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Beyond the pill – are digital health deals set to spike?

Transactions between big pharmaceutical companies and start-ups working on potentially highly disruptive but beneficial technologies in the healthcare space have not taken off as fast as some expected. That could be about to change.

It probably wasn’t meant to take centre stage, but the small white circle on the arm of UK Prime Minister Theresa May certainly grabbed some headlines. She was wearing a glucose-monitoring patch – an essential part of her daily routine to deal with the Type 1 diabetes that, to her credit, she has been happy to be open about – and press photographers were quick to spot it. It’s a high-profile reminder of the increasing role that technology is playing in modern patient care, with digital systems being used to help millions of people manage a growing range of conditions from diabetes, through to asthma, chronic obstructive pulmonary disease, heart conditions, hyper-tension and depression. This ought to be fertile ground for the big pharma companies as they battle a range of growing cost and intellectual property challenges that are forcing them to rethink their business models. Chief amongst those is the time and cost of developing blockbuster drugs – for decades their highly valuable stock-in-trade – and finding cost-effective ways to continue innovating as those drugs near the patent cliff.

But other pressures are mounting too, not least the increasing demand by hard-pressed health authorities, struggling to contain escalating budgets, that drug developers should be paid relative to measurable patient outcomes. These pressures have forced big pharma companies to explore ways to get closer to the patient, to collect and analyse data to help them develop more efficacious drugs, and to find ways to make sure patients follow their prescribed treatment regimes – one step in making treatments more effective and to justify drug costs to payers.

Big data is clearly key to these efforts, as well as to a range of novel technologies to diagnose conditions and to monitor patients, some of which, like the first ingestible monitor (effectively a digital pill) cleared last month by U.S. regulators, are quite mindboggling. It is part of what the outgoing Novartis CEO Joe Jimenez has called the search for "life beyond the pill" to describe the sector’s need to embrace the disruptive technologies that could threaten its long-term survival. With patient data set to be so important a part of future medicine, better that the pharma companies have access to it, than cede that advantage to tech industry disruptors.

Early focus on VC investment

So far, the evidence of industry excitement about digital health has largely been seen through a surge in VC funding. Investment in digital health start-ups is expected to reach USD7bn this year, up from USD6.4bn in 2016, according to recent analysis by Accenture. Investors are largely traditional VCs, but with funds focusing on the sector (such as Rock Health, Khosla Ventures) being well represented. In the past couple of years however, big pharma like Merck, GSK and J&J have also become increasingly active. Yet it’s perhaps a little surprising that, in an industry so familiar with using partnering and M&A as a tool to stock the R&D pipeline, we’ve not seen more follow on transactional activity coming out of these investments. We think that’s likely to change and that we will see an increasing wave of collaboration and M&A.

Eyes on the prize

Much of the focus of investment thus far has been on wearables, monitoring and virtual care – perhaps reflecting where digital companies see some of the "easier" opportunities to enter the more consumer-focused end of the market or to partner with the healthcare service providers and insurers. In one recent example, Sanofi and Alibaba have teamed up to provide a disease management platform to 100,000 patients in China. Big pharma can certainly benefit from these technologies, but there are other very interesting areas that might be ripe for cooperation, collaboration and investment also. For example, Khosla Ventures recently made its first investment in France by leading an USD18m round in Eligo Bioscience, a preclinical-stage company developing biotherapeutics to bring precision medicine to the microbiome, using proprietary methods in synthetic biology, CRISPR-Cas, and protein engineering. The field of genomics, in particular, seems one where big pharma might take more active positions through collaborations or acquisitions, in a bid to increase the efficacy and personalisation of their medicines. In the "back office", technologies like big data and blockchain offer the potential to re-imagine manufacturing processes, the supply chain, and approaches to marketing and pricing, to drive down costs and become more transparent.

A clash of cultures?

One of the factors that might be holding back the pace of digital health transactions in the pharma space might lie in the clear clash of cultures between large pharma companies and technology start-ups. It frequently takes more than ten years to take a major new drug from conception to the market place and the culture, practices and procedures of pharma companies are built around those extended life-cycles – an alien concept in the start-up world.

Big pharma needs to speed up its processes and can clearly benefit from exposure to the agile and fast-moving world of tech. But equally, tech companies have little experience of the highly complex regulated world in which big pharma has to operate and will need to master it to prosper in this promising arena. Both sides have a lot to learn but, for now, there is a sense that they are feeling their way.

Structuring deals

So when momentum starts to build, what are the factors that will help make the deals go smoothly?

Much will be down to structuring deals in a way that can command the confidence of both sides. We expect to see a growing shift to new, more open-source forms of collaboration where the costs and benefits of breakthrough are shared more widely than in a traditional outsourcing approach. More open source arrangements come with particular challenges around the ownership of IP that need to be carefully navigated. Parties should not, for example, assume that joint ownership of IP gives automatic rights to use, licence or carry out transactions, and that the legal treatment of joint ownership differs from jurisdiction to jurisdiction. Parties should use assignments and cross-licences to ensure parties own the rights in the manner intended and have appropriate use rights.

Structuring the financing of deals more flexibly will be increasingly vital, particularly to make sure there is a long enough investment runway to allow a product to be successfully developed before it reaches the point of making a return. It’s also crucial that both sides operate to an agreed and workable project timetable, supported by appropriate sharing of risk and reward. Collaboration in partnering deals and in M&A needs to be built around clear goals and incentives, with each side understanding the other’s interests. Exclusivity can be a deal breaker for collaborations. Parties should balance their possible interests for exclusivity and ask for it only where it will genuinely be important.

Establishing a strong sense of trust between the parties will provide an important foundation for future partnership. In deals between start-ups and larger players, there is inevitably an inequality of bargaining power. But industry participants who take full advantage of the power imbalance can store up future problems. Imagine, for example, the impact of bullying behaviour on a founder team in a situation where, for the buyer, much of the value of the deal comes from retaining key people.

Above all, collaborations of all shapes and sizes need to keep the patient very firmly in sight. This is all about creating better products and services and improving people’s health. In the world beyond the pill, outcomes are everything.

Please click here to access the full Q4 2017 edition of Allen & Overy’s M&A Insights.