BioWorld Insight Contributing Writer

Editor's note: This is a special reprint from the Aug. 22, 2011, edition of BioWorld Insight.

For years, biotechs seeking to out-license their drug candidates have had to retain an increasing portion of the development risk.

According to data from Deloitte Recap LLC, the average up-front payment was more than 20 percent of the deal value in 2000, though that figure slipped to less than 6 percent by 2010.

But data from the first half of this year suggested the pendulum may be swinging back in the other direction. The average up-front payment in the first half of the year was $60 million, considerably higher than the $21 million in 2010 and the $29 million in 2009. In fact, with milestone payments shrinking in the first half of the year, the average up-front payment has ballooned to more than 27 percent of the total deal size.

Part of the change in ratio could be due to fewer multi-product deals, which often contain milestone payments for each potential compound, inflating the size of the deal.

But the constrained capital environment is also likely contributing to the increase in up-front payments. With limited capital available from initial public offerings and secondary offerings, obtaining a larger up-front payment for licensing a drug is a legitimate way for biotechs to keep their pipeline funding alive.

"There's always this push and pull between the biotech sell-side and the buyers as to where the money in the deal goes – whether it's up-front cash or contingent milestones," said Chris Dokomajilar, senior biotech analyst at Deloitte Recap.

"Up-front cash payments are favored and are a subject of strong negotiation in deal making, especially in the absence of other financing opportunities," Dokomajilar said.

While the ability to obtain cash up front is helpful, biotechs can't expect a simple one-for-one exchange of a milestone dollar into an up-front dollar.

Companies licensing drugs take on risk when they make up-front payments and equity investments and commit R&D dollars. If biotechs want more up front, Dokomajilar said they'll likely have to give up more on the back end. The data would suggest that's the case, with average milestone payment falling from $284 million last year to $213 million in the first half of 2011.

Pharma's desire for late-stage products could also be contributing to the increase in up-front payments.

In the first half of 2011, 47 percent of deals were signed for compounds in Phase II or later, the highest level of mid-to-late-stage assets observed by Deloitte Recap. The deals for later-stage compounds tend to have larger up-front and near-term milestone payments because the compounds have been partially de-risked.

Breaking out M&A transactions from the overall business development landscape indicates buyers are increasingly using back-end payments when acquiring biotechs. According to data from HBM Partners AG, 39 percent of acquisitions in 2011 incorporated earnouts into the purchase compared to just 25 percent in 2010. (See BioWorld Insight, Aug. 23, 2010.)

It remains to be seen whether the trend of including contingent value rights (CVR) and earnouts in acquisition deals will continue. Not having any control over the development of the drug and therefore the ability to obtain the additional payment may not sit well with sellers.

The lack of control has caused investors to substantially discount many CVRs.

The CVRs tied to Celgene Corp.'s acquisition of Abraxis BioScience Inc., for instance, recently traded at $1.55 even though they have a potential payout of more than $15. And Genzyme Corp.'s former shareholders are unlikely to see the $1 CVR connected to manufacturing levels of Cerezyme (imiglucerase) and Fabrazyme (agalsidase beta) after Sanofi SA took over operations. (See BioWorld Today, July 29, 2011.)

"[CVRs] might just fade away if sellers put more emphasis on the up-front M&A value vs. an untested contingent phenomenon," Dokomajilar said.

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