By Steve Dickman, CEO, CBT Advisors and Sultan Meghji*
*Sultan Meghji is an entrepreneur and advisor in life sciences, financial services and high tech. He is based in St. Louis, Missouri.
In biotech’s early days, telling a story to a wide audience used to be part of the path to success. Founders would share a compelling early narrative to potential investors, reporters and just about anyone else who would listen. Nature papers were the coin of the realm. Molecular biologists with big dreams even became something of a cliché, memorialized in a joke one of us heard in the early 1990s from one of the scientific founders of Biogen. In the joke, a molecular biologist on his wedding night fails to consummate his marriage. A shocked friend asks the bride what happened and she said, “Oh, he just stood at the end of the bed all night telling me how great it was GOING to be.”
But far from shouting to the rooftops, lately it seems that more and more biotechs are pursuing a different approach. Instead of keeping their technology under wraps until a first financing happens, these companies go into what we call “permanent stealth mode.” The principle here seems to be, “Say no more publicly than necessary and even then, keep it vague.” Meantime, let your actions speak for you: Raise money. Sign partnerships with pharmaceutical companies. And then seemingly out of nowhere, hand consumers and investors a finished product or service.
Lately, we’ve seen some tech companies choose this path. Notably, the company that developed Siri was spun out of SRI International in such a way that Apple acquired it barely three months after the company’s voice recognition app was first offered in the App Store. That route is relatively new in IT and still fairly rare. It seems to be related to the fact that the competitive advantage held by some startups involves algorithms, which can be hard to protect using patents. But such an approach has been even rarer for biotech companies that, until recently, had to fight like rain forest vines for the light and nourishment that publicity could bring.
In this post, we’ll share some examples of three “deep stealth” life sciences companies that chose to stay on the stealthy side well beyond the timeframe of a typical startup: Moderna, Kadmon and Theranos. The first two are developing novel therapeutics and the third is a consumer diagnostics company. We will share what little we can find out about them; offer some analysis about what has motivated the companies to stay stealthy; and ask whether they represent the beginning of a trend and, if so, what that implies for the industry.
In less than four years, Moderna has raised over $400 million. It has built a platform around RNA to trigger the production of protein drugs inside the bodies of patients, thus turning the body into a protein factory. We noted back in 2012 that Moderna’s approach turns the traditional dogma of biotech on its head: instead of manipulating the DNA in the lab and then producing proteins in cells or bacteria, then selling these proteins to the patient, Moderna instead takes messenger RNA, does some fancy chemical tricks to it and puts it into the body as RNA, letting the body’s own protein production machinery do the rest. We also noted that the company had chosen not to publish anything, even in scientific journals, leaving open the question of how the RNA would be stabilized and delivered (RNA in its native form is notoriously unstable and subject to destruction by ubiquitous enzymes) and leaving the rest of us to wonder what the platform could really do and how it does it.
Then came a news bulletin: In 2013, Moderna struck a validating deal with AstraZeneca that included an unusually rich up-front payment: $240 million plus an additional $180 million in potential milestone payments. Then in January, 2014, it announced a deal with Alexion for $100 million up front and a $25 million equity investment plus undisclosed milestone and royalty payments. Yet even as of today, the company has put out but a single publication. Recently, the company spun out a subsidiary called Onkaido to focus on oncology. At the same time, its business strategy seems to be shifting. CEO Stephane Bancel told Xconomy in mid-June that it will become a holding company that spins out drug development companies and that “Moderna will most probably never develop and sell a drug.”
Kadmon, founded by Sam Waksal in 2009, has grown much larger than a typical privately held company ever does. Waksal is known both for founding ImClone in 1984 and for being convicted of securities fraud in 2003. Waksal’s work with ImClone eventually led to the approval and marketing of Erbitux, an early and influential targeted oncology therapy. ImClone was acquired by Lilly in 2008 for $6.5 billion.
Kadmon, which has been built mostly around acquisitions of later stage technologies, is not completely in stealth mode. It does have a web site that lists its clinical pipeline in some detail. Initially focused on oncology, liver disease and metabolic and cardiovascular disease, it now sells the hepatitis drug ribavirin. All of these pipeline products have been brought in by acquisition, beginning with the acquisition of Three Rivers Pharmaceuticals for more than $100 million in 2010, according to the Wall Street Journal. That company had products on the market at the time of acquisition, especially in hepatitis C. Bloomberg reported that Kadmon had reached $25 million in annual revenue by 2012 and was targeting $40 million to $60 million in 2013. Interviewed by Maria Bartiromo on CNBC in January, 2011, Waksal described a new paradigm for building a biotech company with a commercial arm that could serve as a “cash generating machine” so that “we don’t have to go to the [financial] markets to constantly raise money for drug development.”
The corollary to that is that, if it is funded by revenues, the company’s very exciting research does not have to be disclosed, even to venture capitalists and especially not to the public, in the context of fund-raising. At investor conferences, the company has described some fascinating RNA targeting technology that could represent a new generation for gene therapy. Waksal told Bloomberg in 2013 that Kadmon was considering a spinout of a gene therapy company and an oncology company focused on the Chinese market.
In the meantime, there are not too many publications (none linked on the Kadmon web site) and the company has had to cope with multiple warnings from the FDA over its marketed products.
Theranos has recently begun to emerge from stealth mode, although its technology is still secret. This June, 2014, Fortune cover story reported that the eleven-year-old company is valued at $9 billion and that, due to her share ownership, company founder Elizabeth Holmes, a Stanford dropout, is worth $4.5 billion on paper.
Theranos’ blood draw technology replaces traditional, slow, overpriced blood testing with pinprick-style small-volume blood tests. By working efficiently on tiny volumes, Theranos is both cutting prices by half or more as well as increasing efficiency by allowing for follow-up tests to be done right away, according to the Fortune article.
How Theranos does all this remains a secret. But this “black box” has not prevented the company from raising what Fortune reports to be more than $400 million nor from striking a distribution partnership with Walgreens, a partnership that extends beyond Walgreens’ 8200 US stores to its European pharmacy partner Alliance Boots. In parallel, the company is working with hospitals to offer its tests in what the CEO of UCSF Medical Center told Fortune is “the true transformation of healthcare.” (USA Today covered much of the same ground in its July 8, 2014, edition here.)
Theranos’ vast ambition, coupled with its lack of publications subjecting its methods to scientific scrutiny, has not gone unnoticed, especially by competitors. Fortune wrote:
‘The most frequent criticism is that Theranos is using purportedly breakthrough technology to perform tests that are relied on for life-and-death decisions without having first published any validation studies in peer-review journals. “I don’t know what they’re measuring, how they’re measuring it, and why they think they’re measuring it,” says Richard Bender, an oncologist who is also a medical affairs consultant for Quest Diagnostics, the largest independent diagnostic lab.’
The clearest unifying attribute of Moderna, Kadmon and Theranos is “high confidence,” followed closely by “high ambition.” There is no other way to raise the billion-plus dollars these three have raised. There has to be some technical know-how to go along with the bravado. Otherwise multi-hundred-million-dollar partnerships with national pharmacy chains or big pharma companies just do not materialize. Activating a direct commercial channel (in the case of Theranos with Walgreens) or a high-credibility development partner such as Moderna’s partner AstraZeneca is at least a temporary substitute for a look under the hood.
But there is something else going on as well. Let’s call it “stealth as a business model.” All three of these companies seem to share the belief that they will be better off if no one knows what they really do or how they do it. Most notably, they depart significantly from the status quo of publishing and presenting the technologies in an open forum as the gold standard for credibility. This is so unusual in the history of biotech that it made us think about the question the other way around: why would you want to disclose anything about your new biotech company? Just raise the money, sign a partnership and get on with it!
We thought of a good five reasons why many companies share at least the basics of their technical approach. (One company whose chances we like, Heptares of London, UK, published a paper in Nature in 2008 more than a year before they raised their Series A round. That company published in Nature again in early July of this year, gaining credibility from Nature’s name and its peer review process – a more traditional pattern.)
A clue to understanding the trend is the presence or absence of venture capital (VC) money. Of the three companies we chose to examine, only Moderna has disclosed an investment by a traditional VC, Flagship Ventures. It’s fine to stay in stealth if you want to raise money from a single VC, or for that matter from a single VC syndicate. As long as you don’t need “buzz” in the form of news articles and conference hall chatter, you can just go achieve your objectives without sharing much about what you are doing. These days, most early-stage therapeutics investments are done by an initial syndicate that intends to fund the companies through major milestones such as Phase 2 data or partnerships. Therefore the need for buzz is less. Next stop, hedge funds, who couldn’t care less about buzz and whose analysts may in some cases be confident enough to make big-ticket investments decisions based on unpublished data.
So why publish and share at all? Let’s set out some reasons and see if we can shoot them down:
- Fund-raising. As described above, that point seems moot. Atlas Venture in Cambridge has a whole stable of early startups and they keep their technology under wraps for a while – maybe all the way to exit? Third Rock Ventures incubates companies for a year or more before hatching them nearly fully formed and typically not intending to raise more money until the IPO anyway. Why not go all the way in stealth?
- Corporate partnerships. Roche will find out about you whether you publish or not. If your scientific founder is already known to the therapeutic area head, all the better. If not, maybe better to publish.
- Clinical trial recruitment. This is usually handled by intermediaries such as clinical research organizations (CROs). Patients are usually tracked down actively. Companies don’t wait for the patients to be pulled in via news stories (though the stories don’t hurt).
- Hiring. This would seem to be a big one, especially in hotly competitive geographies such as Cambridge or the Bay Area. But now that more and more “virtual drug development” companies are filing for IPO in Phase 2 with staffs of fewer than fifteen people – two of these have been CBT Advisors clients in 2014 and two more have been clients of our co-author – the point seems less relevant
- Overcoming resistance in society to biotechnology. This may have been a factor at the dawn of the industry in the 1980s but now there seems to be much less resistance, even in traditionally conservative societies like Germany. A more nuanced understanding of advanced biotech seems to be emerging and there is strong demand globally for more biotech companies, not less.
When you think about it, publishing has some downsides too. Most threatening among these is that publishing what you are doing will arm your competition. Yes, your patents will be published anyway eighteen months after you file them. But competition has intensified in the era of the patent troll. Why advertise?
The strong implication of all of these arguments is that biotechs should stay stealthy whenever possible. If founding scientists are not required to publish in order to get tenure or to get the next grant, they should, like our examples here, take it to investors, take it to pharma, fund it to the hilt and don’t look back.
In one sense, this does hark back to the early days of biotech, when companies were able to raise considerably more money for technology platforms that were years away from generating tangible products. That model went away early in the last decade, in part because investors – both hedge funds and venture funds – began to apply financial analysis tools to product portfolios, sharply cutting the valuations and the ability to fund-raise for all but products that already existed. The shift into stealth mode seems to be going hand-in-hand with a shift in investor favor toward early funding of powerful platforms such as Moderna’s. Once again, a company able to raise significant amounts of capital can try out several different things and allow some of them to fail quietly without the market playing a role.
We just want to mention one tiny nagging doubt: much of the research that underpins these companies comes about under the auspices of US government funding, typically from the National Institutes of Health (NIH). But in the guidelines we found, there is no formal mechanism requiring disclosure once research is funded. It is not even required to be published. Nevertheless, it strikes us that sooner or later there may be a backlash to all this stealthiness.
And of course the longer term question remains: does having strong financing and a strong commercial channel replace independent peer review of the underlying technology?
In the meantime, we sincerely hope that all of these companies are successful. It would be an amazing day in healthcare if they were. And should that day come, we are imagining a moment when Hollywood decides to make the movie, akin to the way screenwriter Aaron Sorkin imagined the beginnings of Facebook in “The Social Network.” The big difference here is that the script writer will have an awful lot of liberty in shaping a story that no one has ever heard.
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