By Randall Osborne

Editor

Joe Dougherty, senior analyst with Lehman Brothers Inc., doesn't mind acknowledging that the company's new report on genomics is creating ripples in the industry.

"But a lot of the people who are most upset about it haven't read it," he said.

Titled "The Fruits of Genomics: Drug Pipelines Face Indigestion Until The New Biology Ripens," the 109-page report was put together with McKinsey & Co., a management consulting firm.

"The fundamental purpose was to look at the impact on big pharma pipelines," and not to evaluate individual genomics firms, or speculate in detail about their respective futures, Dougherty told BioWorld Financial Watch. That much said, the report provides guidance for investors that short-term players many of whom have their fingers in pharmaceutical and genomics pies may find troubling.

"We're looking at a rapidly changing technological situation here, as the target mix that pharma is working on changes to a higher proportion of novel targets" cranked out as a result of the genomics revolution, said Dougherty. "It's easier to do something that someone else has already done."

The word, in short, is that the next five years will be tough. Dougherty said 2005 is "when we see things turning back around." Until then, watch for Phase II blowups of drugs that first seemed promising, he warned, noting that to make such a forecast is hardly to question the steady improvement of target validation technologies.

"Things going into Phase II [trials] now were in basic biology five years ago," he said and the basic biology wasn't all that good. "We see that playing out in preclinical [studies]. That's an inexpensive place to fail, but we also see an increased failure rate in Phase II."

Noting the "toxicity issues around chemistry are likely to be a lottery ticket that's pretty similar" across the board, Dougherty said, Phase II is "where you find out that you didn't quite understand the biology."

The report itself sounds an unsettling call: "Investors, based on an analysis of market expectations for the current group of early stage development projects, do not yet foresee higher attrition rates and would be disappointed should the forecasts of the joint study come true."

Introducing "a thesis about the state of drug development that differs from conventional wisdom," the study said that, despite excitement about improved target validation techniques, they are "unlikely to add value in the near term. These technologies are simply not yet robust enough to yield truly validated targets. In the near term, some of the 'downstream' technologies such as new toxicology modeling, better chemistries and patient stratification in clinical development are likely to provide as much or more value than the much-touted second-generation genomics technologies."

In other words, costs are going up, not down.

"We're talking about the typical small molecule developing drugs and therapies," Dougherty said. "If you've gotten through Phase II, you've probably got a pretty well validated target."

Otherwise, analysts are "upbeat about business models where people are leveraging their own technology platforms, and expanding into a market that is not the market for drugs," Dougherty said, citing the likes of Celera Genomics, of Rockville, Md., and Incyte Genomics Inc., of Palo Alto, Calif.

He called for investor caution regarding the smaller toolbox or database firms, which "tend to have shorter product life cycles. They look more like tech, and less like drugs." Impressive-sounding methods for single nucleotide polymorphism scoring or expression profiling, and high-throughput biology efforts may not be the ticket for profits over any significant term.

"There are many ways to skin some of these cats," Dougherty said. "You can't maintain a decent monopoly." Given the report's projections, an approach of the sort taken by Millennium Pharmaceuticals Inc. in Cambridge, Mass., is more reliable for paybacks, he added.

"Those guys are one of the earliest companies taking a diverse platform and partnering it, and then developing their own products internally," Dougherty said. "It's probably not financially sensible for most companies to develop some of these platforms just for their own drugs, because it can be so expensive to develop the technology, and it can have such broad applications, that those cry out to spread the business more widely than a single company can handle."

Another example, he said, is CuraGen Corp., of New Haven, Conn. "They have, again, a really powerful platform with sophisticated customers," Dougherty said.

Sifting through the toolbox and database enterprises, "investors have to be very clear about how the companies are going to maintain competitive advantages, and what sort of long-term value they can build," he said. "Are they just looking at a couple of years of good sales, and then looking at the risk of being superseded by a better mousetrap?"

Dougherty said the solution is not necessarily therapeutic proteins and antibodies, either, since these "are not without development risk. Everybody's favorite is Epogen [erythropoietin, the red blood cell booster developed by Amgen Inc., of Thousand Oaks, Calif.]. When I was at Genetics Institute Inc. [which developed its own brand of erythropoietin] in the early 1980s, everybody knew it was likely to be a drug. Some products may be 'Epogens,' but some may be gamma interferons that take 15 years to find their best indications."

Investors willing to play the odds in this space ought to scrutinize the prospective drug's function carefully, Dougherty said. "If you can make a good case that you are replacing something in the sick individual," then the compound may have value along the lines of "Cerezyme, Epogen, or even a Neupogen, or insulin," he said.

Cerezyme (glucocerebrosidase) is Cambridge, Mass.-based Genzyme General's replacement enzyme for Gaucher's disease. Neupogen (Filgrastim) is Amgen's white bloodcell booster.

Mark Vincent, spokesman for CuraGen, said he and Dougherty "definitely have a difference of opinion about some of the things in the report," which they recently debated over drinks.

"[CuraGen] has never been a database or a toolbox company," Vincent said. "We just didn't have any venture capital funding, and so we had to build and sell the tools to make the drugs." But the last two deals have been product related, and "we'll be in the clinic in the next 18 months," he said.

Vincent said the report "didn't take into account the increasing horsepower that's out there now," but made the important distinction between product-based and service-based genomics firms.

"That's been difficult for investors to understand, up to this point," Vincent told BioWorld Financial Watch. "It's extremely important, because then you can start to separate your valuations."

Vincent acknowledged that the report deals with small molecules, rather than large, but said this "wasn't clearly explained. The report also talks about genomics in general."

The report "is saying companies aren't doing enough of the wet biology anymore," in Vincent's view. "By no means am I saying we're replacing wet biology, but you can use computational genomics or bioinformatics to shorten the time. How do you triage [the multitude of targets], and funnel them? You have to use computers." Those computers, Vincent said, are increasingly more powerful.

"Genomics in general" is a subject about which many are sensitive, but Dougherty said the report has gained informal endorsement from the pharmaceutical sector it studies.

"We've gotten broad agreement from private conversations with the pharma industry," he said. "People will say, 'We disagree with your numbers here or there, but we agree that you are directionally correct.'"