A new wave of drug startups with big portfolios and precarious valuations has burst onto the scene. Welcome to the era of ‘mega biotechs.’

Summary List PlacementTo understand the hottest new trend in biotech, take a look at the firm Centessa Pharmaceuticals.  Centessa was formed just seven months ago by the life-sciences venture-capital firm Medicxi, which fused together 11 startups. These startups likely would have been harder to finance as independent entities, said Perceptive Advisors'...

Hand popping bubbles filled with logos of mega biotech companies, as a looming valuation bubble burst may occur

Summary List Placement

To understand the hottest new trend in biotech, take a look at the firm Centessa Pharmaceuticals. 

Centessa was formed just seven months ago by the life-sciences venture-capital firm Medicxi, which fused together 11 startups.

These startups likely would have been harder to finance as independent entities, said Perceptive Advisors’ Chris Garabedian and another venture capitalist who was not authorized to speak to the media (Neither had inside knowledge of the deal, and both said their assessment was based on their experience as biotech VCs). Medicxi likely wanted to dress them up to create a more attractive investment opportunity.

Centessa came out of stealth mode in February, announcing that it had raised $250 million. It quickly filed for an initial public offering and says it could be worth $917.6 million, according to a regulatory filing

Centessa isn’t alone. A series of new drug companies has emerged in the past two years that meld multiple smaller startups to either create a single new venture or a holding company with many subsidiaries.

These startups are drawing large financing rounds and high valuations, creating companies that are larger in scale than a standard drug startup but not quite in Big Pharma’s league. Call them “mega biotechs.” 

Centessa Pharmaceuticals CEO Saurabh Saha

The rise of the mega biotechs

There are a least a dozen of these mega biotechs in existence today, both public and private, according to Insider’s tally. Six of these were formed or launched in the past year. These companies are larger than their peers but not necessarily further along in the drug-development process.  

Flagship Pioneering, the life-sciences venture giant that is incubating about a dozen startups, according to an Insider tally, has condensed several of the biotechs it’s developing into larger ventures like Sana Biotechnology and Senda Biosciences

Sana was formed from two startups incubated at Flagship. The cell- and gene-therapy-focused company raised $435.6 million in its first financing in June 2020. It launched on the Nasdaq in February at a $6.3 billion valuation, setting a record for a company that hadn’t begun drug trials in humans.

Another biotech VC firm, RA Capital, recently combined two companies into a new biotech, Eliem Therapeutics, and has multiple oncology companies in stealth mode that the firm’s leadership is considering merging, according to a person who was not authorized to discuss the firm’s plans. Insider has verified their identity.

“The way we thought about Eliem and the merger is that we wanted to put together a team that couldn’t fail,” the person said. 

‘Priced for perfection’ in a challenging industry

But these biotechs aren’t too big to fail. By raising large, early private-market rounds, they’re setting higher stakes with investors, creating expectations of future growth that could prove difficult to live up to over time.

Most biotechs start out with an idea and a small amount of funding. They raise increasing money — at higher valuations — as they collect more trial data from animals and eventually humans.

There will be many failures — less than 5% of drugs ever make it to market, and dozens of companies go bankrupt every year — but some will reward investors by launching on the stock market or being acquired by a bigger drug company. 

“They’re priced for perfection,” said Garabedian, the manager of Perceptive Advisors’ Xontogeny venture portfolio. “The bar goes up when you deploy more capital. When you raise $100 million or $300 million, how do you get investors a five times return on that? And if you fall short, you’re not likely going to be able to return to that level.”

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Record venture capital funding has flowed into the drug industry over the past several years. 

VCs handed over $10.5 billion in the first quarter of 2021 alone, according to a PitchBook-NVCA report. That’s about the amount that pharmaceutical and biotech companies raised in all of 2016. 

How could entrepreneurs and venture-creation firms not take advantage of the lush funding landscape?

The abundance of money is also creating a valuation boom. 

Alloy Therapeutics sextupled its valuation in a year

In the best-case scenario, a middle-of-the-road biotech can double its valuation between rounds, according to a PitchBook report.

One mega biotech, Alloy Therapeutics, was able to boost its valuation from $91.25 million in May 2020 to $563 million in its April Series C round, according to a company executive who asked not to be identified. That’s a sixfold increase in about a year. 

Alloy is growing through what’s called the hub-and-spoke or portfolio model — one method of building a mega biotech. In this business model, teams work on different drugs in independent subsidiaries but share resources through a central hub.

The company also licenses out research technology and is building an in-house startup incubator, giving it a mix of stable revenue and more speculative sales. It’s that mix of internal and external revenue streams that makes CEO Errik Anderson confident in the valuation. 

Companies like Alloy, he added, are the next generation of VC-backed biotechs. 

Alloy Therapeutics

Just a couple of seasoned hub-and-spoke biotechs have actually made it to the finish line: launching a commercial drug.

Iterations like BridgeBio in Palo Alto, California, or Boston-based PureTech Health have toyed with the business model, sometimes spinning out their subsidiaries into independent companies, with mixed results

PureTech CEO Daphne Zohar says the biotech company of the future will look a lot like her company. PureTech is one of the original mega biotechs, building an ecosystem of separate research projects in its Boston laboratories. But that doesn’t mean these companies need to gobble up all of the funding on the table, Zohar said. 

It takes discipline to develop new drugs

The process of creating a new drug can take several years, if not a decade or two. It’s highly risky, and sometimes requires scrapping a project near the end of the line. When you have more money to spend, like Centessa’s $250 million Series A round or Sana’s $435.6 million raise, you might be more willing to keep working on doomed drug candidates. 

PureTech raised only $45 million in funding between 2005 and 2014, Zohar said. With that money, PureTech has launched two commercial products and has more than a dozen others in clinical trials that address brain, immune-system, and digestive-tract disorders. 

The company operated leanly, and Zohar credits the company’s success to its dedication to cutting underperforming research projects early.

“My gut is that you should have your core programs in place and have clinical stage assets before raising hundreds of millions of dollars,” she said. 

Daphne Zohar PureTech

After all, gluttony is still one of the seven deadly sins. Atlas Venture partner Bruce Booth put it bluntly during a recent blog post: “The average health of the herd goes down with an overabundance of food.”

How an MIT economist helped create mega biotechs

When the MIT economist Andrew Lo came up with the concept of the hub-and-spoke model for the drug industry, it was to reduce the financial risk of developing drugs for rare forms of cancer.

Investing in the creation of those treatments wasn’t appealing to biotech financiers because the customer base would be so small. If someone could pool several smaller products, it could become a little more attractive to investors. 

That’s what BridgeBio has done. The biotech has taken Lo’s model and applied it to developing treatments for rare and ultrarare genetic diseases. Its subsidiaries have set their sights on a brain disorder that affects roughly 100 people in the US and Europe and an adrenal-gland disorder that’s found in more than 75,000 people. 

To further balance the scales, BridgeBio is also developing cancer therapies that could be used on more than 500,000 patients. 

Biotech Lab

The idea wasn’t originally a big draw — about 200 investors turned down the company’s pitch five years ago. But it’s built up goodwill with investors over time. On the eve of its first drug approval in March, the company had a market value of $11 billion. 

That $11 billion is a healthy market cap for a young biotech company. But Centessa, for one, wants to be the next drug giant.

“The bar is higher every day I talk to him,” Centessa CEO Saurabh Saha said, referring to cofounder and Medicxi partner Francesco De Rubertis. “It goes from $20 billion to $50 billion to $100 billion pharmaceutical company. The message there is to be one of the top pharmaceutical companies eventually in the world.”

Building a big mega-biotech business

It’s unclear at this point whether BridgeBio, Centessa or any of these mega biotechs can reach large-cap territory like Gilead Sciences’ $80 billion valuation or Amgen’s $136 billion valuation.

BridgeBio has set itself up well, but there’s generally a disconnect between the valuations private-market investors will assign to these companies and the valuations on the public stock market, said the Mizuho analyst Salim Syed. 

“The nature of biotech is that you can raise these massive Series A, Series B, and crossover rounds, but we’re not seeing startups getting large valuation step-ups as they head into the public markets,” Syed said.

A Centessa spokesperson said they didn’t feel that trend applied to the startup, which completed only one private round before launching its IPO.

One of the original mega biotechs, Roivant Sciences, has seen only modest valuation bumps in later private raises. The company hit a $5.6 billion valuation in its second major financing round in 2017 — a figure that reached $7 billion with a 2018 financing round and then $9 billion in a 2020 deal with Sumitomo Dainippon Pharma, during which it also sold five subsidiaries, according to PitchBook.

Roivant said Monday that it would go public through a special purpose acquisition company, or SPAC. The deal would value the company at $7.3 billion.

On top of that, pooling assets into one entity, known in finance as securitization, had led to trouble in the past. Securitizing home mortgages contributed to the 2008 financial crisis. If they’re valued too optimistically, they could crumble, Lo has acknowledged.

The only way to ensure these asset portfolios live up to their valuations is having a third party use data to evaluate them. That mechanism doesn’t exist yet for the drug industry, Lo told Insider. 

In the end, these mega biotechs will likely perform on par with their more moderately sized peers. 

“Like most broadly accepted scientific or managerial innovations, this model will likely produce a small number of fantastic successes,” said the SVB Leerink analyst Mani Foroohar. There will likely be a larger number of false starts, he added.

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