| Biotech spin-offs can start their lives as subsidiaries of their parent organizations, much like satellites that orbit around their planets. But these spin-offs, which take on a character of their own, may in the end become totally independent from the parents by completing an initial public offering. Or, they may be acquired by a third organization. It's even possible that a spin-off can grow so large and powerful that it becomes the predominant member of the pair, in the end absorbing the parent organization. But whatever their fate, biotech spin-offs have been one of the main forces behind a constantly-expanding biotechnology universe. |
The biotechnology industry is in constant flux. In times like the present, when the financing well has run dry, many established firms simply disappear -- whether by acquisition or by a slow and painful demise due to lack of cash. But even as the older companies are declining in number, new ones are springing up to take their places. Some new firms arise de novo, of course, but others are created from within existing companies as subsidiaries or spin-offs. This phenomenon has existed almost as long as there has been a biotechnology industry.
In fact, some spin-offs have existed as independent entities for so many years already that it's hard to reconstruct their lineage. But if you delve into the records, you'll find that Celtrix Pharmaceuticals Inc. came out of Collagen Corp. (now Collagen Aesthetics Inc.). and that Targeted Genetics Corp. was born of Immunex Corp. Lynx Therapeutics Inc. was spun out of Applied Biosystems Inc. and Cadus Pharmaceuticals Inc. evolved from ImClone Systems Inc. The roster has continued to grow. New additions include Cytovia Inc., InterMune Pharmaceuticals Inc., Akkadix Inc. and PPGx Inc. But it doesn't stop there.
As diverse as these companies are, they do share one important attribute: They were all created as a means to access capital. Spin-offs can be opportunity-driven or need-driven, but they're still set up in such a way as to attract financing from sources external to the parent organization. There are variations on this theme, of course, even though each spin-off has its own story to tell.
If the parent company ascertains that the various aspects of its business are under-appreciated by the investment community, that firm may choose to spin off some of these into separate entities, usually subsidiaries. Millennium Pharmaceuticals Inc. has taken this approach. In other instances, the parent company may want to capture the value of a technology or product that it has acquired -- without putting undue stress on its own R&D programs -- by creating a separate company to deal with it. Connetics Corp., among others, has chosen this route. Sometimes, the parent firm may find itself with an exciting technology developed in-house, but absolutely no way to finance it internally. CoCensys Inc. found itself in this situation. And, infrequently, the spin-off company ends up holding technology that is more valuable than the parent's, causing the parent to merge with and into the spin-off. Cytel Corp. is now in the process of doing just this with its majority-owned subsidiary Epimmune Inc.
 
Entrepreneurship can be one of the strongest drivers of spin-offs. It's the force that created Affymetrix Inc., for example. According to Kenneth Nussbacher, executive vice president at Affymetrix, "In order to succeed, Affymetrix had to be very different than Affymax [the parent organization]…It didn't fit the broad business strategy at Affymax. It required a different capital structure and management style." Affymax was oriented towards pharmaceutical R&D, which involves a long development time frame. The concept behind what became Affymetrix, however, was marketing-oriented. It had short-term goals. It became critically important to show potential investors a financial model for the company. "That's one of the reasons that Affymax was sold to Glaxo," Nussbacher said. "Justifying the market value of an R&D-based drug discovery company got to be a real challenge."
Thus, in general, if a new technology arising from within the parent organization is unrelated to the business of the parent company, but it's worth pursuing, then it requires independent financing. This provides the new entity with operating capital, of course, but it also creates stock. And it's a well known fact that stock and stock options are remarkably effective incentives for attracting key employees as well as members of the board of directors.
Affymetrix's raison d'etre is the GeneChip, a disposable DNA probe array containing gene sequences on a chip, the same kind used in the semiconducter industry. The concept was revolutionary: to marry biology and electronics. These GeneChips can be used to discover genes, analyze their sequences, monitor gene expression and perform genotyping. And, in fact, they are being used for all these purposes. The first commercial application, in January 1997, came through a collaboration with Glaxo Wellcome plc to use GeneChips to identify HIV gene mutations that enable the virus to resist drugs. But the business has exploded since then; Affymetrix has signed innumerable agreements with pharmaceutical companies, biotech firms and universities to provide access to GeneChips for a broad spectrum of uses.
Affymetrix was founded in early 1991; by March 1992 it had been incorporated as a subsidiary of Affymax N.V. of Amsterdam. By the summer of 1993, Affymetrix had put together a management team and was operating out of offices in Santa Clara, Calif. It raised its first $21 million through a Series A financing in October 1993 from investors in Europe, the Far East and the U.S., including Affymax and the College Retirement Equities Fund. This financing was the defining moment for the fledgling company's future, Nussbacher said. "Affymetrix wasn't committed to a capital structure until somebody outside the company took a stake."
From there, it raised another $39 million or so in private placements and then went public in June 1996, raising an impressive $92.3 million in gross proceeds. Affymetrix's IPO was, in fact, one of the richest in 1996. It was bested by Paris-based Genset S.A., which garnered $99.4 million earlier that month, and Bermuda-based Axogen Ltd. (a spin-off of Irish pharmaceutical firm Elan Corp. plc), which raised $95.2 million in its November 1996 IPO.
Meanwhile, Affymetrix's parent had been acquired. In January 1995, U.K. pharmaceutical giant Glaxo plc (now Glaxo Wellcome plc) paid about $540 million to acquire Affymax. Through this purchase, Glaxo also gained a hefty stake in Affymetrix, giving it about 65 percent ownership, according to Nussbacher. After Affymetrix's IPO, Glaxo's stake decreased to slightly more than 34 percent. In April 1998, however, Glaxo bought $50 million of convertible preferred stock in Affymetrix; if this were to be converted into common stock (at the set price of $40 per share), Glaxo would hold 37 percent of Affymetrix, Nussbacher said.
But even though it's a large shareholder, Glaxo tends to stay well in the background. It's not even Affymetrix's biggest customer (for GeneChips), he added. "Glaxo looks at Affymetrix principally as a financial instrument...We don't feel captive." And if Glaxo decides to buy out Affymetrix sometime in the future, it would "have to approach the non-Glaxo directors and make a proposal," Nussbacher said.
In all ways, Affymetrix stands as the perfect example of a successful spin-off. Three years after one of the most lucrative biotech IPOs on record, Affymetrix's market cap stands at $1.1 billion -- three times the post-IPO market cap. It's also worth twice as much as Affymax, its parent organization, was when Glaxo bought it. Moreover, since Glaxo's 37 percent stake in Affymetrix is worth about $407 million today, the British pharmaceutical company has recouped most of the money it spent to buy Affymax.
| Spin-Off (Parent) |
Date Of Spin-Off |
Date Of Spin-Off's IPO/Post-IPO
Market Cap |
Spin-Off's Market Cap On
6/23/99 |
Parent Company's Market
Cap On 6/23/99 (Or Current Status) |
Abgenix Inc.
(Cell
Genesys Inc.) |
6/96 |
7/98
$88M |
$231M |
$120M |
Affymetrix Inc.
(Affymax
NV) |
3/92 |
6/96
$336M |
$1.1B |
Acquired by Glaxo for $540M
(5/95) |
Celtrix Pharma-
ceuticals Inc.
(Collagen
Corp.) |
12/90 |
2/91
Spun off as a dividend to shareholders in form of separate
public company (MC not available) |
$20M |
$118M |
Guilford Pharma-
ceuticals Inc.
(Scios Nova
Inc.) |
7/93 |
6/94
$29M |
$222M |
$144M |
 
Axys Pharmaceuticals Inc. was forged from the merger of Sequana Therapeutics Inc. and Arris Pharmaceutical Corp. in November 1997. Once it integrated all the technologies under one roof, the new drug discovery company had created a comprehensive technology platform -- encompassing everything from gene identification forward to clinical trials. It was sitting on a wealth of potential product opportunities -- too many, in fact, to exploit by itself. So, Axys started spinning out businesses. It now has three: in combinatorial chemistry (the Advanced Technologies Division), in pharmacogenomics (PPGx Inc.) and in agricultural biotechnology (Xyris Corp.) The affiliated businesses are intended to leverage Axys' broad technology platform for near-term capital and value creation. Two of the spin-outs, PPGx and Xyris, are independently financed, as well, a move than reduces the parent company's risk at the same time that it maintains a majority ownership in each. "We wanted to create something for Axys that produces equity value for us at the end of the day," explained John Walker, Axys' chairman and CEO.
The first spin-out was the Advanced Technologies Division, which Axys formed in January 1998, right after the Sequana/Arris merger was consummated. Axys hasn't sought venture capital for this division, which is also located in South San Francisco, but instead relies on collaborations with big pharmaceutical houses and other biotech companies to provide the funding. In fact, the division contributed 25 percent of Axys' total revenue in 1998. "The Division is an operating business. It's the for-profit part of the company," Walker explained. "The nature of the business is different enough to set it up under its own management structure and P & L [profit and loss statement]." Still, until the present, the division has been wholly owned by Axys. Only now is the parent company looking at a more formal subsidiary status for the division, Walker added. "Axys has the opportunity to raise capital directly for the Advanced Technologies Division or for Axys by selling a portion of Axys' stock holdings," he said.
Next came Xyris, which was formed in May 1998 as a majority-owned subsidiary and funded by a $10 million infusion from Bay City Partners. Post-money, Xyris was valued at $33 million, Walker said. Axys holds a 60 percent stake in Xyris, which is a separate corporation with its own stock. Thus, employees have options in Xyris, not Axys. This is a great incentive: it allows the company to attract key personnel, including its president and board of directors as well as top scientists. "If we had kept it as a division, it would have been difficult to get independent capital. But when we set up a subsidiary, we were able to attract both capital and management to run the business." Less than a year later, in April 1999, the agricultural genomics firm took its first major step when it acquired privately held Global Agro Inc., a plant genetics company also based in San Diego. This all-stock transaction will create a new company with a new name -- Akkadix Corp.
Axys spun out PPGx in February 1999 as a majority-owned subsidiary and a joint venture with contract research organization PPD Inc. PPD holds an 18 percent stake and is providing the initial funding for the joint venture, which is located in La Jolla, Calif. PPD also contributed two former subsidiaries, Intek Labs Inc. and Intek Labs Ltd., which have been absorbed into PPGx. This put PPGx's initial valuation at $62 million, Walker said.
Axys' long-term goals for its spin-offs are very similar. In all cases, the parent company is interested in obtaining liquidity. "The main driver is to raise capital for drug discovery." For Xyris, now Akkadix, the aim is to either bring the company public or sell the business in the next four to five years, Walker said. The same time frame holds for PPGx: "We want a certain amount of money out of it in four to five years. PPD can buy stock directly from Axys to increase its ownership to a level equal with Axys'. Then, in three years PPD would have an opportunity to make a bid for PPGx." Going public is another option. As well, Walker said that he sees the Advanced Technologies Division as either an IPO or a sale in the future.
| Spin-Off (Parent) |
Date Of
Spin-Off |
Date Of Spin-Off's IPO/Post-IPO
Market Cap |
Spin-Off's Market Cap On
6/23/99 |
Parent Company's Market
Cap On 6/23/99 (Or Current Status) |
Intercardia Inc.
(Interneuron Pharmaceuticals Inc.) |
3/94 |
2/96
$101M |
$37M |
$126M |
Lynx Therapeutics Inc.
(Applied Biosystems Inc.) |
11/92 |
11/92
Spun off as a dividend to shareholders in form of separate
public company (MC not available) |
$127M |
Acquired by Perkin-Elmer for
$330M (2/93) |
Targeted Genetics Corp.
(Immunex Corp.) |
2/92 |
5/94
$54M |
$48M |
$10.3B |
 
Back in 1989, Seattle-based Immunex Corp. executives had gathered for a strategic planning session. "We wanted to ascertain whether our focus and mission were still viable and appropriate," explained H. Stewart Parker, who was then Immunex's vice president of corporate development. "When we looked at our internal R&D programs to see which projects fit with the mission, we determined that cytokines and cytokine products were a good focus for Immunex, but there were lots of programs that didn't fit." One of those, as it turns out, was retroviral vector technology; Immunex scientists had been collaborating with Dusty Miller at the Fred Hutchinson Cancer Research Center since the mid-1980s to develop this technology, Parker said. There was some basis at the time for thinking that retroviral vectors were useful in gene therapy, "but we couldn't afford to develop a program within Immunex," she continued. "That was before the Cyanamid deal and Immunex was cash-constrained." [In December 1992, American Cyanamid Co. bought 53.5 percent of Immunex for $600 million, merged it with its Lederle Oncology Labs, and forged a new Immunex Corp. By November 1994, however, American Home Products Corp. (AHP) had acquired Cyanamid, making AHP the majority owner of Immunex.]
So, Immunex officials put together a business plan to form a gene therapy spin-off, and took that plan to venture capital groups. The result was Targeted Genetics Corp., which was spun out in February 1992 with Parker at its helm. (She is currently the president and CEO). Post-spin-out, Immunex owned 40 percent of Targeted Genetics, Parker said. The two companies had a structured arrangement that allowed Targeted Genetics access to Immunex's infrastructure -- which meant a considerable cost-savings to the newborn firm -- as well as a licensing agreement on the technology. This agreement was exclusive for technology developed at Immunex before Targeted Genetics was spun off and non-exclusive for technology developed between the time of the spin-off and February 1999, Parker explained. That relationship has "evolved over time as the individual players have changed. Today there is no structured arrangement; we interact on an informal basis." Targeted Genetics has changed, too. "As the gene therapy field has evolved, we've de-emphasized the viral vectors and turned to adeno-associated vectors and non-viral gene delivery methods," she said. Yet, the ties remain. Targeted Genetics is still situated in Seattle and Immunex still holds an equity stake -- a little under 10 percent, according to Parker. "Immunex sees us as its gene therapy arm."
 
Necessity is the mother of invention, they say: It certainly was for CoCensys Inc. when it created Cytovia Inc. and then turned around and sold it a year later.
"When I came to CoCensys in January 1997, the company had six months of cash left before it went under," said F. Richard Nichol, CoCensys' chairman of the board, president and CEO. "We had to take specific actions rather quickly." He restructured the company, sold its pharmaceutical sales and marketing division to Watson Laboratories Inc. and refocused the company on neuroscience. "At the same time, we reviewed the entire science portfolio, and found that the company didn't have enough money to drive all the technologies forward," Nichol said.
Richard Nichol |
One of those that looked especially promising was CytoCasp, a drug screening technology that company researchers had developed based partially on in-licensed technology. CytoCasp uses living cells from any organ or tumor to screen for drugs that inhibit or activate a family of enzymes called caspases, which are involved in the apoptotic signal transduction pathway. "Company scientists had been working on this for about one-and-a-half years. There were about 8 to 10 people on the project, and we determined that we would have to spend $7 million to $10 million a year to make it go forward." The technology was still early-stage, too, meaning that it wasn't yet mature enough to license out to pharmaceutical or biotech partners. That left one choice: to spin it off.
That's how Cytovia came into existence. It was launched in January 1998; CoCensys provided the new firm with start-up funds and loaned it some space in its Irvine, Calif. facility. (Cytovia later moved to San Diego.) But although Cytovia was formed as an independent company, it was still tied to CoCensys in several ways. For one, CoCensys retained a substantial equity stake. For another, Nichol had a seat on the board of directors. Also, CoCensys had contractual rights with Cytovia covering the use of CytoCasp to screen neuroscience-related therapeutics as well as right of first refusal to develop any compounds discovered by Cytovia that had applications in central nervous system diseases. Nichols took the business plan to venture capital investors in April 1998 and raised $10 million in financing for Cytovia.
A year later, in May 1999, Cytovia was up for sale. Not surprisingly, one of the same venture capital groups that had participated in Cytovia's first round --together with certain stockholders -- ended up buying CoCensys' stake (about 13 to 14 percent) for $3.3 million. "I would have kept the company for three or four more years, using it as a driver of stockholder value," Nichol said, but external forces were mounting. CoCensys desperately needed the cash to buy back some of its Series E convertible preferred stock. "The convertible preferred stock is the reason our common stock is going south," he explained. "There's virtually unlimited selling pressure." It's the death spiral often caused by so-called toxic converts. "We had to liquidate the Cytovia holdings" to buy back some of those shares. CoCensys repurchased 3,180 shares ($3.18M in face value) with the cash from the Cytovia sale; it has now retired about 66 percent of the outstanding converts, Nichol explained. "It was the best solution for a difficult situation."
"If we hadn't spun out the technology, it would have languished in the labs and the scientists would have left. We also wouldn't have had the money to survive. Now CoCensys is alive for the next 10 months." As to Cytovia's fate? Nichols said that the buyers, entities associated with Domain Associates LLC, will probably "take it as a classic biotech play -- either as an IPO or as a sale to a big pharmaceutical company."
 
When Connetics Corp. acquired all product rights to Actimmune from Genentech Inc. in May 1998, it needed a way to develop the full potential of that product without draining resources from its own R&D programs. At the same time, however, since Actimmune was an FDA-approved product, Connetics wanted to realize the profits from its sales. By setting up an independent company centered on Actimmune, Connetics was able to focus its own resources on products already in development and simultaneously profit from the product's current and future sales.
Actimmune, or interferon gamma-1b, was approved by the FDA in 1991 for the management of chronic granulomatous disease (CGD), a rare inherited disorder that impairs the immune system. Genentech, its developer, had been marketing the product, although sales turned out to be fairly minimal. In 1997, for instance, Actimmune generated net sales of only $3.5 million.
Connetics actually acquired limited rights to Actimmune from Genentech in December 1995; these covered the development and commercialization of the product for treating dermatologic diseases. However, "the clinical trials for severe atopic dermatitis did not work out, so we backed away from that indication," explained Thomas Wiggans, president and CEO of the Palo Alto, Calif. firm. In 1998, Genentech licensed the remaining rights to Connetics: These also included the U.S. marketing rights for the CGD indication. "Actimmune did have a small revenue stream, but Genentech wasn't interested [in it], so we acquired all the rest of the rights," Wiggans said.
Thomas Wiggans |
Then Connetics had to decide what to do with it. "Do we want to take it forward ourselves, spin it out or partner it with another company?" Wiggans explained that "the most compelling argument for us was Connetics' strategy, which has been and continues to be a revenue and near-term profit model. We didn't want to incur product development costs with Actimmune. It didn't fit with our model of moving toward profitability. It came down to a financial decision for us." Even if Connetics partnered the drug, it would still have infrastructure costs associated with product development, Wiggans said. Thus, in the end, Connetics chose to spin it out. "The best option was to deal with independent investors. We got money up front, reimbursement for services and an equity position in the spin-out."
In late April 1999, less than one year after it had in-licensed Actimmune, Connetics completed the spin-out of InterMune Pharmaceuticals Inc., with Connetics' former senior vice president of product development and operations Scott Harkonen as president and CEO. It achieved this by selling a majority ownership stake to outside investors in a $6 million private placement of Series A preferred stock. This arrangement provides independent funding for the development of new indications of Actimmune -- and potentially, for the development of new products as well. InterMune has already completed Phase III clinical trials of Actimmune in osteopetrosis (a congenital bone disorder) -- for which it intends to file a BLA this summer -- and clinical studies on atypical mycobacterial infections. Recently, InterMune has in-licensed the rights to pseudomonas antigen technology (for use as a vaccine) developed at the Medical College of Wisconsin in Milwaukee and the University of California, San Francisco.
Connetics retained a 10 percent stake in InterMune; it also got an initial cash payment of $500,000 and will receive additional cash and equity over the next three years. As well, Connetics retains commercial rights and revenues to Actimmune for CGD for the first three years and gets a royalty thereafter. Connetics also retains product rights for potential dermatological applications of the product. "Connetics has multiple opportunities to win with this approach. It was just the right deal for us," Wiggans explained. "We spun out a company that has the characteristics that investors like right now," he added. "It's got revenue and near-term prospects for more revenue. As a free-standing company, InterMune has its own chances of being successful. It's an appropriate business model for the times."
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