A new portfolio model for biotech

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Until recently, biotech companies tended to be founded with a focus on a single technology or biological pathway. An early exemplar of this was Genentech, founded in 1976 on the promise of recombinant DNA to generate proteins relevant for human health.1 Proof of concept came with the production of the hormone somatostatin in 1977, and the company made its synthetic insulin breakthrough in 1978, alleviating the need to harvest the protein from animal pancreases.

Over the past five years, however, an innovative business model has emerged for biotech. In it, a portfolio manager controls a set of companies spanning multiple technologies and disease areas. Instead of focusing on a single technology or in the traditional way, the portfolio manager uses a distinctive form of expertise—such as in fundraising, investment, venture creation, R&D, manufacturing, commercial management, leadership, and broad credibility—to start a suite of subsidiaries, each dedicated to an individual drug program.

That portfolio model is being pioneered by companies such as BridgeBio and Roivant Sciences. Each has a central management team with a distinctive skill set and a diversified portfolio of programs covering different therapeutic areas, indications, and technologies. The portfolio managers not only make investment decisions but also play critical roles in managing the portfolio companies, with varying levels of direct control over decision making in them. Similar portfolio models have been adopted by other companies, including Biohaven Pharmaceuticals, ElevateBio, Gossamer Bio, Nimbus Therapeutics, and PureTech. As of August 2020, such companies had raised approximately $6 billion in capital and had an estimated public- and private-market valuation of approximately $20 billion (Exhibit 1).

The biotech portfolio model has emerged over the past decade, with more than $5.5 billion in capital raised in the past six years.

A number of venture-capital investors, such as Atlas Venture and Flagship Pioneering, share some similarities with the portfolio model for biotech because they engage in venture creation and early-stage-company management and may sometimes have some direct control. While there are both advantages and disadvantages to employing a portfolio model, the approach is gaining in use and reshaping the R&D landscape for biotech.

What are the advantages of the portfolio model?

In the traditional biotech-investment model, investors bet on a company’s technology or understanding of a disease. That can be a risky bet, with roughly one in 20 preclinical-stage biotech assets making it to launch.2 In the portfolio model, investors put capital behind a central management team that offers a distinctive edge and harnesses its expertise to pursue many different bets. Investors can leave their capital invested in a management team over the long term. Individual entities within a portfolio may reach an IPO or be sold off, but the portfolio-management team continues.

The new model can also allow a portfolio manager to raise capital from a broader group of investors, such as those that seek exposure to early-stage biotech, lack the technical-due-diligence capabilities or risk appetite for individual bets, and wish to diversify their risk. Investors that believe in the success of an individual subsidiary can sometimes follow up with direct investments at a later stage. Investors without biotech or life-science expertise can also rely on the portfolio manager’s expertise, saving themselves the time of performing due diligence on each new play executed by the portfolio manager.

Companies within a portfolio each focus on a narrow program, often a single drug. Whereas large companies have multiple assets in development at any one time, each company in a portfolio can be dedicated to a single asset or small family of assets. With a team focused exclusively on one program that determines the success or failure of the whole business, governance and resource allocation are simplified. Asset valuation may be more accurate, too, since investors valuing early-stage companies tend to focus on the lead asset, with the rest of the pipeline sometimes being unfairly discounted.

The single-asset focus of individual portfolio companies also gives the portfolio managers flexibility in capital financing. Portfolio managers can raise funds centrally through private markets or IPOs. The same options are available for individual companies. Portfolio managers with Wall Street or venture-capital expertise have been particularly creative in their financing strategies.

The portfolio model is also highly attractive to employees. Portfolio companies have successfully recruited top biomedical personnel who sometimes have little previous experience into their executive roles because the resources and expertise of the portfolio managers’ central teams can complement the new executives’ deep biomedical expertise. Portfolio managers have also attracted a growing number of skilled professionals from Wall Street, consulting firms, and even the biopharma industry. The roles available to people with those backgrounds are attractive in responsibility, learning opportunities, and compensation.

A single-asset company structure creates clear financial incentives for employees because performance-related pay is directly tied to one program. Such a structure seems to appeal to senior talent seeking greater financial benefits with less bureaucratic complexity than they might see at a large pharma company. It also appeals to junior talent looking for start-up experience with some financial upside but less risk than in an independent venture. If a company should fail, its employees may be able to pursue other options in the portfolio.

Portfolios also offer flexibility in resourcing when general and administrative functions are managed centrally and a portfolio-management team can tap into relevant expertise. For example, a central team could bring in biopharma veterans from an operations or commercialization team to support subsidiaries in making critical decisions at inflection points. More broadly, the portfolio model allows early-stage R&D platforms to access scaled-up capabilities and resources such as procurement functions, lab software subscriptions, and leasing.

Finally, there is some emerging evidence that the portfolio model is an effective R&D machine. In 2020, BridgeBio reported more than 20 disclosed programs in its pipeline, more than ten investigational-new-drug applications submitted since 2015, 16 ongoing clinical trials, and two product launches expected in 2021.3

What are the disadvantages of the portfolio model?

Any portfolio could accumulate risk and give rise to systemic failure. Diversifying based on a central team’s strength is a challenge. A portfolio manager in cell-therapy manufacturing, say, would need to place bets across a range of manufacturing methods, cell types, indications, and locations. Even then, the potential for a portfolio-wide failure would remain. That is true of any specialism—especially, perhaps, those focused on a biology or disease hypothesis. For instance, a portfolio based on the amyloid hypothesis for Alzheimer’s disease would have failed.

Portfolios may also create inefficiencies by sustaining programs that should fail. Portfolio managers have more cash on hand than an individual biotech would, though not necessarily on a per-asset basis. That allows managers to fund programs for longer than may be prudent. Diligence and discipline in resource allocation are needed to prevent such waste. Similarly, too many maturing clinical programs can rapidly expand the capital needs of a portfolio, creating an urgent need for private or public fundraising.

Another potential downside is that, with a central portfolio-management team and distributed asset-leadership teams, decision-making clarity can suffer. Portfolio managers need to be clear as to where their CEOs’ autonomy begins and ends, who controls the allocation of centrally held resources, and how disputes should be resolved.

Finally, centralizing critical functions has both advantages and disadvantages. Centralized functions can bring economies of scope and scale and foster an environment centered on customer needs. That enables capability developers to focus on creating value and opens up a rich testing ground for refining and improving offerings, as seen in projects such as Roivant Science’s Datavant and VantAI. On the downside, a company has to compete for time and resources with other companies in the portfolio and may not get the service it needs from central functions. Moreover, some internal high-need use cases may be given lower priority than larger use cases for external customers. As portfolio managers work to create efficient core functions, they may also shortchange functions, such as pharmacovigilance and quality, that tend to mature in later-stage biotech companies.

What is driving the growth of portfolio-model use in biotech?

An increasing share of launched products are now being filed by emerging biopharma.

A traditional biopharma-innovation model is based on a specific technology, a biological insight, or both (for example, using exon-skipping technology to treat Duchenne muscular dystrophy). By contrast, the portfolio model in biotech is based on more abstract propositions, such as neglected monogenic diseases, abandoned drug arbitrage, expertise in developing and manufacturing cell therapies, and excellence in business development. Raising capital to pursue options like those requires a portfolio structure.

Venture creation is maturing as managers and investors build portfolios and the supply of talent grows. The new generation of flexible junior operators and investors makes for ideal employees for a portfolio manager. Such workers have the right training to dedicate time to a subsidiary, float it within a portfolio, and support an investing team.

Many early-stage biotech companies are keen to retain control and keep as much value for themselves as possible, rather than ceding ground to pharma companies. They represent growing shares of innovation and originators launching their own drugs (Exhibit 2).

A portfolio manager with access to pooled capital offers asset developers an alternative to the pharma-company route. When a portfolio manager acquires or seeds a new company, that company will likely have access to a larger pool of capital, which provides the originator with financing options outside pharma-company acquisition and IPO. Even so, pharma companies are likely to offer high premiums for strategic acquisitions, as well as compelling liquidity options, for biotech shareholders. Competition for assets looks likely to increase as portfolio managers enter the field. At the end of the day, portfolio managers will be also looking for liquidity, but with their ability to hold assets longer, they may give originators the option of holding their stakes deeper into development.

In spite of the downturn associated with the COVID-19 crisis, pharma companies still have significant capital at their disposal: the top ten companies have a near-record $116 billion in cash on hand (Exhibit 3). Meanwhile, venture-capital investors continue to invest at scale, spending $16.6 billion in 2019 across 866 pharma and biotech deals.4 Private-equity investors have entered life sciences too.5 All in all, plenty of investment dollars are available for biotech companies at various stages of development.

Cash on hand for the top ten pharma companies has increased significantly over the past two years.

Innovative asset classes are in high demand, as seen in a number of large gene-therapy acquisitions in the past few years. AveXis was bought by Novartis for $8.7 billion, Spark Therapeutics by F. Hoffmann-La Roche for $4.8 billion, Audentes Therapeutics by Astellas Pharma for $3.0 billion, and Nightstar Therapeutics by Biogen for $0.8 billion.6 Those deals were not only large, they also commanded high premiums. Both Audentes Therapeutics and Spark Therapeutics were acquired at a more than 100 percent premium over the previous day’s close.7

How could the portfolio model disrupt R&D in biotech?

The impact of using the portfolio model will differ for biotech companies, pharma companies, pharma-service providers, and investors.

For biotech companies, the portfolio model represents an alternative to an acquisition or IPO. Companies have traditionally funded maturing pipelines through a combination of public investment and industry partnerships. Portfolio models—with their access to leading talent from discovery to launch, shared services, and subsidiary-level focus on individual assets—may be able to shepherd a program all the way to commercialization without a pharma-company partner. Partnerships can still be pursued but primarily to reduce a portfolio manager’s risk exposure to an asset, rather than to satisfy a need for expertise or capital.

For pharma companies, the portfolio model represents a two-pronged threat. It could increase competition not only for innovative assets, as mentioned previously, but also for talent. As a preemptive move, pharma companies could emulate portfolio managers by introducing equity-based incentive structures for their own internal-asset teams to reward winners for the success of their programs. This would be similar to an internal version of the earnout or licensing models that pharma companies use for external partnerships. We see some early evidence of that change emerging—for example, when Bayer acquired BlueRock Therapeutics, Bayer left the cell therapy company operating as an independent company.8

Competition among pharma-service providers could increase as central functions are externalized. Companies such as Datavant and VantAI, as well as those with a central manufacturing capability, such as ElevateBio, are emerging as important forces in the pharma-services landscape. In this way, a new wave of vendors could emerge to compete with existing contract research organizations, contract development-and-manufacturing organizations, and data and analytics specialists.

For investors, the portfolio model offers three benefits. First, the stability provided by portfolio-management teams may appeal to investors with long horizons, such as pension funds and sovereign wealth funds, that are seeking attractive ways to invest in a traditionally risky asset class. Second, the portfolio model expands the options for biotech investment beyond those offered by an asset- or platform-based approach, allowing investors to support otherwise unattainable areas, such as abandoned asset arbitrage. And third, those two benefits may attract new classes of investors that see exciting opportunities in an industry they have not previously considered investing in.

The portfolio model has emerged as an innovative solution to biotech financing and operations—and a way for a strong central team to maximize its impact. While portfolio managers have experienced some clinical-trial setbacks over the past few years, the world will learn more about the long-term success of the model in the next few years, with pipelines developing and regulatory and commercial success being tested. As companies mature and clinical-trial data flow in, the industry will be able to judge how well the portfolio model performs compared with others. If the signs are positive, changes in the dynamics of biotech investments and operations are likely to accelerate.

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