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Pharma: Why out-license?

Sep 11, 2007

In last week's article, we had brought to the fore the steps taken by domestic pharma companies to hive off R&D into a separate company in a bid to unlock value from the same in the longer term. Another strategy, which has been gaining momentum among domestic players, is the out-licensing of their molecules to global innovator companies. In this article, we shall take a look at some of the pros and cons associated with this strategy and our overall view on the same. The pros...
Mitigating costs: As we had highlighted last week, since clinical trials form a larger chunk (around 43%) of the total R&D investment, domestic pharma companies are increasingly looking to out-license molecules to a global pharma companies after these molecules reach a certain stage. This shifts the burden of incurring additional costs from domestic pharma companies to global innovator companies to whom these molecules have been out-licensed, thus easing the pressure on the former. Global innovator companies also stand to benefit given the fact that they have stronger resources and also due to the fact that they are facing problems of a drying R&D pipeline.

Generating revenues: Besides reducing the burden of costs, this strategy is also effective in terms of generating revenues from the pipeline at an earlier stage. It must be noted that on an average it takes around 10 to 12 years for a drug to reach the market (if all goes well) and during this period there are no revenues to offset the rising R&D costs. However, on out-licensing molecules, domestic pharma companies receive milestone payments, which depends upon the progress of the molecule in clinical trials.

Besides this, in the event that the molecules gets commercialised, domestic pharma companies are entitled to royalties on the sales of the drug and could also retain the rights for the drug in certain markets. Thus, this strategy enables companies to monetise their R&D pipeline at an earlier stage.

Access to better expertise: Indian research is still in its nascent stages and the pace of activity on this front has intensified after the introduction of the product patent law. Having said that, the skill set required for drug discovery research is on a different level as compared to research conducted for generic drugs. Hence, in that sense, out-licensing of molecules helps domestic pharma companies leverage on the expertise of global innovators besides capitalising on the monetary benefits creating a likely win-win situation for both the parties.

The cons...
Revenue potential capped: While out-licensing augments the revenue streams of domestic players in the form of milestone payments, as mentioned earlier, the companies also stand to gain royalty on sales. Having said that, these royalties are calculated as percentage of total sales decided upon by both the parties. As a consequence the revenue potential gets capped, as the entire amount of sales generated by the commercialised drug will not accrue to domestic companies, which would have been the case had the latter conducted the entire R&D process completely on its own.

Risk of failure: Despite the huge potential on commercialisation of a drug, R&D is basically a high-risk affair and the entire process is costly and time consuming with no guarantee of success. This holds true even when the molecules are out-licensed. For instance, if the innovator company in the course of conducting clinical trials does not find any significant value in the same, it can terminate the agreement or return back the molecule halting the milestone payments. Also, even if the molecule does complete clinical trials, the risk of the USFDA not approving the same cannot be ignored.

To conclude...
Out-licensing has assumed significant importance of late with Glenmark having taken the lead when it signed a landmark agreement with Forest Laboratories, US for its molecule for asthma 'Oglemilast' (deal size of US$ 190 m). Other domestic companies have also indicated their willingness to go in for out-licensing as and when the right opportunity comes along. In fact, companies, which have hived off their R&D into a separate company, have outlined out-licensing as one of the means of generating revenues in the initial stages.

Investors should note that the further the molecule progresses, the higher are the amount of milestone payments that can be received. Also, if a company is able to strike an out-licensing deal at the later stage of the entire drug discovery process, then the potential to strike a deal of a larger size and the number of innovator companies taking interest in the same also increases. Thus, after weighing the pros and the cons, we are positive on the out-licensing strategies of domestic pharma companies in the longer term till such time that these companies are able to build the necessary expertise and the financial strength to conduct R&D entirely on their own.

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