A month ago, representatives of the three divisions of Eli Llly & Co. responsible for collaborations (NYSE:LLY) visited Israel: Eli Lilly executive director global external R&D Europe Dr. Andrew Wood; Eli Lilly senior director business development Mark Muller; and Lilly Ventures principal Dr. Ron Laufer, an Israeli. Lilly Ventures supports companies that are not yet ready for merger and acquisition, but could become so.
“Eli Lilly believes in outside innovation,” says Wood, while Muller adds, “30% of molecules in our pipeline come through cooperative ventures, a fairly high proportion for the industry. The areas Eli Lilly are most interested in are endocrinology and obesity, cardiology, cancer, and neuropsychological diseases. We’re also interested in small molecules and biotechnology. Although we have a reputation as a pharmaceutical company, we’re now also the third largest biotechnology company in the world.”
Medical devices are not Eli Lilly’s core business. In 1995, the company decided to focus on pharmaceuticals and spun off its medical devices business, which ultimately became Guidant, recently acquired by Johnson & Johnson (NYSE:JNJ). Lilly Ventures, however, is still happy to invest in medical devices start-ups.
Eli Lilly’s approach is more suited to companies that want to preserve a degree of independence. “We’re less interested in mergers and acquisitions, generally preferring to establish a joint venture held by both the inventing company and Eli Lilly,” says Wood. “Cialis, one of the company’s strongest drugs (a strong competitor of Viagra - G.W.) was developed by a venture held in equal shares by us and Icos Corporation (Nasdaq:ICOS), with whom we share profit.”
Eli Lilly also likes licensing agreements.
Three deals in Israel
Talk about three possible investments in Israel are backed by the two deals Eli Lilly has already made with Israeli companies: a joint development project with D-Pharm Ltd., which began five years ago and failed laboratory tests, but nevertheless left Eli Lilly with a favorable impression about Israel; and a new project with Optimata Ltd., which models drugs’ effects and helps Eli Lilly to design clinical trials for cancer treatments. Lilly Ventures is also an investor in Remon Medical Technologies Inc.. In addition, Eli Lilly has had an office in Israel since 1997, managed by Doron Shalit. The office is responsible for marketing the company’s products in Israel and conducting clinical trials at Israeli hospitals and research institutes.
“Globes” How many Israeli companies did visit during your last visit, and what kinds?
Wood: “We visited about 20 companies, presented by venture capital funds. We’re seeking to cooperate with companies from the Phase I clinical trials stage and onward. We spoke with six such companies. However, we also examined companies in the animal testing stage, and even spoke with entrepreneurs who were still only in the concept stage, in order to monitor them later.
“In 2001-02, after the bubble, it was normal for large companies to wait for later stages to buy a drug, calculating that it was better to invest more money to reduce the risk, because there was a large supply of early-stage companies that could not raise money, and were on the market at close-out prices.
“In recent years, the number of advanced-stage companies has plummeted. At the same time, innovation at large companies has been falling, and they need more outside products. The result is that the price of drugs after Phase II trials is rising and rising to the point where it’s no longer worthwhile. This is killing deals that could be good for both sides.
“The result is licensing or cooperation at an earlier stage. This is good for the industry; more molecules are backed by the money of the big companies. It’s even logical in terms of internal politics at the large companies. What pharmaceutical company executive wants to take the risk of buying a molecule for $100 million, whose failure is liable associated with his name? It’s better to buy several cheap molecules at the earlier stages. The ones that fail are quickly forgotten, and those that succeed are remembered as winners.”
Learning from Australia
What is the main purpose of a pharmaceutical company’s corporate venture capital fund?
Laufer: “As a part of Eli Lilly, we know and understand the life sciences market. We have an opportunity to build a venture capital fund that will bring money to the corporation. We pick investments based on our return on the money, the same as with every venture capital fund.
“However, an equally important goal is to expose Eli Lilly to what’s happening in the market, keep our finger on the pulse of innovation, in order to achieve the best deals later on. Although we don’t promise Lilly Ventures’ portfolio companies exclusivity vis-a-vis Eli Lilly, the connection itself gives us access to good deals.
“In addition, we build start-ups that, even if they aren’t integrated into the parent company, they’ll build the industry and move it forward. In other fields, such as software, a corporate investment fund normally invests in companies that generate demand for its products, or in companies with which it will be possible to cooperate later. Lilly Ventures is based on the model of SR1, the venture capital fund of GlaxoSmithKline (NYSE; LSE: GSK), which both operates out of the profit motive and takes care to actively participate in building its portfolio companies.
“A year ago, we decided not to operate on the basis of the model of raising a first fund, closing it, and then raising a second fund. Instead, we use the ‘evergreen' model, under which we reinvest money from exits in new companies. This provides greater stamina for companies, and enables us to focus on investment and managing companies, rather than raising more funds from the corporation.”
Critics of the corporate venture capital fund model claim that investing in companies does not guarantee deals, but only dilutes management attention and creates competition with the company. They say that corporations play at founding companies during boom times, but close them during lean years.
“It’s true that we’re liable to create competitors, but that’s the price of doing business. Like any company business, corporate funds have a tendency to expand and contract in line with the market climate. Time is needed until such a business is consolidated, and managers without patience are liable to close the fund after the investment and before they see the results.”
How much money do you usually invest in each company, and how do you make a valuation?
“We make an initial investment of $2-5 million, with the understanding that $10-15 million will be needed during the lifespan of the investment.
“There are several basic models for calculating company value for an investment. There’s the benchmarking approach, under which you check the value of other companies in your field at the same stage in recent years. There’s the current value approach, in which you calculate the expected exit multiplied by the chance of success, and divided by the return you want to get on the investment.
“The truth is that these models are not well known in Israel, and entrepreneurs are therefore liable to approach venture capital funds with unrealistic expectations. An entrepreneur calls his friend who worked with him in the lab and asks him how much he was offered for his product, even if this was a completely different product for another market entirely. This causes a lot of mistakes in negotiations with potential partners. In the US, entrepreneurs somehow feel that they’re less special, so their demands are more realistic.”
Eli Lilly specializes in pharmaceuticals. Medical devices generate smaller exits, and competition in the sector is only intensifying. Eli Lilly has enough money to build a portfolio consisting solely of pharmaceuticals, unlike Israeli venture capital funds. Why do you nevertheless continue to support medical devices start-ups?
“The classic medical devices sectors are really very competitive, and precisely for that reason the industry has developed an appetite to invest in completely new fields. In addition, medical devices companies are beginning to invade classic pharmaceutical fields and develop integrated devices.”
Is this good or bad for Israel?
“Israelis manufacture sophisticated devices, so development of the sector is good for us. That said, I don’t necessarily believe that the future will resemble the past. In my opinion, it’s possible to exploit basic science in Israel just as well for pharmaceuticals. Medical devices will not necessarily be an exclusive market leader in Israel.”
In your opinion, what needs to be done for Israel to develop a worthwhile pharmaceutical industry?
“I read the headlines about the dismal situation of Israel’s pharmaceutical industry, and I don’t agree with them. I believe a pharmaceutical industry will grow in Israel because of the country’s fundamental capabilities. The right investment by the government will boost development, but even without it, we’ll see successes by the industry that will attract investment.
“The main barrier at the moment is money. Israeli funds have limited means, so they make small investments in products with a small market. An Israeli Medtronic will not grow from such investment. That’s why I believe that in the Israeli pharmaceutical industry one well managed molecule is enough to grow a whole company. Many biotechnology companies grew independently and reached Nasdaq with only venture capital investment.’
What do you think about the TASE as a source of financing for these companies?
“It’s possible to learn from the experience of Australia, another country with good basic science that wants to develop a life sciences industry. New biotechnology companies were floated at low valuations with the participation of small private investors. This created an ongoing hunger for capital. The companies were no longer suitable for venture capital, and they constantly had to go back and raise money all the time. They didn’t have the necessary financial peace of mind to build themselves for the long term.
“The need for capital market financing developed because there wasn’t enough Australian venture capital and the Americans didn’t invest there. But then Australians who’d been around the world a bit started to come home, bringing with them money and experience in venture capital. They built stronger funds, which made the companies stronger too. Suddenly, the companies were interesting enough to go the US route.
“The problem with US investors is that they usually want to see companies close to home. Therefore, it might still be worthwhile to raise money from Israeli institutions after stretching the capacities of Israeli venture capital to the limit. That said, in this case, it might be better to raise private capital and not hold a public offering on the TASE.”
Published by Globes [online], Israel business news - www.globes.co.il - on July 10, 2006
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006 Medtronic (NYSE: MDT)