketing spend on a potential new product only to receive a final ‘non approvable’

letter from the FDA can captured by the model.

Figure 4.24: Drug market diffusion curve – product lifecycle

3% 6%13%

25%

50%

88% 88%

75%

38%

19%

9%5% 2% 1%

75%

94%97%97%

100%

94%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Year (post-launch)

Prop

ortio

n of

pea

k sa

les

Source: Author’s research and analysis Business Insights Ltd

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Evaluation modeling

The first stage of evaluation modeling is to transpose all input values into current

values. In order to do this we first have to arise at 2006 values and then account for any

changes in the real cost and value of real inputs. This will allow evaluation results to be

expressed in a common value measure (namely 2006 US dollars).

In order to account for the changes in R&D costs and likely drug values between 2000

and 2006, key trends in costs and values were extrapolated from the two key source

papers – DiMasi, Hansen and Grabowski, 2003 and Grabowski, Vernon and DiMasi,

2002. Over the ten year period leading up to 2000 it was shown that clinical

development costs have increased at a rate of 11.8% per annum in constant 2000 dollar

values. It is clear that clinical trials have gotten larger over the past 10 years or so and

this increase in costs seems broadly reasonable. Over the same ten-year period, average

peak drug sales have increased at a rate of 2.9% per annum in constant 2000 dollar

values. The smaller rise in sales compared with drug development costs seems

reasonable given the continued rise of healthcare cost containment measures across

major markets and the impact of aggressive generic competition on prices.

In order to arise at 2006 cost and revenue levels a general US dollar inflation rate must

also be included alongside the price increases in constant dollar amount, and was

estimated to be a further 3% per annum. For example, the 2006 cost of a phase I trial

expressed in 2006 dollars will involve calculating 6 years of price increases as a result

of increased trial costs (11.8%) as well as accounting for the change in dollar value

between 2000 to 2006 dollars (3% per annum). The resulting sum is as follows:

2000 phase I trial cost (2000 dollars) x (1 + 11.8% + 3%) ^ 6 = 2006 phase I trial cost (2006 dollars)

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Table 4.1: R&D cost by phase and peak sales, 2006 (expressed in 2006 dollars)

2000 Year-on-year Year-on-year 2006 (expressed in increase in increase in (expressed in R&D costs 2000 dollars) cost/ revenue dollar value 2006 dollars) Phase I 15.2 11.8% 3.0% 34.8 Phase II 23.5 11.8% 3.0% 53.8 Phase III 86.3 11.8% 3.0% 197.5 Long term animal 5.2 11.8% 3.0% 11.9 Post approval 140.0 11.8% 3.0% 320.5 Peak sales 458.0 2.9% 3.0% 645.1 All figures in US$ millions

Source: Author’s research and analysis Business Insights Ltd

Once the 2006 levels for all key costs and revenues have been established the real

increase in these values over time must also be added to the model. Costs and revenues

remain in 2006 dollar values but the real increases in costs and revenues (11.8% and

2.9% per annum respectively) must also be extrapolated. In this way, all costs and

revenues are expressed in a common, constant value measure and reflect the real levels

of increase in costs and values that will occur over time. In this way, all figures can be

added together to represent true total value, without needing to discount values in order

to adjust for inflation.

It is important to point out that the base case model must involve cost and revenue

projections that account for real increases over time and are expressed in a common

value measure (e.g. 2006 dollars) in order to allow a real valuation aggregation. Most

approaches fail to separate inflation from a general level of nominal discount rate and

the resulting model is needlessly complicated. By having a simple model accounting

for real price increases only there is no need to discount values to begin calculating

value. The baseline valuation for a licensing deal should have a real discount rate of

0%.

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When calculating net present values, future values are discounted in order to represent

the opportunity cost of investing in an alternative but similar investment. It is important

to recall that net present value (NPV) measures are comparator measures and not actual

values. If for a pharmaceutical investment I normal expect a rate of return equivalent to

10% per annum, then discounting a pharmaceutical investment by the 10% factor in

order to arrive at an NPV only represents the value of the project over and above that

expected on average from similar investments. If the resulting NPV for a project is a

loss of US$10 million, this does not mean the project has no value, but rather the

project is likely to return US$10 million less than the opportunity cost of capital (an

average investment in a similar project). NPV is a decision-making tool rather than a

valuation tool. It is better to allow a pharmaceutical company to compare different

internal rates of return for projects than to simply reply on a comparison of value with a

mythical alternative investment project (opportunity cost). This separation between

valuing a project rather than ranking it amongst its comparators is particularly

important when dealing with licensing projects, given that the discount rate used by

one company can be quite different the one used by another.

It would be difficult to be more provocative than stating that net present value is the

wrong tool for valuing licensing agreements, particularly given that we have

established that more than 70% of companies are using NPV to support licensing

evaluations. However, potential licensing partners need to relieve themselves from the

need to discount value and instead look at the real value being created, adjusted for

risk, and then determine how this might be shared between parties.

As well as adjusting for price inflation, the main reason for discounting values is to

account for risk – the greater the risk, the greater the discount rate threshold. However,

given that most approaches to pharmaceutical drug evaluations make use of a decision-

tree or expected value approach it appears better that specific development phases are

actually discounted based on their technical risk rather than using a common project-

wide discount rate across all phases. In this way, different outcomes (e.g. failure in

phase I, success in phase I but failure in phase II etc) can be weighted by their

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85

likelihood and eventual outcomes can be used to calculate a weighted average of all

possible outcomes based on the risk of project failure.

The likelihood of specific outcomes for a new phase I, phase II and phase III drug are

shown in Figure 4.25. A new phase I drug has only a 15% chance of reaching the

market, while a new phase III drug has a 69% chance of reaching the market. It is clear

that an NPV projection with a common discount rate would do a bad job in capturing

the differences between these two investments.

Figure 4.25: Likelihood of outcomes for new phase I, phase II and phase III drugs

29%

49%

7%15%

69%

10%22%

32%

69%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Phase I only Phase 2 only Phase 3 only Launch

Like

lihoo

d of

out

com

e

New phase I New phase II New phase III

Source: Author’s research and analysis Business Insights Ltd

The non-discounted real values for each potential drug outcome are shown in Figure

4.26. Obviously, only those outcomes that eventually result in a successful drug launch

have a positive real value in constant 2006 US dollars. When weighted against the

likelihood of different outcomes, as shown in Figure 4.25, the expected real values for

new phase I, phase II and phase III drugs can be calculated. Based on these expected

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86

outcomes a new phase III drug is around four times as valuable as a new phase II drug

and around seven times as valuable as a new phase I drug. Given that the risks

associated with drug development are accounted for in the expected value calculations

and that any market risks have been averaged out into a single point peak sales

forecast, the resulting valuation represents the expected additional value added by the

licensing opportunity (e.g. US$271 million for a new phase I drug) in constant 2006

US dollars.

Figure 4.26: Expected real values (non-discounted) for new phase I, phase II and phase III drugs

271 464

1,797

-500

0

500

1,000

1,500

2,000

2,500

3,000

Phase I only Phase 2 only Phase 3 only Launch Expectedvalue

Dru

g va

lue

(US

$ m

illio

n, 2

006)

New phase I New phase II New phase III

Source: Author’s research and analysis Business Insights Ltd

In order to illustrate the impact of different discount rates on values, the expected

discounted real values for drugs at different development stages are shown in Figure

4.27. These results show that at a real discount rate of 6% the NPV of a new phase I

drug falls below zero, while at a discount rate of 8% the NPV of a new phase II drug

falls below zero. Given that pharmaceutical companies often base R&D investment

decisions on a real NPV discount rate of around 8-10% these numbers clearly do not

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87

stack up. Either the NPV model fails to accurately capture the risk associated with

pharmaceutical R&D or some of the base model inputs would need adjusting to ensure

the results appear reasonable.

Figure 4.27: Discounted expected real values for new phase I, phase II and phase III drugs

-200

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Real discount rate (annual)

Exp

ecte

d dr

ug v

alue

(US$

mill

ion,

200

6)

phase 3phase 2phase 1

Source: Author’s research and analysis Business Insights Ltd

For example, in order to ensure the model results appear more reasonable, the real

annual increase in clinical development costs could be reduced. Figure 4.28 shows the

impact on the discounted expected real drug values of changing the rate at which costs

escalate over time. If the rate of increase in the real cost of clinical trials is reduced

from 11.8% to just 3.0%, a similar rate to the increase in likely revenues, the impact on

NPV calculations is significant. Both new phase I and phase II compounds show

positive NPVs with real discount rates of up to 10%. This check for reasonableness can

help to inform modeling and bring about agreement between licensing partners.

However, for the purpose of this illustrative example the rate of clinical cost increase

has been kept at 11.8% per annum.

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Figure 4.28: Discounted expected real values for new phase I, phase II and phase III drugs (adjusted for lower R&D cost inflation)

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

2,750

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Real discount rate (annual)

Expe

cted

dru

g va

lue

(US$

mill

ion,

200

6)

phase 3phase 2phase 1

Source: Author’s research and analysis Business Insights Ltd

Model outputs

While an understanding of total deal values are generated by the base case model,

negotiations around licensing agreements are informed by looking at how that value is

shared between potential partners with respect to risks, returns and responsibilities. The

first model outputs are shown in Figure 4.29 and Figure 4.30 and outline all potential

cash flows for each partner over the lifecycle of the licensing agreement. As an

example, a new phase II product has been used to illustrate the potential returns for

each partner. The deal terms modeled involve an upfront payment to the out-licensor of

US$20 million, a milestone payment of US$40 million for successfully completing

phase II trials, a further US$60 million for completing phase III trials and US$100

million for gaining regulatory approval. Upon the drug reaching the market, royalties

based on gross sales of 10% are payable to the out-licensor.

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Figure 4.29: Deal outcomes for out-licensor

-60

-40

-20

0

20

40

60

80

100

120

1 2 3 4 5 6 7 8 9 1011 12 13 141516171819 20 21 222324252627 28

Cost

/ sal

es (U

S$ m

illio

n, 2

006)

Out-licensorlicensepayments/royaltiesOut-licensorcosts/ sales

Year

Source: Author’s research and analysis Business Insights Ltd

Figure 4.30: Deal outcomes for in-licensor

-300

-200

-100

0

100

200

300

400

500

600

1 2 3 4 5 6 7 8 9 10111213141516171819202122232425262728

Cost

/ sal

es (U

S$ m

illio

n, 2

006)

In-licensorcosts/ sales

In-licensorlicensepayments/royalties

Year

royalties

-300

-200

-100

0

100

200

300

400

500

600

1 2 3 4 5 6 7 8 9 10111213141516171819202122232425262728

Cost

/ sal

es (U

S$ m

illio

n, 2

006)

In-licensorcosts/ sales

In-licensorlicensepayments/royalties

Year

royalties

Source: Author’s research and analysis Business Insights Ltd

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Understanding potential cash flows over the lifecycle of the licensed compound does

not inform each party as to its expected share of potential value. As with the total

licensing opportunity evaluation, expected values are calculated using a weighted

average of all potential project outcomes. Using the same licensing terms as outlined

above the respective shares of expected licensing value can illustrated, as shown in

Figure 4.31. These expected values allow for a negotiated agreement over the sharing

of risk and expected values. In the illustrative example the maximum out-of-pocket

cash flow for the in-licensor is more than double that of the out-licensor. However, in

order to reward bearing a greater share of development risk the out-licensor is able to

secure a greater share of the sales returns for a successful product and as a result a

greater share of the expected overall licensing agreement value.

Figure 4.31: Share of expected deal outcomes by partner

200 264

-400

-200

0

200

400

600

800

1,000

1,200

1,400

1,600

Phase 2 only Phase 3 only Launch Expected value

Dru

g va

lue

(US

$ m

illio

n, 2

006)

Out-licensor In-licensor

Source: Author’s research and analysis Business Insights Ltd

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Having an understanding of both potential licensing cash flows and expected, risk-

adjusted licensing values provides a benchmark for constructive licensing negotiations.

Agreeing on broad, independent value parameters and using a flexible but clear

approach to modeling licensing opportunities helps potential partners to facilitate deal-

making negotiations around common estimates of value and not around pre-determined

target deal terms prepared in isolation by each party.

As a final word on deal-making licensing valuations, it is important to generate ‘buy-

in’ for the collaborative valuation and negotiation process as early as possible. Ideally,

an independent valuation should be provided by the out-licensor as part of any detailed

licensing prospectus and any challenges to the model’s validity should be dealt with as

a priority. A collaborative valuation will only prove to be a useful negotiation tool

where both licensing parties have confidence in the valuation and are fully committed

to the process.

Model refinements

A base case valuation model is used as a starting point to arrive at mutually agreeable

licensing deal valuations based on unbiased sources. Single point, largely

unsubstantiated commercial claims by out-licensors are always going to be ignored, or

at best challenged, by in-licensors. It is important, therefore, for companies to exhaust

all industry-wide valuation parameters before beginning to add drug-specific data

relating to the potential claims of the drug. As has already been shown in the base

model, the likely valuation of a drug varies significantly by development stage.

However, other key value parameters include therapy area and company profile.

R&D costs, lead times and risks all vary by therapy area, as shown in Figure 4.32,

Figure 4.33 and Figure 4.34. Therapy area specific data for analgesic/anesthetic, anti-

infective, cardiovascular and central nervous system (CNS) drugs were presented in the

Drug Information Journal article ‘R&D costs and returns by therapeutic category’

written by Joseph A. DiMasi, Henry G. Grabowski and John Vernon and published in

2004 (DiMasi, Grabowski and Vernon, 2004). R&D costs vary significantly, with

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phase III trials for anti-infective drugs (which include large scale HIV and hepatitis

drug trials) more than twice as expensive as average analgesic/anesthetic and CNS drug

trials.

Figure 4.32: R&D costs by phase by therapy area, 2000

0

20

40

60

80

100

120

140

160

Phase I Phase II Phase III

Deve

lopm

ent c

osts

(US$

mill

ion,

200

0)

All Analgesic/ Anesthetic Anti-infective Cardiovascular CNS

Source: DiMasi, Grabowski and Vernon (2004) Business Insights Ltd

Drug development lead times are greatest for CNS drugs, which are almost double

those found for analgesic/anesthetic and anti-infective drugs, as shown in Figure 4.33.

Both CNS and cardiovascular drugs take significantly more time for regulatory review,

largely as a result of the increased complexity of many of the indications involved in

these therapy areas.

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Figure 4.33: R&D lead times by phase by therapy area, 2000

72.1

46.4 50.561.0

18.2

15.4 12.5

21.0

92.5

22.1

0

20

40

60

80

100

120

140

All Analgesic/Anesthetic

Anti-infective Cardiovascular CNS

Mea

n tim

e to

com

plet

e ph

ase

(mon

ths)

Clinical phase Approval phase

Source: DiMasi, Grabowski and Vernon (2004) Business Insights Ltd

The probabilities of progressing through clinical phases do not vary significantly

between therapy areas, as shown in Figure 4.34. However, phase II anti-infective drugs

are slightly more likely to progress through into phase III trials than drugs from other

therapy areas, while phase III analgesic/anesthetic drugs are more likely to receive final

approval than other drugs.

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Figure 4.34: R&D success probabilities by phase by therapy area, 2000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Phase II Phase III Approval

Pro

babi

lity

of e

nter

ing

phas

e (2

000)

All Analgesic/ Anesthetic Anti-infective Cardiovascular CNS

Source: DiMasi, Grabowski and Vernon (2004) Business Insights Ltd

Figure 4.35: Peak sales and year of peak sales by therapy area, 2000

Year 12

Year 9

Year 6

Year 10

Year 9

0

100

200

300

400

500

600

700

800

900

All Analgesic/Anesthetic

Anti-infective Cardiovascular CNS

Peak

yea

r sa

les

(US$

mill

ion,

200

0)

Source: DiMasi, Grabowski and Vernon (2004) Business Insights Ltd

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A range of peak sales by therapy area are also presented in DiMasi, Grabowski and

Vernon, 2004. The greatest peak sales revenues are generated by CNS drugs, which

generated sales almost twice that of pharmaceutical drugs on average, as shown in

Figure 4.35. Cardiovascular peak sales occur slightly later in the product lifecycle to

other drugs, occurring in year 12. Peak sales for cardiovascular drugs are almost twice

the sales for an average anti-infective drug.

As shown in Figure 4.36, CNS drug sales are highly skewed by a small proportion of

CNS drugs generating significant revenues, including multiple blockbuster products for

the treatment of depression and psychosis. Cardiovascular drugs appear to promise the

greatest minimum value, generating the highest NPV at the 25th percentile level.

Figure 4.36: Discounted value of sales by therapy area, 2000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Mean 25th percentile Median 75th percentile

NPV

sal

es (U

S$

mill

ion,

200

0)

All Analgesic/ Anesthetic Anti-infective Cardiovascular CNS

Source: DiMasi, Grabowski and Vernon (2004) Business Insights Ltd

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Further differences by therapy area were presented in the Journal of Health Economics

article ‘Productivity in pharmaceutical-biotechnology R&D: the role of experience and

alliances’ written by Patricia M. Danzon, Sean Nicholson and Nuno Sousa Pereira and

published in 2005 (Danzon, Nicholson and Pereira, 2005). Data taken from over 900

pharmaceutical firms showed that the predicted probability that an indication in phase

III trials will be approved by the FDA is 22 percentage points below the sample

average for CNS drugs and 21 percentage points above the average for hormonal

preparations. For drugs in phase I, respiratory indications have the lowest predicted

probability of being approved (30%), with hormonal preparations having the highest

probability of success (78%).

Danzon, Nicholson and Pereira, 2005 also presented some key trends relating to the

experience of the developing company. The likelihood of phase II success for a

company that has previously participated in only one phase II trial is 69%. However,

this likelihood of success increases to 81% for a firm with experience in 25 phase II

compounds. The likelihood that an indication will complete phase III trials successfully

for a company that has previously participated in only one phase III trial is just 51%

compared with 81% for a firm that has developed 30 phase III drugs. There were no

discernable trends between experience and success for phase I trials, which is perhaps

consistent with the idea that experience only really impacts on large, complex trials in

phase II and phase III, which require perfecting dosing and generating statistical

evidence for efficacy across large patient samples.

Danzon, Nicholson and Pereira, 2005 presented further trends relating to the overall

effect on development success for drugs developed within an alliance rather than by

one single company. The results showed that indications developed in an alliance are

no more likely to progress through phase I trials than those developed independently.

However, alliance drugs are significantly more likely to complete phase II and phase

III than those developed by a single company. In phase II, the likelihood of an alliance

drug progressing through to phase III is 9 percentage points higher than when an

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indication is developed independently. In phase III, co-developed indications have a 14

percentage point higher likelihood of success.

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CHAPTER 5

Licensing best practices

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Chapter 5 Licensing best practices

Summary

With no two drugs or partnerships the same, there are no hard-and-fast rules for successful pharmaceutical licensing. Lessons can be learned by looking at the leading deals and deal-makers, but the application of best practices must always be directed by the specifics of the deal, rather than reverting to a list of generalized benchmarks.

The leading strategic pharmaceutical licensing deal, mentioned by the greatest number of surveyed licensing executives, is the ongoing relationship between Roche and Genentech. Over the course of the 16 year relationship Roche has acquired non-US marketing rights to a range of Genentech products, including Rituxan (rituximab) in 1995, Herceptin (trastuzumab) in 1998 and Avastin (bevacizumab) in 2003.

Novartis was considered to be the in-licensing partner of choice in 2006. The company has worked hard to position itself as a preferred licensing partner, employing a structured process providing a quick evaluation of opportunities and the early involvement of senior management to expedite decision-making. As part of this standard review process, Novartis employs a single gateway for all opportunities allowing for improved coordination and contact management.

Cephalon was considered to be the out-licensing partner of choice in 2006. Cephalon’s licensing model of acquiring rights to marketed products in order to generate revenues cash flow to help fund the development of in-house products appears to have worked well. More importantly, as an out-licensor, the company has been willing to share promotional rights for its lead products, particularly in the US and Japan, in order to maximize the returns from its internal assets.

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Introduction

Licensing best practices provide guidance and benchmarks for successful deal-making.

However, with no two drugs or partnerships the same, there can be no hard-and-fast

rules for pharmaceutical licensing. Lessons can be learned by looking at the leading

deals and deal-makers, but the application of best practices must always be directed by

the specifics of the deal, rather than a list of generalized benchmarks. An understanding

of key licensing trends, the major objectives underpinning licensing processes and the

success stories to be found in recent licensing deals will help to inform and support

strategic licensing. However, understanding the most important objectives for each

deal-making process will always be the value added by a capable and experienced

licensing manager.

Top licensing deals of the 21st century

The following four deals, all mentioned as leading strategic licensing agreements by

surveyed licensing executives, outline trends towards long term, multi-product

alliances and a shift in power towards the biotech out-licensor. The Genentech-Roche

and Idenix-Novartis agreements both illustrate the profound effect a long term

agreement can have on the pipeline of the in-licensor and the financial security of the

out-licensor. The Millennium-Ortho Biotech and AstraZeneca-AtheroGenics deals

illustrate the new found confidence of biotech companies with strong late stage

products to hold out for the best possible deal.

Genentech-Roche

The leading strategic pharmaceutical licensing deal, mentioned by the greatest number

of surveyed licensing executives, is the ongoing relationship between Roche and

Genentech. First signed in 1990, and renewed in 1995, a licensing agreement gave

Roche a 10-year option to acquire the ex-US rights to Genentech’s developmental

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drugs once they have completed phase II trials. As a result of this relationship Roche

has acquired Rituxan (rituximab) in 1995, Herceptin (trastuzumab) in 1998 and Avastin

(bevacizumab) in 2003.

In 1999, Roche exercised its option to buy Genentech outright. However, this position

was soon reversed and by the beginning of 2000 Roche had sold 40% of Genentech’s

shares back to the public. Aside from turning a profit of around US$2 billion through

the acquisition and divestment, the decision to keep Genentech an independent

company has remained the critical success factor for the 16-year agreement.

Independence in a biotech company, both in management and the freedom to form

partnerships with other companies, is critical for maintaining a creative and innovative

partner for new drug development.

Idenix-Novartis

Another licensing deal of note, mentioned by several surveyed licensing executives, is

the 2003 agreement between Novartis and Idenix. Primarily formed around two clinical

stage hepatitis B products, the deal also included the right for Novartis to access all

suitable Idenix drugs reaching phase II trials, similar to the Roche-Genentech deal.

Significantly, Novartis was able to use this deal to rapidly accelerate the development

of its antiviral therapeutic franchise. Successful products arising out of the deal will be

co-promoted by both partners in the US and Europe. As well as providing Idenix’s

private shareholders with significant funds (51% of the company was acquired for

US$255 million), the deal also promised significant milestone payments to Idenix in

order to fund the continued development of the two hepatitis B drugs along with further

development activity in other areas.

Millennium-Ortho Biotech

A recent deal that truly illustrates the new-found bargaining power of biotech

companies with late stage compounds is the 2003 deal between Millennium and Ortho

Biotech (Johnson & Johnson) for cancer therapy Velcade (bortezomib). Millennium

managed to retain all US commercialization rights, as well as double digit royalties for

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European sales and up to US$500 million in upfront and milestone payments.

Millennium maximized its returns from Velcade by advancing development and

bringing multiple potential partners to the table. Once detailed negotiations with Ortho

Biotech were underway, Millennium was then able to find a sophisticated deal

structure to mirror the specific business objectives of each partner.

In late 2002, Millennium was speaking to more than twenty different interested parties

about Velcade, conducting CEO-level talks with more than ten different companies.

Having narrowed down the list of potential partners in early 2003, Millennium

collected five term sheets and three deal structures. Following Velcade’s approval in

May 2003, another two parties re-established their interest. It was against this

significant level of competition that Ortho Biotech was able to secure the deal.

Millennium considered three different deal structures, the first of which was a co-

promotion agreement in the US alongside a profit-sharing arrangement on Velcade and

one of the partner’s products. The second deal involved co-promotion in the US with

Millennium retaining over 50% of profits. A third deal structure, centering on

partnering for the ex-US rights only, was finally selected in an attempt to retain

medium to long term upside as well as balance the strategic goals of both partners. Not

only did the deal result in a clear split between marketing rights, but the agreement also

made a clear distinction between future development responsibilities which were

divided by tumor rather than by geography.

AstraZeneca-AtheroGenics

Another recent example of a biotech company holding out for a good deal is

AtheroGenics’ recent 2005 agreement with AstraZeneca for atherosclerosis treatment

AGI-1067. The anti-inflammatory cardiovascular drug was already in phase III trials

when the agreement was made, which could be worth up to US$1 billion plus royalties.

The deal comes after AtheroGenics reacquired full rights for the drug back in 2001,

following an earlier agreement for AGI-1067 with Schering-Plough in 1999. The

agreement includes potential royalty rates in the mid-30s depending on cumulative

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sales levels as well as a 125-person dedicated sales force funded by AstraZeneca to co-

promote the drug.

Preferred licensing partners

Leading in-licensing companies

A survey of 142 licensing executives revealed Novartis to be the in-licensing partner of

choice in 2006, as shown in Figure 5.37. Other leading in-licensing partners include

Pfizer, Johnson & Johnson (J&J) and Roche. Interestingly, Amgen was the fourth

ranked in-licensing company, illustrating the biotech company’s affinity with smaller

biotech companies as a preferred alternative partner to big pharma.

Figure 5.37: In-licensing partner of choice, 2006

14

9

7

6

6

5

4

3

2

1

Novartis

Pfizer

J&J

Amgen

Roche

GSK

Eli Lilly

AstraZeneca

Merck

Sanofi-Aventis

Number of survey respondents

Source: Licensing trends survey, 2006 Business Insights Ltd

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Novartis

Aside from the Idenix agreement detailed above, Novartis has stepped up its licensing

activity over the past five years. Recent deals signed in 2006 include:

An agreement with Human Genome Sciences for hepatitis C interferon drug

Albuferon, set to enter phase III trials in late 2006;

An agreement with Servier for a novel phase III antidepressant.

In 2005, Novartis signed deals with:

Senju Pharmaceutical for an early stage glaucoma treatment;

SeBo for an early stage renal disease treatment;

Arrow Therapeutics for an early stage respiratory syncytial virus (RSV) treatment;

Anadys Pharmaceuticals for an early stage hepatitis C treatment;

Arakis and Ventura for a phase II chronic obstructive pulmonary disease (COPD);

Otsuka for a phase III treatment for dry eye.

Novartis has worked hard to position itself as a licensing partner of choice. Its website

includes a downloadable presentation explaining the company’s key qualities as a

licensing partner. Figure 5.38 shows the structure of the business development and

licensing team at Novartis and Figure 5.39 shows the licensing process as described in

the company’s ‘Novartis: Your partner of choice’ presentation1. The website also

includes a clear explanation of the process for licensing employed at Novartis,

highlighting a structured process providing a quick evaluation of opportunities and an

1 ‘Novartis: Your partner of choice’ presentation,

http://www.novartis.com/downloads_new/bizdevelopment/Novartis_Presentation.ppt

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106

early involvement of senior management to expedite decision-making. As part of this

standard review process, Novartis employs a single gateway for all opportunities

allowing for improved coordination and contact management.

Figure 5.38: Business development and licensing department, Novartis

Global BD&LV. HartmannGlobal BD&LV. HartmannGlobal BD&LV. Hartmann

USA, EULatam, Asia

USA, EULatam, Asia

USA, EULatam, Asia

JapanI. Ohhashi

JapanI. Ohhashi

JapanI. Ohhashi

FinanceM. Ceulemans

FinanceM. Ceulemans

FinanceM. Ceulemans

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Research AlliancesS. Strub

Research AlliancesS. Strub

Research AlliancesS. Strub

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Alliance ManagementD. Weston

Alliance ManagementD. Weston

Search/EvaluationG. Cupit

Search/EvaluationG. Cupit

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

PartneringH. GirsaultPartneringH. Girsault

Global BD&LV. HartmannGlobal BD&LV. HartmannGlobal BD&LV. HartmannGlobal BD&LV. HartmannGlobal BD&LV. HartmannGlobal BD&LV. Hartmann

USA, EULatam, Asia

USA, EULatam, Asia

USA, EULatam, Asia

USA, EULatam, Asia

USA, EULatam, Asia

USA, EULatam, Asia

JapanI. Ohhashi

JapanI. Ohhashi

JapanI. Ohhashi

JapanI. Ohhashi

JapanI. Ohhashi

JapanI. Ohhashi

FinanceM. Ceulemans

FinanceM. Ceulemans

FinanceM. Ceulemans

FinanceM. Ceulemans

FinanceM. Ceulemans

FinanceM. Ceulemans

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Project ManagementJ.M. Séquier

Research AlliancesS. Strub

Research AlliancesS. Strub

Research AlliancesS. Strub

Research AlliancesS. Strub

Research AlliancesS. Strub

Research AlliancesS. Strub

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Development Alliances/Out-Licensing

I. Csendes

Alliance ManagementD. Weston

Alliance ManagementD. Weston

Alliance ManagementD. Weston

Alliance ManagementD. Weston

Search/EvaluationG. Cupit

Search/EvaluationG. Cupit

Search/EvaluationG. Cupit

Search/EvaluationG. Cupit

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

Mature BusinessA. Hörning

Primary CareS. Saxena

OphthalmologyS. De Vries

TransplantationM. Grannatt

OncologyG. Golumbeski

Anti-InfectousM. Grannatt

PartneringH. GirsaultPartneringH. GirsaultPartneringH. GirsaultPartneringH. Girsault

Source: ‘Novartis: Your partner of choice’ presentation Business Insights Ltd

Figure 5.39: Licensing process at Novartis

S & E

Negotiation

PreselectionInitial

TechnicalEvaluation

Full Evaluation Negotiation

Alliance Management

S & E

Negotiation

PreselectionInitial

TechnicalEvaluation

Full Evaluation NegotiationPreselection

InitialTechnicalEvaluation

Full Evaluation Negotiation

Alliance Management

Source: Novartis: Your partner of choice’ presentation Business Insights Ltd

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Leading out-licensing companies

A survey of licensing executives revealed that the leading out-licensing partner in 2006

is Cephalon, as shown in Figure 5.40. However, the survey selections of leading out-

licensing partner were dispersed across a wide range of companies, with no single

company receiving more than 3 votes. Other leading out-licensing partners include

Ablynx, Amylin, Genentech and UCB.

Figure 5.40: Out-licensing partner of choice, 2006

3

2

2

2

2

Cephalon

Ablynx

Amylin

Genentech

UCB

Number of survey respondents

Source: Licensing trends survey, 2006 Business Insights Ltd

Cephalon

Cephalon has an interesting business model, based on limiting risk through licensing

agreements and acquisitions. The company has both in-licensed and out-licensed the

rights to pharmaceutical products in order to facilitate its business model. From an in-

licensing perspective, Cephalon has acquired rights to Trisonex (arsenic trioxide) from

Cell Therapeutics in 2005, the rights to Gabitril (tiagabine) from Sanofi-Synthelabo in

2002 and the rights to Actiq (fentanyl) from Elan in 2002 after acquiring Anesta in

2000.

Experience from being on the in-licensing side of multiple licensing agreements has led

to a number of recent examples of successful out-licensing deals with development and

marketing partners. In 2006, Cephalon signed an agreement with Takeda

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Pharmaceuticals North America in order to add 500 Takeda sales reps to co-promote

narcolepsy treatment Provigil (modafinil) in the US. The agreement included an option

to extend the relationship to include new treatment Nuvigil (armodafinil). A similar

agreement signed with McNeil Consumer and Specialty Pharmaceuticals in 2005

provides co-promotion support for Attenace (modafanil) in preparation for the approval

of a pediatric label for attention deficit/hyperactivity disorder (ADHD). A 2003

agreement with Tanabe Seiyaku provided the company with a license to promote Actiq

(fentanyl) in Japan.

Cephalon’s licensing model of acquiring rights to marketed products in order to

generate revenues to fund the internal development of in-house products appears to

work well. More importantly, as an out-licensor, the company has been willing to share

promotional rights for its products, particularly in the US and Japan, in order to

maximize the returns from its internal assets. By out-licensing the US promotional

rights for key products without having to share any co-development costs and risks, the

resulting licensing agreements have been kept simple and focused. Moreover, the

agreements with Takeda and McNeil illustrate Cephalon’s willingness to partner with

market leaders (and potential competitors) in order to maximize total licensing

revenues.

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Recommendations for the future

The key recommendations from this report can be summarized under four main

categories.

Licensing trends

As licensing deals continue to increase in value and complexity, pharmaceutical

and biotech companies must look to extend their deal-making to form long lasting

partnerships involving multiple products;

As more and more pharmaceutical licensing moves towards long term relationship

building, companies must work even harder to find the right collaborator with the

right deal in order to protect a reputation for being a reliable and productive

licensing partner.

Licensing process

Pharmaceutical companies must align licensing activities around a determined

strategy that is consistent with broader, corporate-level objectives;

When considering licensing opportunities, companies must also be introspective

and evaluate what they can add to the deal, as a developer, marketer or

collaborative partner;

A distinction between a licensing valuation used to select appropriate opportunities

and a valuation used to inform negotiations and deal-making must be made in order

to ensure the different objectives for each exercise are satisfied;

‘The proof of the pudding is in the eating’ and all licensing efforts should be

focused on creating deals that can ultimately be successfully implemented, not just

successfully agreed and signed.

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Licensing valuations

Licensing valuations should ideally be shared and form the basis for open

discussions over total project values and appropriate deal terms for sharing risks,

returns and responsibilities;

Licensing valuations for deal-making should be based largely on independent and

unbiased model inputs in order to limit any areas of subjective disagreement;

Valuations should be simple and clear to understand in order that all interactions

between costs, risks and revenues are fully understood;

Discount rates are not necessary to understand value and should not be used to

create a base case deal-making valuation;

By creating licensing valuations based on a common valuation measure (e.g. 2006

US dollars) a common language for discussing deal terms between licensing

partners is provided.

Licensing best practices

Best practices are specific to a particular deal and should not be applied as a more

general set of licensing rules;

Lessons can be learned from the leading deals and deal-makers – which tend to

involve clear licensing objectives, long lasting agreements and creative deal terms –

in order to capture the unique characteristics of each deal and deal-making partner.

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CHAPTER 6

Appendix

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Chapter 6 Appendix

Primary research survey

A survey of 142 licensing executives was completed in early 2006 in order to identify

trends and best practices for this report. As shown in Figure 6.41, survey respondents

were drawn from across all major healthcare industry segments, including

pharmaceuticals, biotechnology, drug delivery, generics and medical equipment and

diagnostics. The survey was dominated by executives from pharmaceutical companies

(55%) and biotech companies (20%).

Figure 6.41: Licensing trends survey respondents by company focus

Drug delivery9%

Generics4%

Medical equip/ diagnostics

3%

Other9%

Biotech20%

Pharma55%

Source: Licensing trends survey, 2006 Business Insights Ltd

As shown in Figure 6.42, survey respondents were drawn from a range of different

functional responsibilities, though each respondent had some level of decision-making

responsibilities for pharmaceutical licensing. Executives from the licensing and

business development function made up the majority of respondents (56%), with a

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further 20% involved in sales and marketing and 13% involved in corporate functions

or senior management.

Figure 6.42: Licensing trends survey respondents by functional responsibility

Corporate & Senior

Management13%

R&D6%

Industry analyst/

consultant5%

Sales & Marketing

20%

Licensing & Business

Development56%

Source: Licensing trends survey, 2006 Business Insights Ltd

As shown in Figure 6.43, survey respondents were comprised of 63% that had

responsibilities relating to both in- and out-licensing, 22% with responsibilities for in-

licensing alone and 15% with responsibilities for out-licensing alone.

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Figure 6.43: Licensing trends survey respondents by licensing responsibility

Out-licensing15%

In-licensing22%

Both63%

Source: Licensing trends survey, 2006 Business Insights Ltd

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Sources

Cockburn and Henderson, 2001 Scale and scope in drug development: unpacking

the advantages of size in pharmaceutical research.

Iain M. Cockburn and Rebecca M. Henderson.

Journal of Health Economics 20 (2001) 1033-

1057

Danzon, Nicholson and Pereira, 2005 Productivity in pharmaceutical-biotechnology

R&D: the role of experience and alliances. Patricia

M. Danzon, Sean Nicholson, Nuno Sousa Pereira.

Journal of Health Economics 24 (2005) 317-339

DiMasi, Grabowski and Vernon, 2004 R&D costs and returns by therapeutic category.

Joseph A. DiMasi, Henry G. Grabowski and John

Vernon. Drug Information Journal 38 (2004) 211-

223

DiMasi, Hansen and Grabowski, 2003 The price of innovation: new estimates of drug

development costs. Joseph A. DiMasi, Ronald H.

Hansen and Henry G. Grabowski. Journal of

Health Economics 22 (2003) 151-185

Grabowski, Vernon and DiMasi, 2002 Returns on research and development for 1990s

new drug introductions. Henry Grabowski, John

Vernon and Joseph A. DiMasi.

Pharmacoeconomics 20 Suppl 3 (2002) 11-29

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Index

Ablynx, 107

Alliance management, 62, 63

Amgen, 104

Amylin, 107

Anadys Pharmaceuticals, 105

Arakis, 105

Arrow Therapeutics, 105

AstraZeneca, 23, 62, 101, 103

AtheroGenics, 101, 103

Biotechnology, 12, 67, 103

Cardiovascular, 95

Cephalon, 14, 107, 108

CNS, 36, 37, 91, 92, 95, 96

Deal making, 19, 60, 76

Drug delivery, 48

Eli Lilly, 10, 18, 62

Genentech, 10, 14, 18, 27, 101, 102, 107

GlaxoSmithKline, 23, 27

Human Genome Sciences, 105

Idenix, 27, 101, 102, 105

Johnson & Johnson, 102, 104

McNeil, 108

Merck & Co, 23

Millennium, 101, 102, 103

Novartis, 14, 23, 27, 101, 102, 104, 105, 106

NPV, 13, 58, 74, 84, 85, 86, 87, 95

Ortho Biotech, 101, 102, 103

Otsuka, 105

Pfizer, 23, 104

Pharmaceutical, 1, ii, iii, 12, 17, 19, 23, 43, 49, 58, 63, 67, 109

Portfolio management, 47

Roche, 14, 23, 27, 63, 101, 102, 104

Sanofi-Aventis, 23

SeBo, 105

Senju Pharmaceutical, 105

Servier, 105

Takeda, 107, 108

Tanabe Seiyaku, 108

UCB, 107

Valuation, 75

Ventura, 105