A recent paper in Nature Biotechnology suggests that we could use creative financing techniques for funding biomedical innovation on a mega-scale. I argue that this could be a possible way for jump-starting the African biotech century …
‘Valley of death’ or ‘terra incognita’?
Considering the looming patent cliff (1), the broken block-buster drug business model (2), surging costs for drug development (3), increasing complexity of biological research, disappointing rates of success of ‘Translational’ initiatives (4), and the patchy, if not decreasing, financial returns on investments made by venture capital (VC) funds (5, 6), it should come with no surprise that many look at the prospects of the life science / biomedical industry with skepticism, if not in despair.
The ‘valley of death’ metaphor (7) is often used to describe the demise of a large fraction of early-stage biotechs who fail to make it because promising candidate molecules or exciting new diagnostic tests do not achieve critical performance criteria. The phenomenon has been known for a while, which is why governments all over the world are stepping in to invest strategically in this space in order to stimulate growth of their respective bio-economies.
The situation is no different for Africa, even though the problem here presents itself in a slightly different manner. In Africa, to use the ‘valley of death’ metaphor is actually an oxymoron: It would assume that there is a large number of ventures that have tried and failed when entering the critical early stage of biomedical product development. In reality the number of such endeavors has been, and continues to be, so low that it is probably be more apt to speak of aterra incognita that remains largely unconquered on the African continent.
And yet, what makes Africa so interesting is that it combines urgent needs for biomedical innovation with a wealth of opportunities, such as in the form of professionals who are as ingenious as can be in view of the often challenging context (and often achieve remarkable successes with what little support they have got) and a biological diversity (human, animal, plant, microbial) that should make investments into biotech innovation hugely attractive, in principle (*).
What, then, can be done in order to fully realise the slumbering potential of an African biotech century?
Clever financing techniques to the rescue!
A recent paper in Nature Biotechnology (8) provides an interesting answer to this question.
Taking into account the rather dismal gains made by life sciences venture capital firms and the disappointingly low rate of investment into translational efforts over the last 10 years, the authors set out to propose a securitisation based approach to financing biomedical innovation (8).
Although creative mechanisms of financing, and securitisation in particular (9), are viewed with scepticism in the wake of the 2008 financial crisis, the authors argue that there is merit in exploiting such techniques for the benefit of much needed large-scale financing of biomedical innovation.
In essence, the approach they propose is composed of two components: (i) creating large diversified portfolios—‘megafunds’ on the order of $5–30 billion—of biomedical projects at all stages of development; and (ii) structuring the financing for these portfolios as combinations of equity and securitized debt so as to access much larger sources of investment capital (8).
This is based on a number of premises:
- Long-term annuities, such as in case of 10-15 year bonds, are more in sync with the typical life cycle of drug or diagnostic product development, as opposed to the 2-3 year horizons of VC and private equity investors (and, oddly enough, of some institutional investors too).
- A large-scale fund could cater to a broader range of investor ‘risk appetites’ by way of structuring debt (and equity, for the higher risk/higher return clientele) into different types of maturities (say, 5, 10, and 15 years). Consequently, these maturities will yield different returns. Although not comparable to rates of return desired by VCs, these will be attractive enough to large scale pension or sovereign funds.
- A megafund is able to attract capital from a diverse range of investors. In favor of this, the paper argues that ‘at the end of 2010 the California Public Employees Retirement System held $226 billion of investable assets, the Norwegian government pension fund held $537 billion and nongovernment US institutional money market funds held $1.1 trillion. Moreover, as of the end of 2010, the total size of the US bond market was $35.2 trillion. In relation to these magnitudes, a megafund of $30 billion no longer seems as unattainable if debt-financing is feasible’ (8).
- A bio-innovation fund of such a scale makes investments into the projects across the entire spectrum of the innovation chain feasible, from early-stage development to ‘close-to-market’ projects. The reason for this is that risk and uncertainty of success are diluted out due to the large number of programs undertaken simultaneously. Even though it may be impossible to predict which of these programs will succeed, or fail, the likelihood of success will increase with the number of programs undertaken. The authors go on to show that even at a predicted success rate of 5%, the megafund is viable and yields returns in the order of 5 and 8% for senior and junior obligations, respectively, and in the order of 9% for the equity portion of the fund (8). In simulations run by the authors, investors were repaid in > 99% of the time.
Notwithstanding practical challenges when creating such a megafund, there are a number of opportunities that make it look like an interesting solution for the creation of a bio-economy in the developing parts of the world. From a South African perspective, the following comes to my mind:
- Although the life and biomedical sciences private equity and VC sector is literally non-existent, the financial sector in South Africa is very strong. In fact, it’s probably one of the most resilient and stable sectors in comparison to others in the world, considering its ability to absorb the 2008 financial crisis shockwaves.
- There is a socio-political climate that supports, in principle, the creation of a bio-economy.
- Considering South Africa’s rich bio-diversity (human, animal, plant, microbial, etc), there is ample opportunity for ‘biological exploration and mining’ ventures.
- There are pressing health needs that warrant the development of fit-for-purpose solutions (in particular drugs and vaccines that are both affordable and efficacious), yielding socio-economic benefits in the mid- to long term. This, amongst others, is something that should appeal to ‘social responsibility’ minded investors.
- South Africa, and Africa, has a rapidly growing middle class, making the development of products for this geographical region an interesting prospect on the mid- to long-term.
In summary, I think there is an interesting opportunity for players from the financial and the life sciences sectors to explore synergies and complementary expertise in creating innovative new ways for financing biomedical innovation in Africa…
* The obvious strategy for governments in Africa, assuming that there is a genuine interest in building a bio-economy, would be to invest strategically for a period of at least 10-15 years, in order to build the institutional capacity, and knowledge, necessary for biotech innovation. Amongst others, this would require that large-scale commitments are made into ramping up the number of early-stage investments and to concentrate on learning, not pushing for returns. Trying to pick the proverbial ‘close-to-market’ cherries won’t work, simply because, (i) achieving meaningful returns is a problem of size and statistics and, (ii), the success rates will only go up over time, if only marginally, due to the accumulation of institutional knowledge. The latter will only happen if significant amounts of investments were made in the first place. Following this (i.e. after an initial period of 10-15 years), they could then concentrate on luring private capital into that space, who will be more willing to come in view of a public show of confidence; and, when they can rely on access to relevant institutional knowledge at the same time.
1. ‘Patent Cliff’ Hits Europe Drug Makers (25 October 2012)
2. Lessons from Lipitor and the broken blockbuster drug model (10 December 2011) The Lancet, 378, 1976.
3. Roger Collier (2009) Drug development cost estimates hard to swallow. CMAJ, 180(3): 279–280.
5. The Biotech Venture Capital Math Problem (15 March 2012)
6. When It Comes to Venture Funds, Small Is Still Beautiful (19 January 2012)
7. Fixes in Financing – Financial Innovations for Translational Research. Milken Institute.
8. Jose-Maria Fernandez, Roger M Stein & Andrew W Lo (2012) Commercializing biomedical research through securitization techniques. Nature Biotechnology, 30: 964-975.