Thursday, October 25, 2012

Can the Cure for Cancer Be Securitized?

The October 2012 issue of Nature Biotechnology offers several articles on the theme of "Commercializing biomedical innovations." The opening "Editorial" sets the stage this way: "Investment in biomedical innovation is not what it once was. Millions of dollars have fled the life sciences risk capital pool. The number of early venture deals in biotech is smaller than ever. Public markets are all but closed, biotech-pharma deals increasingly back-loaded with contingent,
rather than upfront, payments. Paths to market are more winding and stonier. Government cuts are closing laboratories and culling blue-sky research. Never has there been a more pressing need to look beyond the existing pools of funding and talent to galvanize biomedical innovation."

Thus, the papers look at a variety of interactions: interactions between universities and the biomed industry; different business models for biomed firms; how venture capital firms often seem to enter biomed start-ups "too early," well before a commercial payoff can be expected; funding research through nonprofit foundations that promote free dissemination of any findings; and others. But my eye was particularly caught by a proposal by caught by three economists,  Jose-Maria Fernandez, Roger M. Stein and Andrew W. Lo, who offer a proposal for "Commercializing biomedical research through securitization techniques."

 These authors point out a paradoxical situation in biomedical research. On one side, the research journals and even the news media are full of breakthrough developments, "including gene therapies for previously incurable rare diseases, molecularly targeted oncology drugs, new modes of medical imaging and radiosurgery, biomarkers for drug response or for such diseases as prostate cancer and heart disease, and the use of human genome sequencing to find treatments for diseases that have confounded conventional medicine, not to mention advances in bioinformatics and computing power that have enabled many of these applications."

On the other side, the existing business structures for translating these developments into new products doesn't seem to be working well. "Consensus is growing that the bench-to-bedside process of translating biomedical research into effective therapeutics is broken. ... The productivity of big pharmaceutical companies—as measured by the number of new molecular entity and biologic license applications per dollar of R&D investment—has declined in recent years ... Life sciences venture-capital investments have not fared much better, with an average internal rate of return of −1% over the 10-year period from 2001 through 2010 ..."

Fernandez, Stein, and Lo suggest that the fundamental problem is that the technological breakthroughs present a vast array of possibilities, but these possibilities are complex and costly to pursue. A large portfolio of new biomed innovations is probably, overall, a money-maker. But when firms need to think about pursuing just a few of the many possibilities, at great cost, they may often decide not to do so. They write:

"The traditional quarterly earnings cycle, real-time pricing and dispersed ownership of public equities imply constant scrutiny of corporate performance from many different types of shareholders, all pushing senior management toward projects and strategies with clearer and more immediate payoffs, and away from more speculative but potentially transformative science and translational research. ... Industry professionals cite the existence of a ‘valley of death’—a funding gap between basic biomedical research and clinical development. For example, in 2010, only $6–7 billion was spent on translational efforts, whereas $48 billion was spent on basic research and $127 billion was spent on clinical development that same year."

What's their alternative? " We propose an alternative for funding biomedical innovation that addresses these issues through the use of ‘financial engineering’... Our approach involves 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. These two components are inextricably intertwined: diversification within a single entity reduces risk to such an extent that the entity can raise assets by issuing both debt and equity, and the much larger capacity of debt markets makes this diversification possible for multi-billion-dollar portfolios of many expensive and highly risky projects. ... In a simulation using historical data for new molecular entities in oncology from 1990 to 2011, we find that megafunds of $5–15 billion may yield average investment returns of 8.9–11.4% for equity holders and 5–8% for ‘research-backed obligation’ holders, which are lower than typical venture-capital hurdle rates but attractive to pension funds, insurance companies and other large institutional investors.

Frankly, I have no clear idea about whether the Fernandez, Stein, and Lo approach raising money for biomed companies is viable. One never knows in advance whether an innovation will function well and fulfill real-world needs, whether that innovation is financial or real. But if the markets can put together this sort of deal, it might offer an enormous boost to the process of translating biomedical innovation into actual health care products. In the aftermath of the Great Recession, the words "financial innovation" are often spoken with a heavy dose of sarcasm, as if all we need for a 21st-century economy is good old passbook savings accounts. But financial innovation like this Fernandez, Stein and Lo proposal is an example of how financial innovation might save lives by addressing an important real-world problem. This financial innovation seems well worth someone trying it out--with the proviso that if it doesn't work, no one gets bailed out!