Royalties continue to flow in healthcare

Last year was a record for healthcare royalty transactions with 38 deals valued at $2.7bn, according to specialist US-based capital provider Healthcare Royalty Partners (HC Royalty).

This surpassed the previous record of 28 deals valued at $2.6bn in 2011 after more than a decade of growth since the 4 deals valued at $180m in 2000.

The outlook for the next few years appears to be strong, as the main US healthcare industry undergoes further change, and royalty groups look to work with a wide range of potential partners, such as universities and corporations.

Paul Hadden, principal at HC Royalty, who has completed more than $650m in royalty transactions, said: “We expect the royalties market to be robust for the next few years and stable even if IPOs [initial public offerings] and VC [venture capital investment] come and go.

“There is increasing licensing activity [Deloitte figures], which provides a larger opportunity set for us. R&D [research and development] has not delivered for big pharma as they face a patent cliff so they have over the past five to seven years been looking externally through licensing products and patents.”

HC Royalty, formerly known as Cowen Healthcare Royalty Partners until June 2012, although it still remains affiliated with investment bank Cowen Group, has been one of the most active capital providers in return for royalties in healthcare. The firm’s senior investment team, who spun out from secondaries investment firm Paul Capital Partners in 2007, said they had participated in more than 45 royalty financings valued at over $2bn over the past decade, particularly after closing its second HC Royalty fund at $1bn at the end of 2011. This followed its first fund at about $500m in 2008.

The closing of the fund saw a surge of public dealmaking by HC Royalty over the following year. HC Royalty committed more than $425m in eight deals in 2012, of which more than $300m closed across five investments in December that year. But while HC Royalty has only made two public deals since then, peers, such as Capital Royalty and DRI Capital, have been active. Capital Royalty’s deals since the second fund was closed at $805m in May 2013 have included Biodesix ($20m), Solta ($40m), Exagen Diagnostics ($25m), RainDance Technologies ($35m), Valeritas ($100m) and Good Start Genetics ($28m). DRI closed its third fund at $1.45bn later that year and has 32 products in its portfolio, according to its website.

However, an adviser to HC Royalty said it had completed a number of other deals in 2013 that couldn’t be disclosed for various reasons and added: “The one thing we have observed in this space over the past decade is that many royalty deals are not publicly disclosed unless it’s a publically traded company for example that is bound by the SEC [Securities and Exchange Commission, the US regulators] to disclose the transaction. You frequently see this in the university space and definitely with inventors who don’t want it to be known that they just received $10m in cash.”

Universities and their spin-offs have been one area of focus for HC Royalty. Hadden said: “The university and research institution sector, as well as non-profits, have increasing demand because they are limited in their other fundraising opportunities because they cannot sell shares, alumni can only be tapped so many times and grants are facing draconian budget cuts through sequestration to NIH [US medical research agency National Institutes of Health].

“However, the university setting is different to small biotech starving for cash. They are large institutions so take a different approach and are much more iterative in their thinking, even if they need the money today for a new building. But the crux of the negotiation is the same: product sales. We provide capital upfront and then take a percentage of sales, anywhere from 1% to 20%, over five to 10 years.

“That universities are collaborating, such as the basis for Costim spin-out, is more of an opportunity than challenge for us. If they have already had discussions and resolution on who owns and gets what in a startup then it helps our due diligence. If our IP [intellectual property] due diligence brings up a potential clash or conflict between different universities then it might cause a step-down in potential royalties.

“For us, we have to make good decisions immediately on patents that could last seven to 10 years as we cannot trade in and out. Our diligence is on a number of areas: IP, to see if a patent is valid, has freedom to operate and actually covers the product; commercial, to look at the market today and the competition set and see how the market might change over time by the unique knowledge of what the trials pipeline looks like; public health need, whether it is a new area or into an established market for treating or diagnosing a condition; the manufacturing of the product, ie whether they are new or has a clean history; clinical and regulatory risk of whether a product could be removed from the market (usually for liver toxicity or cardiovascular problems); and the reimbursement environment, which has been increasingly important to understand over the past few years.

“We can ask where the product sits and the budget impact, for example it can be valued differently if it is expensive but a small market versus a product treating lots of people.

We like to invest alongside smart investors who can design clinical trials for reimbursement, especially at the early-stage.

“Over the next five to 10 years, there will be hard decisions on this [reimbursement]. We are ahead of the curve, by looking to back products with a high unmet need and with few substitutes, such as vaccines, which once they are on a panel are necessary and had by every infant [four million births per year in the US].”

“We see med-tech as a growing opportunity but the life cycle is different from pharma/biotech as the market for say a stent can change dramatically in a year if new product showing only marginal improvements come out. In chemistry and biology the lead time is so long.  

“Overall, we are seeing exciting things coming out as R&D is cyclical. There were lots of products coming out in the mid- to late-1990s and then the focus shifted to their commercialization and blockbusters of $500m to $1bn to even $10bn. But the pipeline slowed in the late-2000s and now we are seeing exciting new ways to treat diseases and crack cancer. There will still be blockbusters but they will be different – not generated through volume of patients but targeted patient types where the improvement is meaningful and higher prices justified.”

Box – HC Royalty public deals since 2012

There are several types of deals being done by HC Royalty and others in this space, including

• Royalty monetisation: the purchase and monetisation of an existing drug revenue stream from a healthcare company or royalty owner.
• Synthetic Royalty financing: the structuring of a new royalty agreement tied to a specific product(s) or an alternative way to provide non-dilutive capital.
• Structured debt:  royalty or revenue backed debt.
• Project financing: structured investments to achieve specific finance and R&D objectives.
• Equity: traditional equity purchases alongside core investments1

HC Royalty public deals since 2012 have included:

2014 — Suneva Medical, a private aesthetics company, raised $35m split between a growth-capital term loan, a working capital facility, and a series B equity round financing of $20m from a consortium including venture capital firm Polaris Partners and HC Royalty.

2013 – TearScience, a private medical device company, raised up to $70m from HC Royalty. 

2012 – Nuron Biotech, a specialty biologics and vaccines company, raised $80m from HC Royalty as a $30m eq
uity investment and a $50m Synthetic Royalty agreement.

• HC Royalty purchased a royalty interest from an inventor in Lyrica, one of Pfizer’s premier drugs for the treatment of neuropathic pain with trailing twelve month sales exceeding $3.5bn worldwide.  
• A $50m loan agreement was completed with Nasdaq-listed Raptor Pharmaceuticals to help fund the commercialization of Procysbi.  
• HC Royalty acquired a royalty interest in Eligard’s European sales from Medigene for $18m.