Balaji K, Industry Analyst, Asia Pacific Biotech Practice, FROST & SULLIVAN

The relationship between a cutting-edge technology and the venture capital industry is said to make or break the technology. More so with biotechnology. With its long gestation periods and difficult-to-understand technology, it is an art to make the relationship work. The key question to be answered is: has Australia made the VC-Biotech relationship work?

Though the history of the Australian biotech industry can be traced back to the early 1970s, Australia focused on biotechnology only in the early nineties. Even if a trifle late in taking off, the Australian biotechnology industry has grown considerably. Australia's traditional strengths in medical and agricultural research have helped it to move up the value chain in a short time. The Australian economy is small compared to those of behemoths such as the United States and Japan that have made it big in biotechnology. It is to the Australian Government's credit that it realized the importance of innovation through industries such as biotechnology to boost the economy. This has translated to generous research funding and conducive policy atmosphere for the industry that, in turn, has grown steadily.

Australia's strengths in biotech research include agricultural and medical research in general, but particularly immunology and vaccines, stem cells, proteomics, and bioinformatics. Though its research base is not large, the quality is high. Being an emerging industry, the Australian biotechnology sector does not have many commercialized products. However, many products are in the research pipeline.

What makes the Australian biotech sector the ideal bride in waiting? The statistics of course. Consider this. The Australian biotech industry comprises around 500 biotechnology companies. There are around 280 core biotech and 210 related biotech companies in Australia. Of these, 67 are listed in the Australian Stock Exchange (ASX). About 40 of these are core biotechnology companies. Most of these are small- to mid-sized companies that possess a good amount of intellectual property. The market capitalization of listed companies is about $3.37 billion (A$6.00 billion). Revenues of listed biotechnology companies have been growing at around 23 percent a year. The listed core biotechnology companies have total revenues of about $506.19 million (A$900.00 million).

The figure below indicates the attractiveness ranking of Australia as a biotech destination to international players in the Asia Pacific region, on a scale from 1 (least attractive) to 10 (most attractive) in 2002.

The Australian biotech industry has excellent potential and is likely to emerge as a significant player in the international arena. A true bride in waiting.

With more than $3.72 billion (A$6.30 billion) under management, Australia's venture capital (VC) industry is not only the largest in the Asia Pacific region with excellent potential for growth, but is also an able suitor for the Australian biotech industry, which has been nurtured by the paternal Australian Government to date.

Unfortunately, until recently, Australian VCs have shied away from the ‘advances’ of the Australian biotech industry. Much like its global counterparts, the Australian venture capital industry had never fancied investing seed and start-up venture capital in Australian biotech ventures. Unlike areas such as information technology, the biotechnology sector is a high-risk one, which requires long-term investments. This combined with the high volatility of biotech stocks have traditionally been the bugbear for the VC industry.

According to the Australian Bureau of Statistics, only 5 percent of the country's $2.86 billion (A$4.90 billion) venture capital investment was in biotechnology in 2000. One key reason for the poor VC investment is the integral mismatch between the way VCs function and the way the Australian biotech sector functions. The venture capital industry is primarily interested in investing for a defined period during which measurable progress in the development process is expected. In the past, the major output from Australia's medical research community has been biological targets rather than lead molecules, much of this too early for venture capital funding.

The only way this imbalance can be corrected is by the Australian biotech industry implementing strategies to convert intellectual property from biomedical targets to lead molecules. The Australian biotech industry needs to map a clear exit route for the VCs to enable them to encash their investments. Stronger partnerships between public and private institutions and with pharmaceutical majors can make the biotech start-ups more attractive to the venture capital industry. These multidisciplinary collaborations, involving researchers and academicians, to achieve common goals can enable the Australian biotech ventures to actively engage in drug discovery/technology platform endeavors and, simultaneously continue pure basic research, a potent mix for the success sought by the VC industry.

Australia's capital gains tax structure was another impediment for venture capital partnerships and foreign investment in Australian biotech start-ups. However, recent changes in the legislation aim to remove some of these hurdles. The Australian Government announced these changes in October 2001. The Government has said that it would extend the existing capital gains tax exemption on venture capital investments by providing venture capital limited partnerships with flow-through taxation treatment, applying the new rules from July 2002. These tax reforms are also likely to attract further international investments not only to the Australian venture capital industry but also to the country from the global venture capital industry. This should augur well for the funds-starved biotech companies.

VC Perspective: Australian VCs have, by and large, understood the business dynamics of biotech companies only now. Today, they are aware that unlike the dotcoms that promised a quick buck, these companies have a longer gestation period, and that returns can be reaped over a longer period. Australian VCs have clearly understood that it will take a minimum of ten years for a biotech venture to define drug targets, develop drugs, and take them through various phases of clinical trials. It is only after this that the venture can go public, or the venture/drug be acquired and the VC reap the benefits of its investment.

Australian VCs are also appreciating the fact that the Australian biotech companies are increasingly meeting management quality, a key factor influencing their investment decisions. It is a widely acknowledged fact that the present quality of management in biotech ventures has caught up with the pace of scientific advances in the field of genomics and the computational power and technology of bioinformatics.

The hot picks for Australian VCs today are biotech companies that have pharmaceutical companies as clients and have potential blockbuster drugs as concepts or undergoing clinical trials. This is in tune with the global trend. For example, globally, VCs are making most of their investments in biotech ventures involving anti-infective drug research, one of the fastest growing categories of the global pharmaceuticals industry. This segment promises great returns to VCs as global pharmaceuticals majors have stayed away from cutting-edge research in anti-infectives for fear of cannibalizing their portfolio of blockbuster anti-infectives. Another hot area benefiting global VCs comprises biotech ventures developing path-breaking therapies for diseases such as HIV, cancer, and diabetes, where a successful therapy can rake in very high profit margins due to the high potential demand. This is yet another trend that has caught on with the Australian VCs as well.

Biotech Perspective: In the past, it was much easier for a biotech company to classify itself as a genomics company involved in developing tools or compiling data for the study of genes, and walk away with a piece of the VC pie. This has now changed. Pharmaceutical companies are desperately seeking to bolster their sagging bottom lines with blockbuster drugs. The name of the game for an Australian biotech venture seeking funds is to sell them a drug or have promising compounds in Phase III clinical trials.

In the present scenario, an Australian biotech venture focusing on becoming a biopharmaceuticals company aiming to produce marketable drugs stands a better chance of obtaining funding. This strategy, however, is fraught with challenges. As per a recent study by the Tufts Center for the Study of Drug Development, it takes $810 million and 10 to 15 years to get a drug to market. These are staggering odds indeed. Nevertheless, the advantage against a tools and data company is that once a drug discovery becomes marketable, the value generated by it is incomparably higher than tools and data products, which become commodities in a very competitive market over a short period. A global example is Amgen, which is marketing its drugs, as against a company such as Celera, a tools and data company.

The gap between discovery and drug launch is huge and is critical to determining the success of a biotech company. Australian biotech companies can help narrow this gap through the integration of basic research and the clinical trial process so that each benefits from the other, leading to the company’s success. Though the process is time consuming, more VC funds are opening up to this integrated approach.

One Australian biotechnology company that is working in the right direction is Peptech. An important player in the Australian biotech industry, Peptech is a biopharmaceutical company focused on the development and commercialization of fully human monoclonal antibody therapies for a variety of diseases. It is one of the top 200 companies listed on the ASX and had a market capitalization of approximately $73.11 million (A$130.00 million) as of November 2002.

The company focuses on the research and development of peptides and proteins, which occur in nature and mediate a wide variety of physiological functions. It aims to enhance its level of expertise as a developer of peptide- and protein-based drugs through identification of novel biological targets, improved screening systems, and drug delivery systems. Peptech's achievements include two license agreements resulting in royalty income and three patents and three Notices of Allowance on Tumor Necrosis Factor (TNF) patents.

Peptech has an R&D collaboration pact with the Cambridge (UK)-based company Domantis (previously known as Diversys), for the identification and development of a domain antibody product against TNF. Domantis is an antibody engineering company with a powerful IP position and Peptech holds 33 percent of its stock. As part of the agreement, Domantis will develop four target compounds for Peptech for further development as biological agents. The first of these has been identified and is currently under development. Peptech has non-exclusive license agreements with companies such as Abbott Laboratories Inc. and Centocor Inc. for the manufacture and sale of products.

Gone are the days when the ‘Boom’ word attached to anything meant ‘$’ and tons of it. With the dotcoms going bust and people afraid of coining the phrase ‘Biotech Boom’, the venture capital-biotech relationship has been based more on realities than fantasies. The scenario in Australia is no different.

To sustain their attractiveness, Australian biotech companies that are developing new therapeutic products should prove that their platforms and algorithms can actually produce drugs. To gain VCs’ confidence, they need to reveal their targets and their approaches to convincingly take drug discoveries through the various stages of clinical trials. Australian biotech companies will have to prove that they can acquire or in-license products, validate drug targets, generate leads from these targets, and manage clinical trials and regulatory affairs apart from manufacturing, selling, and marketing, to get a share of the VCs’ money.

Australian VCs, for their part, need to develop a stronger understanding of biotech and the gestation periods involved, develop an insight into picking a technology with a bright future, and most importantly, sustain their investments through the long period of clinical trials. In Australia, VCs and biotech ventures are all set to explore, discover, develop, produce, and reap the benefits.

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