One alternative to an acquisition is an option-based deal, which may become more favorable to pharmaceutical companies as a way to mitigate risk. This structure, which requires a relatively small initial payment and provides an exclusive purchase options upon the results of clinical trials, allows pharmaceutical companies to hedge their financial exposure until R&D risks are known more fully, and avoid overpaying for an unsuccessful drug candidate.
In the recently announced acquisition option transaction between Cephalon and Ception, for example, Cephalon paid $100 million for an option to acquire Ception Therapeutics. Cephalon may exercise the option to purchase Ception for $250 million at any time until final clinical trials are known, thus protecting itself from exposure to risk of failed clinical trials that it may otherwise have to assume in an acquisition.
Ception will also receive the benefit of the initial $100 million investment and shareholders may also receive additional payments tied to clinical and regulatory milestones.
Another alternative to an acquisition is a corporate partnering or strategic alliance transaction. These deals can be structured to give biotech companies the capital needed to complete testing, as well as an infrastructure and finishing level that biotech companies cannot develop on their own without significant expense. Such transactions can also provide biotech companies with a less dilutive source of capital, which is even more attractive considering the recently depressed valuation of many biotech companies and the current financing environment.
Pharmaceutical companies benefit from filling the gap in their current product pipelines and can structure their investment so that, at first, relatively little capital is at risk. Pharmaceutical companies can exit the arrangement if milestones, such as successful clinical trials, are not met, thus avoiding future funding obligations. One recent example of such a strategic alliance arrangement is the Merck/Galapagos diabetes and obesity drug partnership announced in January 2009.
In this deal, Galapagos received $2 million initially with development and regulatory milestone payments that could exceed $228 million. It is also eligible for unspecified sales milestones and royalties for any product that reaches the market. Merck benefits by receiving an exclusive option to license candidates for clinical development and worldwide commercialization.
The combination of the need for new products by pharmaceutical companies and the need for capital by biotech companies, together with a volatile market and uncertain economy, may have a significant impact on the big pharma/biotech deal market in 2009. These factors may drive significant deal activity, despite the economy, and result in a buyer’s market as valuations will likely trend lower in 2009.
A reduced tolerance for risk, however, may result in a larger percentage of announced acquisitions failing to close. Further, pharmaceutical companies will have strong incentives to move away from acquisitions and toward partnering and option deals with biotech companies. As a result the number of acquisitions, relative to other types of corporate deals, may decrease.