Pablo Legorreta is down but not out. The man behind the high profile and often crabby campaign to acquire Ireland's largest indigenous pharma group Elan is puzzled by what he clearly sees as a bewildering refusal of Elan management to at least open discussions with him during the recent hostile takeover bid.
But he’s still keen to talk, interested in looking at ways of making the deal work.
In many ways, that sums up Legorreta – the deal. The former financier admits that most of his working day is involved in sitting at a desk poring over clinical data, looking for drugs that have a future and then getting in early to acquire part of the royalties they will deliver over a protracted period of patent protection. Looking for opportunity.
That was how he got into the business. A banker with Lazards specialising in cross-border merger and acquisitions deals, Legorreta stumbled across a team at Paine Webber that was adopting a new approach back in the 1980s to funding early stage pharma and biotech businesses.
“Back in the late-1980s, they came up with a very interesting structure to finance the first wave of biotech drugs.”
He says many of the most innovative companies at the time were struggling. They had little or no revenues and market capitalisations, if any, of about $400 to $500 million. They had the money for early-stage trials of their drugs but when it got to larger and more expensive phase III late-stage human trials, money became harder to find.
It's strange today to hear companies such as Amgen and Roche's Genentech spoken of in such terms, but back then the heavyweights of the lucrative biotech sector were minnows.
“Typically what companies would do is they would do a deal with a big pharma,” says Legorreta. “And what the big pharma [company] would do is they would take the product leave the biotech with a small royalty – around 20 per cent.
“But they would take all the economics for themselves and then the big pharma would also be the marketing partner.”
What Paine Webber did is create a structure where money was raised from private investors through a limited partnership. Many were doctors or others from the medical sphere who would readily recognise the value of some of the early-stage therapies.
Speaking ahead of the collapse of Royalty Pharma’s unsolicited offer this week, he refers to Neulasta and Neupogen, which stimulate white blood cells in patients undergoing chemotherapy. These days, Neulasta is the second best selling drug for Amgen. Along with Neupogen, it last year accounted for $5.4 billion in sales.
“So that was developed by Memorial Sloan-Kettering and licensed to Amgen,” Legorreta says. “Amgen took this product, put it into this partnership, raised money with private investors, funded the phase III, kept the economics of the drug and Amgen is today an $80 billion market cap company. Maybe, in some respects, [that is] due to the fact they were able to keep the economics of that drug and not license it to big pharma.”
The Paine Webber team eventually folded its tent but Legorreta was bitten. Initially setting up closed partnerships with friends, he first began buying up royalties from those early investors.
"We were doing it small scale with a few friends and it worked out well," says Legorreta. So well, in fact, that in 1996 he decided to take the plunge, leaving Lazards and establishing Royalty Pharma with one of the old Paine Webber team, Rory Riggs, who now chairs the company.
“What had piqued my interest was the realisation that there were many many royalties in the hands of academic institutions and research hospitals,” he says.
“They had those royalties because discoveries were made in those institutions, that were licensed to biotech companies or big pharma. And what I realised is that we could help these institutions monetise these assets.”
In the process, he didn’t just set up a business, he created an industry. Royalty is now one of a handful of companies specialising in dealing in royalty income from patented drugs.
He refers again to Neulasta and Memorial Sloan-Kettering, which had retained certain royalties in relation to its discovery of the drug.
The hospital had a endowment fund of $1.6 billion invested broadly across stocks, bonds and property. It also had the Neupogen/Neulasta royalty, which Legorreta and his Royalty Pharma team value at around $500 million.
“So the institution had $2.1 billion in financial assets, of which the royalty was a quarter,” Legorreta says. “Monetising it to diversify made a lot of sense for them.”
He says the trustees had become uncomfortable how dependent the hospital had become on the cash flows of this one drug to finance the R&D of the hospital. Royalty offered $400 million for 80 per cent of its royalty.
“Another attraction was that, instead of waiting for years to collect that in small quarterly payments, they got the money upfront to invest into new research, and they kept the other 20 per cent to keep an interest.”
A second innovation Legorreta introduced to Royalty was allowing the groups and individuals from whom he was purchasing the royalties to invest some of that money back into Royalty Pharma, essentially becoming stakeholders in a much more diversified array of pharmaceutical royalties than would have been the case if they had simply held on to the rights of their own discoveries.
Today, Legorreta says, 53.3 per cent of the company’s shareholder base is comprised of such individuals, institutions, university endowments and foundations.
A further 12 per cent is held by pension plans with company management holding around 4.4 per cent, with the balance accounted for by private wealth funds.
Advantageous taxation
In 2003, Legorreta moved his business to Ireland, although the base of operation still was to found effectively in New York.
Structured as a partnership originally and treated for tax purposes as a fund rather than a more traditional corporate structure, Legorreta says the decision to open a Dublin headquarters was because “Ireland has been so visionary in trying to set up this country as a domicile for asset management businesses. Because you have good laws, and obviously very advantageous taxation, and you have all the service providers . . .
“We have been here for 10 years and we have built a business here that is three to five times bigger than Elan if you look at the revenues we have and the cash flow we have.”
Royalty estimated its 2012 revenue at $1.39 billion and boasts an impressive portfolio of drugs from which it receives royalties. These include Pfizer's Lyrica, J&J/Merck's Remicade and Abbott's Humira, and Gilead's Aids drugs Atripla and Truvada. Nine of its 38 drugs are blockbusters – drugs with sales of more than $1 billion annually.
But, for all his efforts to stress the differences between a company such as Royalty and big pharma, both face some of the same issues, most notably patent expiry. Royalty specialises in patented drugs. When those patents expire, so too does its stream of royalty income.
So, just like big pharma, it is constantly on the lookout for the next big thing. The stream of royalty income from Elan’s multiple sclerosis blockbuster Tysabri was the hook that attracted it to Elan in the first place.
The deal with Biogen, in which Elan sold control of the drug, gives it royalty income of up to 25 per cent of sales over much of the next decade.
Ironically, when they first started talking, it was Elan that was looking at taking over Royalty. It was only when they crunched the numbers – both in terms of relative size and tax structure – that Legorreta and his team decided to flip the deal in the other direction.
It was a big move. With one exception, Royalty has invested in drugs not companies and it has done so very much under the radar.
It’s hostile approach to Elan is now dead. Elan shareholder support for a $200 million share buyback forced the withdrawal of the bid that valued the company at up to $8 billion.
But Royalty is still in the game. In a last- ditch effort to face down Royalty, Elan put itself on the market, inviting Legorreta and his team to take part if they wished.
While others will also be involved – Forest Labs was one mid-range company this week rumoured to be among those sizing up Elan's attractive corporate tax structure for US pharma groups – Royalty is still interested in pursuing Elan.
Whether it succeeds is yet to be determined: what is certain is that Legorreta is unlikely to fall off the radar in a rapidly consolidating pharma sector.
