Biotech Grows Up

By Unmesh Kher With Reporting by Maryann Bird/London, Dan Cray/Los Angeles, Andrew Goldstein/Washington, Michelle McCalope/Houston, Jennifer Prittie/Toronto, Jennifer L. Schenker/Paris, Regine Wosnitza/Berlin and Steve Zwick/Cologne

You have to have a strong stomach to invest in biotechnology. Last year a few words from Tony Blair and Bill Clinton about making genes "freely available to scientists" took half the value out of the typical biotech stock within a month. Early this year, when Celera Genomics and the Human Genome Project said they would publish a working draft of the human genome (the full complement of human genes), biotech shares rallied briefly.

But they took another dive, in part because of news that the draft included fewer than 40,000 genes--about 60,000 short of the number expected. After Sept. 11, biotech crashed along with the rest of the market, but it has lately risen resolutely. One reason is all the talk of bioterrorism and the need for remedies. But the other, more important one is that biotech firms, many of which survived for years on their promise, are increasingly turning into real businesses, with real managers, products and earnings.

Genomics firms in the U.S. and Europe--those involved in sexy explorations of the genome--once swore they would steer clear of risky drug development and stick to peddling genetic information. But many are now busy recasting themselves as little pharmaceutical firms and buying up smaller companies to fill the holes in their drug-development technology. Meanwhile, big drugmakers such as Aventis and Bristol-Myers Squibb, under pressure to jump-start their slowing rates of drug discovery, are investing billions of dollars in collaborations with biotech firms to mine the genome for new medicines.

Wall Street's recent drug addiction strikes some as ironic. Robert Erwin, CEO of the Vaca Valley, Calif., biotech firm Large Scale Biology, recalls being told all last year that investors were interested only in hearing about his company's technology. "Now the advice I get is, 'Don't talk about your technology. People only want to hear about your products.'"

Millennium Pharmaceuticals of Cambridge, Mass., has been a step ahead of most competitors. It announced on Dec. 6 the acquisition of COR Therapeutics of South San Francisco, Calif., for a stock swap worth $2 billion--the largest in biotech history and Millennium's fourth acquisition in as many years. That was just the latest in a series of mergers that have changed the face of the industry. Last month Celera Genomics, once the quintessential genetic information-services company, paid $174 million for Axys Pharmaceuticals of South San Francisco, a master designer of drugs. Another major information-services firm, Incyte Genomics, based in Palo Alto, Calif., laid off 400 employees from one of its gene-analysis services to focus resources on drug development. Late last month Incyte's founder hired a pair of veterans from DuPont Pharmaceuticals as CEO and chief scientific officer.

There's plenty of cash available to fuel more drug-driven consolidation, particularly in the U.S., where, according to Ernst & Young, annual biotech revenues have risen at an 11% clip since 1995. Although only 60 of 339 publicly traded U.S. firms turned a profit last year, that's three times as many as did in 1995. And 42% of them have enough cash squirreled away to last at least five years at current burn rates--up from 24% in 1998. Worldwide, as money has rushed out of telecom and digital-technology stocks in the past couple of years, biotechs have raised more than $47 billion in public and private financing. Says Mark Edwards, head of Silicon Valley consultancy Recombinant Capital: "The best genomics companies have all the money and moxie they need to step up and create the kind of pharmaceutical firm that pharmas would like to be."

The biotechs also have a healthy crop of experienced managers to guide them through the transition. "There's a lot of this dotcom--whoops--dotbomb stuff that people think about" when they think about biotechnology, laments Steven Burrill, CEO of the San Francisco merchant bank Burrill & Co. But the image of "crazy guys throwing companies together with dreams of grandeur and no understanding of business" is not accurate, he says. Respected, seasoned executives at large biotechs such as Millennium and Human Genome Sciences of Rockville, Md., have carefully thought through the challenges they face as they move from the genome to the pharmacy.

Meanwhile, the industry's scientific focus has also shifted--away from genes to the proteins those genes encode. These proteins are the molecules on which drugs exert their effects. The medicines that doctors use to treat cancers, for example, work by invading and disabling the proteins responsible for a tumor's uncontrolled growth. The best of them--like Novartis' hot new pill Gleevec--pick their targets selectively and cause fewer side effects than standard chemotherapy.

The multibillion-dollar race under way to identify those target proteins is transforming drug discovery in the same way that the assembly line transformed the automotive industry. Drug development in much of the past century was a charmingly fuddy-duddy affair, carried out amid frothing beakers and spiraling tubes. Today it is conducted through the chilly mediation of robots and beeping computers.

But outside a handful of laboratories, the process still relies more on brute force than strategy. It begins with what's known in pharmaceutical jargon as "target validation"--checking out a protein to see if it plays a role in disease. If so, the protein is subjected to a battery of molecules until one binds to it and exerts a desired effect--say, shutting it down. That binding molecule is then modified in a variety of ways, and the cycle is repeated until a potential drug emerges. This proto-drug is analyzed to ensure that it can be absorbed by the body and isn't too toxic. Only then does it move to clinical trials on humans.

The costs and inefficiency of this approach are staggering. Today's drugs attack just 500 out of an estimated 5,000 proteins that they could be devised to attack. On average, only 1 in 1,000 molecules that bind to a target makes its way to human trials. Of the survivors, just 1 in 5 reaches the market. If failures are taken into account, pharmaceutical companies on average spend $802 million--and 10 to 15 years--to develop each new drug, according to a report released on Nov. 30 by the Tufts Center for the Study of Drug Development in Boston.

This does not bode well for the pharmaceutical industry--nor for patients waiting for a miracle drug. Large pharmaceutical firms such as GlaxoSmithKline and Aventis will each have to launch up to 45 new drugs--not the variations on existing ones that now account for so much of the industry's output (and advertising)--in the next decade if their sales are to grow at an 8% rate, estimates the consultancy Accenture. By 2010 that will mean producing six new drugs a year. Most companies today grind out just one or two a year. "Productivity is the No. 1 issue going forward in the pharmaceutical industry," says Millennium CEO Mark Levin.

Genomics can help increase productivity by ramping up the identification of target proteins and by increasing the efficiency of drug discovery. Says Ben Conway, principal at Boston venture-capital firm Adams, Harkness & Hill: "Genomics was going to be the Holy Grail. Now people appreciate that it's come down to proteomics"--the large-scale analysis of proteins.

CuraGen of New Haven, Conn., is one of the innovative firms that have refined this art. Its proprietary technology--an adaptation of a decade-old technique--allows CuraGen's scientists to put human genes into yeast cells and effectively "fish" for proteins relevant to drug discovery. "We learned at the seat of the inventor of this technology," boasts technology group leader Bruce Taillon, "and showed him what would happen when CuraGen was set loose on it." The company stunned the biotech world in January, when it announced a 15-year, $1.4 billion deal with Bayer to develop drugs against obesity and diabetes. "CuraGen has a mastery of the genome," says CEO Jonathan Rothberg. "We needed a large drug company like Bayer to help us turn that mastery into a product."

This kind of deal is "a model we're likely to see more of as big pharmas and big biotechs try to incorporate these new technologies into their drug-discovery programs," says Ernst & Young analyst Scott Morrison. And in this case it seems to be working. CuraGen has presented Bayer with 24 targets for drug development.

Not all proteomics involves baker's yeast. Millennium uses mass spectroscopy--a way of producing unique signatures of proteins by tearing them apart and weighing the fragments--to detect drug targets rapidly. Its technology has won the company strong alliances with traditional drug firms, including a $450 million anti-inflammatory drug-development alliance with Aventis and a $465 million research agreement with Bayer. Millennium also has a $250 million partnership with Abbott Laboratories focused on metabolic diseases. Last month the pair announced that they were beginning clinical trials on a candidate drug against obesity.

Human Genome Sciences, like many of these companies, hopes to use proteins themselves as drugs--and has six in clinical trials. CEO William Haseltine says HGS does hundreds of experiments on some 10,000 distinct proteins in its hunt for novel drugs. The firm has invested heavily in bioinformatics to get a grip on the mounds of data this process generates (see box).

That investment has paid off. HGS moved a drug against autoimmune disease into clinical trials within 18 months of its discovery. Haseltine has managed his pharmaceutical aspirations astutely, building commercial manufacturing facilities for proteins years in advance--aware that a lack of capacity has hampered some of the most exciting biotech drugs. "It is my belief that if a skill is critical to your success," says Haseltine, "you must build it and control it yourself." But underscoring the risks of drug discovery, HGS's shares dropped 10% last week when it announced that its leading drug in clinical trials is safe but seemingly ineffective.

Proteomics is all the rage in Europe as well. The British biotech Oxford GlycoSciences announced this month that it had filed for patents on 4,000 proteins. It has $280 million in cash reserves and is awaiting U.S. and European approval of a drug for Gaucher disease, a rare inherited disorder.

To speed the discovery of drugs that attack their targets without poisoning those who take them, many biotech firms rely on design rather than serendipity. Vertex Pharmaceuticals of Cambridge, Mass., has halved, to 18 months, the time it takes to discover candidate drugs and is today among the most prolific generators of leads.

Yet the nuts and bolts of its discovery strategy are not radically new. Vertex essentially finds the structures of its target proteins and designs molecules that slip selectively into the grooves found along the proteins' surfaces. It did this expertly in designing the anti-HIV drug Agenerase, which it promotes with GlaxoSmithKline. A handful of other firms have developed their own drugs in similar ways.

Because a protein's structure is essential to its function, those proteins that perform similar functions often have stretches where they are similarly shaped. Instead of focusing on the structure of just one target, Vertex homes in on entire families of proteins as it seeks out its leads. This is done by crystallizing a protein of interest and exposing it to intense X-ray beams. The way those beams are scattered reveals how atoms along the molecule's length are arranged--information that is converted into a protein structure by computers. Chemists use this structure to digitally model molecules that should fit--like the pieces of a jigsaw puzzle--into grooves on the protein's surface. When the company has found about 100 that might work, it produces them and tests each out against the target.

Here's the clever part. While all this testing is going on, Vertex's chemists are already at their computers using the protein's structure to model what its cellular kin might look like and thus develop drugs against each one of them. Rather than starting from scratch, however, the chemists dip into the compounds they derived from their digital screening of the first target and apply them to each member of its family. The power of this approach is that these steps are taken simultaneously--with all the tedious testing needed to move a drug into clinical trials.

There's more than bragging value here. Vertex's approach has won it 25 partnerships with drug firms. Last year Vertex signed an $800 million alliance with Novartis to develop eight drugs that target a family of proteins called kinases to treat diseases such as cancer and diabetes.

Actelion, based in Basel, Switzerland, applied parallel drug discovery to produce a drug for pulmonary hypertension that received FDA approval last month. It has other drugs in late-stage development against heart failure. The French company Cerep, meanwhile, also boasts a computer-savvy parallel drug-design strategy but plans to license out its drug candidates after the first phase of clinical trials. And there is no shortage of competition in the U.S. "The future of medicine is in structure-based drug design," says Celera CEO Craig Venter, explaining his company's acquisition of Axys.

The strongest biotechs and pharmaceutical firms are working to integrate what Vertex CEO Joshua Boger calls "all the technologies that are advancing drug discovery." Eager to boost its target- and drug-screening expertise, Vertex scooped up Aurora Biosciences for $600 million this summer. Millennium has bought four companies in the past four years to master each step of the drug-discovery process. "To think of any of these technologies in isolation," says chief technology officer Michael Pavia, "doesn't really help you much. You have to put them all to work together."

Managing the information these technologies generate and distributing it efficiently across the company are just as important. "The people who do this in an outstanding way will have the competitive edge," says Daniel Vasella, CEO of Novartis. What's harder to say is when--and for whom--that edge will pay off.

Most of the drugs that will emerge from the current revolution in rational drug design won't reach the market for at least another seven years. And some will fail spectacularly. So will some of the companies. On the other hand, because most biotechs are relatively small, their potential for growth is enormous. Modest successes can give a powerful boost to share values. Then there's the science. "This is not e-commerce," says Jan Buck, managing director of Arthur D. Little's Global Health Sciences Fund. "It may have been like e-commerce back in the '80s, but this is stuff that's coming to fruition. This is real product."

--With reporting by Maryann Bird/London, Dan Cray/Los Angeles, Andrew Goldstein/Washington, Michelle McCalope/Houston, Jennifer Prittie/Toronto, Jennifer L. Schenker/Paris, Regine Wosnitza/Berlin and Steve Zwick/Cologne

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