Special to BioWorld Financial Watch
What usually comes to mind when followers of the biotech industry hear the word “virtual“ is something along the lines of a 10-person company with a nascent platform technology and maybe $10 million in venture funding.
But when Steven Briggs, president of the planned Novartis Agricultural Discovery Institute (NADI), said, “We're going to keep everything outside that can be kept outside and stay as virtual as possible,“ he was referring to a project for which $600 million has been earmarked over 10 years.
Novartis AG, of Basel, Switzerland, disclosed its plan for NADI in July. Briggs expects the $50 million facility, sited near the Novartis Institute for Functional Genomics in La Jolla, Calif., to be ready in two years. He expects to be spending at his full allotted annual burn rate of $55 million within three months. He plans to hire 30 to 50 people by the end of 1998, eventually expanding to a 180-person discovery research group.
“In our early days,“ Briggs said, “we'll contract or acquire or partner to get up to full speed right away.“ Virtual? Maybe not in the conventional sense, but it reflects the current scale of R&D investment in the fiercely competitive, highly concentrated arena of big agriculture.
It also represents a dramatic increase in R&D spending — triggered by the desire to access the scope and power of genomics — in a historically low-margin, commodity-based industry.
Pharmaceutical development is a high-risk, high-reward game played with huge R&D budgets. In agriculture, on the other hand, the return on R&D historically has been less because of lower, constrained margins on product sales.
“The proportion of R&D to sales has always been higher in the pharmaceutical industry,“ explained Alan Crane, vice president of business and operations at Millennium Pharmaceuticals Inc. (NASDAQ:MLNM), in Cambridge, Mass. “Therefore, there's been more risk taking.“
However, now the big agricultural companies are changing their philosophy. Over the past decade, consolidation spurred by a strategy of restricting competitors' freedom to operate — including control over acreage, feedstock and distribution infrastructure as well as technology to transfer genes and rights to the genes themselves — has left only a few, massive companies standing.
And because market share is critical to success in a low-margin environment, their drive to innovate is intense.
At the same time, the first transgenic crops have made their impact on the market. In 1996 Bt (insect-resistant) corn, cotton and potatoes were commercialized, as were Roundup-ready (herbicide-tolerant) soybeans. Bt is a toxin from Bacillus thuringiensis and Roundup is an herbicide sold by Monsanto Co. (NYSE:MTC), of St. Louis.
These successful product introductions validated the importance of inserted traits. Or, viewed another way, validation came from the lack of failure of these products.
Novartis' Briggs said, “There was much skepticism until that corn was brought to market, but it became the proof that all of the hype and promise of the previous decade will become true.“
While the appearance of transgenic crops may have whet big ag's appetite for innovation, the driver behind the new agricultural R&D mindset appears to be the maturation of genomics technology.
The rate at which genes can be sequenced has gone up exponentially, enabling researchers to look at an entire genome all at once. High-throughput screening has driven down costs.
David Fischhoff, president of Cereon Genomics LLC, in Cambridge, Mass., observed, “The economics of the R&D have become more than favorable enough. There's been a realization by the agriculture industry that with genomics there would be more products with added value.“ While both sides have recognized the opportunity, he said, “each needed to educate the other about their businesses.“
Cereon is a wholly owned subsidiary of big ag's Monsanto, created in October 1997 through a $218 million technology transfer and licensing deal with Millennium.
Learning From The Past
Elizabeth Silverman, a senior biotechnology analyst covering genomics at BancAmerica Robertson Stephens & Co., in New York, pointed out, “The first wave of startups [in the 1980s] mostly had biotech people founding ag-bio companies and they were set up like pharmaceutical companies. Product development was case-by-case and the value of the improvements was marginal.“
Steven Burrill, whose investment banking firm, Burrill & Co., has raised more than $80 million from Hoechst Schering AgrEvo GmbH, of Berlin, Bayer AG, of Leverkusen, Germany, and Transamerica Corp., of San Francisco, to participate in agricultural spin-outs as well as existing companies, explained it this way.
“There was a belief a decade ago that health-care opportunities and agricultural opportunities were in parallel,“ Burrill said. “But the first-generation ag companies never experienced the same kind of reward. The capital markets were not very permissive and the technology had a ways to go.“
In the past two years, every one of those first-generation companies has disappeared as a stand-alone entity:
* Mycogen Corp. (NASDAQ:MYCO), of San Diego, is in the final stages of acquisition by Dow Chemical Co. (NYSE:DOW), of Midland, Mich.
* Plant Genetic Systems International NV, of Ghent, Belgium, was purchased by AgrEvo, an agricultural joint venture of Hoechst AG, of Frankfurt, and Schering AG, of Berlin.
* Calgene Inc., of Davis, Calif., AgriCetus Inc., of Middleton, Wis., and DeKalb Genetics Corp., of Dekalb, Ill., went to Monsanto.
* Mogen International NV, of Leiden, the Netherlands, is owned by Zeneca plc, of London.
* DNA Plant Technology Corp., of Oakland, Calif., is gone to Empresas La Moderna SA de CV, of Monterrey, Mexico.
Having secured freedom to operate through these technology acquisitions — as well as a series of buyouts of seed and processing companies to bolster their commercial distribution networks — genomics capabilities are No. 1 on big ag's shopping list.
“Now,“ said Silverman, “it's the ag people who are 'borrowing' technology to apply to their needs.“
“The agriculture companies are in the early stages of creating broad commercialization platforms,“ said Sano Shimoda, president of BioSciences Securities Inc., an Orinda, Calif., brokerage firm specializing in agbiotech. “Deals are being made to establish preemptive positions.“
Most prominent — at least in terms of dollars put directly into the genomics companies' coffers — is the Monsanto/Millennium deal that established Cereon. Monsanto also began an alliance with GeneTrace Systems Inc., of Menlo Park, Calif., for genotyping in agriculture in April of this year. Also, like many of the big ag firms, Monsanto has a nonexclusive agreement with Incyte Pharmaceuticals Inc. (NASDAQ:INCY), of Palo Alto, Calif., for generation of gene sequence and expression data.
E.I. du Pont de Nemours and Co. (DuPont Co.), of Wilmington, Del., which already had built extensive internal gene sequencing and screening capabilities, weighed in with a $1.7 billion investment in August 1997 to establish a research alliance and a joint venture distribution network with Pioneer Hi-Bred International Inc., of Des Moines, Iowa, which itself had existing relationships with Human Genome Sciences Inc. (NASDAQ:HGSI), of Rockville, Md., and CuraGen Corp. (NASDAQ:CRGN), of Branford, Conn.
Last month AgrEvo inked a three-year, $45 million exclusive deal with Gene Logic Inc. (NASDAQ:GLGC), of Columbia, Md., to identify genes for development of crop protection products. DuPont and CuraGen also teamed up this July to apply genomics in crop protection.
The structure of the ag-genomics transactions and the responsibilities of each partner reflect a strategy distinct from genomics deals with pharmaceutical companies.
Greg Went, executive vice president of CuraGen, said, “An important differentiating point between our relationships with agriculture and pharmaceuticals is that we encourage our agricultural partners to drive the choice of targets while we drive the choice of technologies.“
The distinction is important because while CuraGen, along with other genomics companies, has in-house expertise in mammalian genetics via internal programs for the discovery and development of pharmaceuticals, it has no similar capability in agriculture.
NADI's Briggs echoed that sentiment. His scientists will “do the work that only they can do,“ and will focus on “discovery, not data generation.“ In his view, “the creative part is in recognizing the problems. This is an industry of technology vendors and technology appliers. The appliers know how to make the money because they know what the problems are.“
Big Ag's Deals More Straightforward Than Big Pharma's
The contrast between agriculture and pharmaceuticals also is reflected in the financial terms in deal structures. Because of differences in volumes and margins, “there's a different reality on the royalty side,“ Went said. “It's always a trade-off between development milestones and long-term royalties. CuraGen strategically shifted toward long-term royalties as we believe our partner will get us to those royalties faster.“
The deals are more straightforward, too. “The error bars on your financial models are much tighter,“ Went explained. “Any financial model of a pharmaceutical deal, when you talk about the introduction curve, when it's introduced and the size of the market, those things are really widespread if you're being honest with yourself. On the agriculture side, you can look at a project or series of projects and feel more confident of the time frame.
“That's why we bet on the long-term revenue stream coming out of agriculture and the long-term position of our partner as a market leader,“ he added.
The flip side — taking the money up front and eschewing milestones — works, too, as evidenced by the Monsanto-Millennium alliance. But that deal may be “a one-time land grab,“ Burrill said. “When Monsanto paid hundreds of millions of dollars to Millennium, it created the impression of undue value.“
Exclusivity also means something different to an ag company — especially in a market used to preemptive strikes to drive away competition — and is a valuable bartering point in an ag-genomics deal.
Gene Logic's pact with AgrEvo was “strikingly similar to drug deals,“ said CEO Michael Brennan, “with one important nuance. Because of the concentration of players in agriculture, we did an exclusive deal.“
On the other hand, Steve Burrill also sees the upside of a “slice-and-dice“ strategy. “There's value in agriculture to having a franchise in a given crop, such as Pioneer has in corn,“ he said. Genomics companies can leverage their technology by addressing niche markets and doing deals with several companies, crop by crop.
The big question remains: Can you capture sufficient value to justify the R&D spend? Inserted traits do not create a new kind of crop, but rather enhance the characteristics of existing products. “Most of the value creation is incremental,“ Burrill noted. But he said companies can create enough value to justify the risk.
The problem has been that value was captured on the input side, from the farmer's seed purchases. That has been a high-volume, low-margin business which some see as having only limited potential and which may resist changing, BancAmerica Robertson Stephens' Silverman said, because it's “the victim of its own success.“
Further, “you can only address so many problems on the input side,“ said Jerry Caulder, president of Xyris Inc., a recent agriculture biotechnology startup established in San Diego in collaboration with Axys Pharmaceuticals Inc., of South San Francisco, a combinatorial chemistry and genomics company. “But the output side is infinite,“ he said.
Why? “On the input side, you're dealing with either nutrition or crop protection,“ Caulder noted. “Once you run out of insects and have a fertilizer, you are no longer adding value.“
“A lot of us believe there's a big opportunity on the output side,“ said Tony Cavalieri, vice president and director of trait and technology development for Pioneer Hi-Bred. “But the industry is not set up to identify or capture that value. The issue is that there's a commodity mindset.“
He observed that Optimum Quality Grains, a Des Moines distribution joint venture established last year between DuPont and Pioneer, is directed at creating output markets, encouraging the farmer to choose seed based on end use.
“The output side is already changing with DuPont's $1.5 billion purchase of Protein Technologies International, the soy processing operation from Ralston Purina Co.,“ declared Xyris' Caulder. Both companies are in St. Louis.
In Caulder's view, that move signals the beginning of a trend toward use of smaller acreages to grow premium products. “Economics of scale are not as important with specialty crops,“ he said.
Room For Startups?
Can startups also grow successfully in this big-money, big-company climate? To establish Xyris, Caulder, who was CEO of Mycogen, is taking combinatorial chemistry and genomics from Axys and combining it with $10 million from Bay City Capital, a private merchant bank in San Francisco. Among the Bay City partners is former Calgene head Roger Salquist.
Xyris is 50 percent owned by Axys — a stake Caulder expects will be diluted as collaborators take new equity. He'll use the $10 million to “bring in the people to decide quickly on which areas we'll work on.“ For the time being, Axys will take a fee from Xyris to manage administration.
Caulder said he can build value by tapping into niche markets. “California alone grows some 250 crops,“ he observed. “No one will be in all of them, especially big companies locked into large crops.“ He cited the potential for making improvements in asparagus, apples, peaches and vegetables as examples.
Caulder urged establishment of a kind of orphan drug bill to support development of traits in small crops that are under attack from newly introduced pests, such as those from Mexico following implementation of the North American Free Trade Act.