What Is In-Licensing?

As mergers and acquisitions of pharmaceutical companies have been prominent so far in 2018, it could be a good idea  to watch them grow through acquisitions and licensing agreements instead of just in-house research and development. These licensing agreements can prove to be very fruitful for both pharmaceutical companies and their respective stock prices.

In fact, licensing deals might be pharma’s preferred mode of business development these days—perhaps even more so than outright acquisitions. The strategy is likewise attractive to investors: licensing drugs expedites corporate development while also mitigating risk, which can cause for confusion. So, let’s clear up some common questions around the strategy:

What exactly does it mean to license a drug? How do royalties affect returns? In what ways does a license differ from an acquisition?

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Investors need to understand the intricacies of this process, so that they can interpret a company’s subsequent actions correctly—and elect to buy or sell at the right time.

In-licensing, explained

In mid-February, Santhera Pharmaceuticals (SWX:SANN) licensed a clinical-phase cystic fibrosis asset from Polyphor, a private Swiss biotech company.

While Santhera is using this to expand its own pipeline and now owns worldwide rights to develop and commercialize the drug, Polyphor will receive US$ 6.5 million upfront and another US$ 121million if the drug licensed passes specific milestones. Polyphor will receive royalty payments from the future net sales of the drug.

These types of deals are known as in-licensing: a company takes on some of the financial or technological burdens associated with developing a product, then gets to share in its returns.

Santhera is just one of the micro-cap companies making use of the strategy. Some other large-cap companies dabbling in licensing are Biogen (NASDAQ:BIIB) and Alkermes (NASDAQ:ALKS) who will develop and commercialize a multiple sclerosis treatment. There’s also Alnylam Pharmaceuticals (NASDAQ:ALNY), the leading RNAi therapeutics company, and Sanofi (NYSE:SNY) announced a restructuring earlier this year so Alnylam will receive global development and commercialization rights to its investigational RNai therapeutics programs and Sanofi will receive royalties.

Sanofi’s vaccine division, Sanofi Pasteur, additionally signed a licensing agreement for flu vaccine technology from SK Chemicals (KRX:285130) to develop broadly protective vaccines.

In-licensing is becoming more and more commonplace, in part because of the influx of small biotech companies on the market. These early stage pharmaceutical companies are a key source of promising product candidates, which pharmaceutical companies then license certain rights to.

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Benefits of in-licensing

Licensing is cost-effective, since the financial burden of product development is shared. It’s also lower risk for the company buying in: they can make deals based on promising preclinical or clinical results. Compare that to the traditional drug discovery process, where a company embarks on a project, investing heavily in its development, all with little data to back up expectations.

Licensing also holds significant appeal when compared to straight acquisitions or mergers. As Aaron Smith wrote for CNN Money, “With licenses, drug companies purchase only the rights for the experimental drugs they’re interested in, and they don’t have to take on another company’s problems or unwanted technologies.”

All of that means in-licensing can hold major appeal for pharmaceutical companies and investors alike. But as mentioned above, it can also generate confusion—confusion which can lead to ill-informed decisions on the part of investors.

Understanding in-licensing

Just as pharmaceutical companies are always looking for the next blockbuster drug, investors are looking for the company who will develop it. In-licensing agreements, then, can appear somewhat off-putting: even if a drug proves wildly successful, its profits will need to be split between two pharmaceutical companies, and therefore two groups of shareholders.

Such was the case with Eliquis, an anticoagulant jointly developed by Pfizer (NYSE:PFE) and Bristol-Myers Squibb (NYSE:BMY). Discovery and clinical advancement was completed by the latter, who joined forces with Pfizer only when entering late stage trials.

This puzzled some investors—after all, the drug seemed like a potential blockbuster. It would be a novel entrant to the market, and benefit a wide number patients. Why split the profits with another company—and one coming late to the game?

As John LaMattina explains in Forbes, there was still plenty of question about the success of Eliquis. The anticoagulant drug market is a competitive one, and there was no guarantee this drug would prove more effective than like products also in development.

Besides, Phase III trials are costly: this one would cost hundreds of millions of dollars. And Bristol-Myers Squibb was already contending with a tight R&D budget.

In the case of Pfizer, Bristol Myers Squibb which distributed the risk involved and eased the financial burden of getting Eliquis approved. It took a long time to roll out the drug, but today, it’s a top earner, bringing in profits for both pharmaceutical companies.

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On the books

Licensing deals also complicate financial statements. “They are not typically recorded as an asset on the balance sheet,” Jeff Margolis, VP of RespireRx (OTCQB:RSPI), explained to the Investing News Network (INN). “They are considered ‘in process research and development’ and the expenditures are considered expenses on the profit and loss statement, typically creating large losses.”

That means the uninitiated investor may misinterpret a company’s financial statement, since it does not “truly account for the value of the licenses.” As Margolis said “the asset is ‘intangible.’”

RespireRx: a case study

The VP of RespireRx, Margolis is intimately familiar with the ins and outs of in-licensing. His company has licensed the rights to dronabinol from the University of Illinois, and is developing the drug as a treatment for obstructive sleep apnea. The drug is currently in Phase II of the company’s product pipeline.

The University of Illinois published a project report on dronabinol, which was paid for by the National Heart, Lung and Blood Institute. RespireRx did not conduct the study and does not control data analysis, but the results—which have not yet been unblinded—will obviously have a major impact on them.

This brings us to another question that can arise with in-licensing. RespireRx submitted an 8K filing for the publication, but less experienced investors may wonder why they have not yet officially taken a position on the study, or published a press release—especially considering the study showed significant clinical differences among treatment groups, for three out of four main outcome variables.

“The Project Report … does not contain any information generated by RespireRx nor any opinion of RespireRx about the content or what it may mean and is entirely the work of the principal investigators,” Margolis told INN. “It does contain a significant amount of information that RespireRx believes investors and prospective investors may wish to know about.” The company will comment on the study once it has been unblinded.

Here again then, we see how in-licensing can be confusing: investors have to understand this process in order to understand RespireRx’s choice to delay its response.

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Sustainable, but not traditional

As pharmaceutical manufacturers move more toward in-licensing, they tend to reduce their massive R&D budgets. This can perturb investors accustomed to the traditional pharmaceutical growth model: drug discovery leads to products, which leads to profits.

But remember that drug discovery also leads to major losses. Pharmaceutical companies spend millions on development, yet only one in ten product candidates ever make it to market. In-licensing can offer an opportunity to cut down that expense and share the burden of risk.

Plus, as pharmaceutical investors are becoming increasingly aware, blockbuster drugs are few and far between these days. “The industry is the victim of its own previous successes,” Dan Hurley explains in an article for The New York Times. “In order to thrive, it must come up with drugs that work better than blockbusters of the past.”

In-licensing may not be traditional, but it could be a more sustainable method of pharmaceutical growth. As the major pharmaceutical companies embrace this model, investors must adjust their own mindset too. The old rules might not apply any longer, and it’s important to reconsider investment strategies in light of industry changes.

Now that you know a bit more about in-licensing, will it affect how you invest in pharmaceutical companies, and why? Let us know in the comments below.

This is an updated version of an article originally published by the Investing News Network in 2016.

Don’t forget to follow us @INN_Resource for real-time news updates!

Securities Disclosure: I Amanda Kay, hold no direct investment interest in any company mentioned in this article.

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