In-licensing may be pharma’s preferred mode of business development these days. Should that impact your investment strategy?
When it comes to investing in pharmaceutical companies, looking at pipelines and research and development prospects is important. But in-licensing is also key when looking at these stocks.
In fact, in-licensing deals might be the pharmaceutical industry’s preferred mode of business development these days — perhaps even more so than outright acquisitions. These agreements can prove to be very fruitful for companies and their share prices.
The in-licensing strategy is likewise attractive to investors: in-licensing drugs expedites corporate development while also mitigating risk. So let’s clear up some common questions around the strategy.
In the article below, we run through what it means to in-license a drug and how in-licensing differs from an acquisition. We also cover how royalties affect returns. It’s key for investors to be aware of these intricacies so that they can interpret a firm’s actions correctly — and elect to buy or sell at the right time.
Some things are best explained by example, so let’s take a look at Santhera Pharmaceuticals (SWX:SANN). In February 2018, the pharmaceutical company licensed a clinical-phase cystic fibrosis asset from Polyphor, a private Swiss biotech company.
Under the deal, Santhera took on worldwide development and commercialization of the drug, and will be able to use it to expand its pipeline. Meanwhile, Polyphor received US$6.5 million upfront and will get another US$121 million if the drug passes specific milestones. Polyphor will also receive royalty payments from future net sales.
In this agreement, Santhera is the in-licenser, meaning it is licensing a product from Polyphor; Polyphor, which is licensing its product to Santhera, is the out-licenser. These deals are popular as they allow one company (in this case, Santhera) to take on some of the financial or technological burdens associated with developing the product of another company (in this case, Polyphor). Both end up benefiting.
The collaboration between Santhera and Polyphor is just one example of in-licensing. Other instances include Biogen (NASDAQ:BIIB) and Alkermes (NASDAQ:ALKS), which are developing and commercializing a multiple sclerosis treatment.
There’s also Alnylam Pharmaceuticals (NASDAQ:ALNY), the leading RNAi therapeutics company, and Sanofi (NYSE:SNY). Earlier this year, they restructured their alliance, allowing Alnylam to receive global development and commercialization rights to Sanofi’s investigational RNai therapeutics programs; for its part, Sanofi will receive royalties.
In-licensing is becoming more and more commonplace, in part because of the influx of small biotech companies on the market. These early stage companies are a key source of promising product candidates, which pharmaceutical companies then in-license certain rights to.
Benefits of in-licensing
In-licensing is cost effective, since the financial burden of product development is shared. It’s also lower risk for the company buying in as it can make deals based on promising preclinical or clinical results. Compare that to the traditional drug-discovery process, where a company embarks on a project, investing heavily in its development — all with little data to back up expectations.
In-licensing also holds significant appeal when compared to straight acquisitions or mergers. As Aaron Smith wrote for CNN Money, “[w]ith licenses, drug companies purchase only the rights for the experimental drugs they’re interested in, and they don’t have to take on another company’s problems or unwanted technologies.”
All of that means in-licensing can hold major appeal for pharmaceutical companies and investors alike. But, as mentioned above, it can also generate confusion — confusion that can lead to ill-informed decisions on the part of investors.
Just as pharmaceutical companies are always looking for the next blockbuster drug, investors are looking for the company that will develop it. For that reason, in-licensing agreements can be somewhat off-putting — even if a drug proves wildly successful, its profits will need to be split between two pharmaceutical companies, and therefore two groups of shareholders.
Such was the case with Eliquis, an anticoagulant jointly developed by Pfizer (NYSE:PFE) and Bristol-Myers Squibb (NYSE:BMY). Discovery and clinical advancement were completed by the latter, which joined forces with Pfizer only when entering late-stage trials.
This puzzled some investors — after all, the drug seemed like a potential blockbuster. It would be a novel entrant to the market, and would benefit a wide number patients. Why split the profits with another company, and one coming late to the game?
As John LaMattina explains in Forbes, at the time of the deal there were still plenty of questions about the success of Eliquis. The anticoagulant drug market is a competitive one, and there was no guarantee that this drug would prove more effective than similar products also in development. What’s more, Phase III trials are costly, and Bristol-Myers Squibb was contending with a tight R&D budget.
In the case of Pfizer, Bristol-Myers Squibb eased the risk and financial burden of getting Eliquis approved. It took a long time to roll out the drug, but today it’s a top earner, bringing in profits for both pharmaceutical companies.
In-licensing deals can also cause confusion by complicating financial statements. “They are not typically recorded as an asset on the balance sheet,” Jeff Margolis, vice president of RespireRx (OTCQB:RSPI), explained to the Investing News Network.
“They are considered ‘in-process research and development,’ and the expenditures are considered expenses on the profit and loss statement, typically creating large losses.”
That means the uninitiated investor might misinterpret a company’s financial statement, since it does not “truly account for the value of the licenses.” As Margolis said, “the asset is intangible.”
Sustainable, but not traditional
As pharmaceutical manufacturers move more toward in-licensing, they tend to reduce their massive R&D budgets. This can perturb investors accustomed to the traditional pharmaceutical growth model: drug discovery leads to products, which leads to profits.
But remember that drug discovery also leads to major losses. Pharmaceutical companies spend millions on development, yet only one in 10 product candidates ever makes it to market. In-licensing can offer an opportunity to cut down that expense and share the burden of risk.
Plus, as pharmaceutical investors are becoming increasingly aware, blockbuster drugs are few and far between these days. “The industry is the victim of its own previous successes,” Dan Hurley explains in an article for the New York Times. “In order to thrive, it must come up with drugs that work better than blockbusters of the past.”
In-licensing may not be traditional, but it could be a more sustainable method of pharmaceutical growth. As the major pharmaceutical companies embrace this model, investors must adjust their own mindset too. The old rules might not apply any longer, and it’s important to reconsider investment strategies in light of industry changes.
Now that you know a bit more about in-licensing, will it affect how you invest in pharmaceutical companies, and why? Let us know in the comments below.
This is an updated version of an article originally published by the Investing News Network in 2016.
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Securities Disclosure: I Amanda Kay, hold no direct investment interest in any company mentioned in this article.