Cowen Doubles Down On Royalties

Cowen Healthcare Royalty Partners and its peers are flush with cash and feeling a little adventurous. It might be good news for biotechs and their investors.

Cowen Royalty Healthcare Partners has convinced its backers to put $1 billion to work in its new royalty fund, a sign that there is still plenty of enthusiasm for the life sciences sector even if investors aren’t uniformly reaping those rewards.

The new fund, Cowen's second, doubles the $500 million it raised for its first fund after launching in 2007. Royalty funds have grown in prominence as a source of capital for owners of biopharma and other life-science intellectual property. Because the funds usually buy the rights to revenue streams from commercial products, they can offer one thing VCs can't: immediate returns to their limited partners. "We invest and the cash [back to investors] starts flowing the quarter after making an investment," says managing director Gregory Brown, MD. "That makes us more attractive to LPs."

Venture capital fundraising in 2011 bounced back a bit from 2010 in the US thanks to a strong fourth quarter, but the $16.2 billion total was barely more than half of the fundraising totals of 2008, according to DowJones. European VCs fared far worse, hitting record lows with $3 billion raised. The totals don't break out health care and life science, but the shakeout of the field of life-science VCs during the recession is almost certain to continue. (See (Also see "Surveys Present Similar Pictures of Plight of VCs" - Scrip, 1 Oct, 2011.) and (Also see "Some VC Funds Have Miles To Go While Others Have Burned What's In The Tank " - Scrip, 1 Jul, 2011.).)

Traditionally, a royalty fund has paid inventors -- such as a university or a small biotech -- upfront cash for the rights to royalty streams from products already on the market. One such blockbuster deal was the $525 million Royalty Pharma and Gilead Sciences Inc. teamed up to pay to Emory University in 2005 for the rights to antiviral medicine Emtriva (emtricitabine).[See Deal] The cash bought out Emory's royalty and redirected some of the payments to Royalty Pharma. Biotechs that have rights to a drug in the hands of another marketer have also turned to royalty deals to raise cash, such as Dendreon Corp. recently selling its royalty rights to hepatitis C drug Victrelis (boceprivir) for $125 million. [See Deal]

But royalty funds have also created more complex financial structures, often around "synthetic" royalties, which are payments to the marketer of the product, or products. One of the new fund's first deals is with Zogenix Inc., which took $30 million from Cowen's second fund and will repay the firm from sales proceeds as well as licensing revenues from its headache treatment Sumavel DosePro and from future products. (Among the terms, Cowen gets 5% of the first $75mm that Zogenix records in net product sales or receives in co-promotion or licensing fees in one calendar year.) [See Deal]

Cowen's blockbuster royalty fund and others, such as OrbiMed Partners' $600 million fund that closed in August 2011, are giving biotech investors who survive the recession hope that if they get a product deeper into clinical trials -- not necessarily all the way to the market -- there could be a source of revenue waiting. (See (Also see "OrbiMed Launches $600M Royalty Fund" - Pink Sheet, 31 Aug, 2011.).) That's because some of the funds are willing to take risks on clinical-stage products (Cowen's Zogenix deal is one example). It's not yet a large portion of their targeted investments, but the increased competition makes some observers believe they'll look farther down the pipeline for deals. "Until a few years ago, they were completely focused on commercial products, but now they're buying contigent value streams of development-stage products," says Kevin Starr, co-founder and partner of Third Rock Ventures, one of the most prolific early-stage biotech investors.

With most acquisitions of venture-backed biotechs now structured with post-acquisition milestones that are sometimes tied to a product's future sales, Starr says the rise of the royalty funds could make those far-off milestones less of a pipe dream. "The royalty funds could become a part of the reshaping of the economic food chain that's happening now," says Starr.

With the creation of synthetic royalties, and with big drug makers more willing to monetize their non-core assets, royalty deals hit their high water mark in 2011, according to Cowen's own estimation. Twenty four were publicly announced for an aggregate value of $2.5 billion, says Brown, and he estimates that represents half to two thirds of all deal flow, with much going unannounced. "Five years ago you didn't see many pharmas willing to sell," he says. "It's a piece of the market that's been unlocked."

Case in point: In June 2011, Japanese firm Astellas Pharma Inc. cashed in on intellectual property that came with its 2010 acquisition of OSI Pharmaceuticals Inc. [See Deal] It off-loaded the royalty rights and patents for dipeptidyl peptidase IV (DPP-IV) inhibitors for Type 2 diabetes to Royalty Pharma for $609 million.[See Deal]

Royalty funds are to venture capital what bonds are to stocks: a lower-risk, lower-return investment, but often with complex structures that purposely limit both parties' risk: "We're willing to give away upside in return for more substantive downside potection," says Brown.

Every so often Cowen will take equity along with its rights purchase, but those slices are small. The Zogenix deal included a $3 million equity purchase -- half for common stock, half for 10-year warrants convertible into 225,000 shares at a $9 per share strike price. Zogenix shares closed June 30, 2011, the day of the announcement, at $4.01 and have since lost about 35% of their value, a situation that doesn't faze Brown. "We're not traders," he says. "We expect to hold long-term."