Moving with the times: biopharma royalty deals on the rise

A spate of royalty deals are changing the way certain biotechs press ahead. This trend seems to be a gradual alternative to traditional biopharma fundraising.

A recent deal that has followed this trend is American muscle disease therapeutics company Cytokinetics’ $575 million pact with Royalty Pharma, a firm that buys up royalties from life science companies. 

Cytokinetics will bag $250 million and is eligible to gain up to $575 million in exchange for Royalty Pharma’s claim on a higher royalty rate on the sales of the biotech’s small molecule drug aficamten. Moreover, Royalty will purchase $50 million in its equity.

The Cytokinetics deal is part of a changing direction that biotechs have decided to take in recent times. While these deals may be for the better for some players in the industry, others may have a lot to lose.

How do royalty deals work? 

While pharma royalty deals are not a new phenomenon as they have been around for a few decades now, according to Michael Ward, Global Head of Thought Leadership, Life Sciences & Healthcare at analytics agency Clarivate, the pace of these deals has changed lately. Ward explained that universities and non-profit organizations like medical charities leveraged this mode of funding to rapidly convert potential income from patented inventions into cash. This cash would further enable them to either fund capital investment or further research.

“More recently they have become an attractive source of non-dilutive financing for biotechs that have licensed out an asset, typically to a pharma partner, in return for future milestones and royalty revenues,” said Ward.

Non-dilutive funding is a type of financing that allows companies, particularly startups, to retain ownership of the company when taking money from investors. Apart from royalty deals, this includes loans and grants.

Royalty agreements involve a buyer – an investment firm or royalty acquisition company – who snaps up the rights to future royalty payments from a seller, which in this case, is a biopharma company. 

“These deals provide immediate capital to the seller in exchange for the right to receive future royalty payments generated by a pharmaceutical product,” said Ward.

Once a royalty acquisition company estimates the projected revenues that it would make from a royalty deal, which will involve analyzing the drug’s market potential, competitive landscape, patent life, and regulatory status, the biopharma will be able to negotiate a discounted purchase price. 

In the past, companies like Royalty Pharma would sign deals with life science companies that had products in the market and were making money, but of late, these deals have spilled over to clinical-stage biotechs. Ward pointed out that these clinical candidates “bear a high degree of regulatory risk and are often difficult to value,” yet these royalty contracts are becoming more common.

Biopharma royalty deals grow over the past year

Cytokinetics is among various other biotechs that have struck similar deals with the likes of Royalty Pharma. Last month, Massachusetts-based pharmaceutical Agios inked a $905 million deal with Royalty. In return, the latter will get the royalty rights to Agios’ inhibitor drug vorasidenib, which was recently granted priority review by the U.S. Food and Drug Administration (FDA) to treat IDH-mutant diffuse glioma, a type of brain tumor.

Another biotech that has flocked to Royalty Pharma is American immunotherapy company ImmuNext. It has sold the royalties of its multiple sclerosis drug frexalimab, which French multinational Sanofi is clinically developing. ImmuNext will rake in more than half a billion dollars as it plans to seek FDA approval for frexalimab in 2027.

In California, another royalty acquisition contender is shopping for drugs yet to hit the market. XOMA, which already has its hands on big pharma antibodies – from the likes of Janssen, Roche, and Takeda – signed a $22 million agreement with San Diego-based women’s healthcare company Daré Bioscience. It will get a hold of royalties from future sales of Daré’s vaginal gel XACIATO as well as two phase 3 candidates. 

Meanwhile, another California-based biotech Arrowhead Pharmaceuticals has just earned $50 million in milestone payments as it has begun a phase 3 trial for its RNA drug olpasiran, which is being tested in patients with atherosclerosis – a heart disease where the arteries thicken, making blood flow difficult. The biotech can continue to make $485 million more, according to the agreement signed with Royalty Pharma in 2022. 

Royalty Pharma’s quarry goes deeper. Its deal with Israel-based drug developer Teva Pharmaceutical traded $100 million in exchange for Teva’s phase 3 schizophrenia drug olanzapine. This follows a billion-dollar Royalty-PTC Therapeutics collaboration where the royalties of the latter’s spinal muscular atrophy drug – marketed by Roche – were handed over to the investment firm.

What’s behind this shift?

As more and more biotechs turn to royalty deals, Ward thinks this shift is due to the current funding climate.

“Biotech company valuations are way down on the highs achieved during the pandemic,” said Ward. “The S&P biotech XBI index is down 45% from its February 2021 high.”

Although things have been looking up for the industry since the funding drought last year, it could be that biopharmas don’t want to give up on this seemingly promising stream of funding just yet.

“Raising money in the current market is highly dilutive and consequently not an attractive option. Similarly, with high interest rates, securing funds through debt transactions can also be expensive. Consequently, the option to sell future royalty streams for upfront cash, even at discounted net present value levels, is an attractive alternative,” said Ward.

The role that royalty investors play is gaining ground. Royalty Pharma, in particular, is “the largest and most active buyer of royalty stream,” explained Ward. 

“In its latest 10K filing to the U.S. Securities and Exchange Commission (SEC), Royalty Pharma reported that, from 2012 through 2023, it has executed transactions with an aggregate announced value of $26.4 billion, which represents an estimated market share of approximately 58% of all royalty transactions during this period,” said Ward.

Moreover, its approach to taking on clinical candidates has yielded encouraging results for the investment firm after spending $8.3 billion in biopharma deals between 2012 and 2023.

Ward said: “As of December 31, 2023, products underlying $6.3 billion of these acquisitions have already been approved, representing a success rate to date of 76%, while products underlying $0.9 billion were not approved and products underlying $1.1 billion are still in development.”

Biotech royalty deals and the impact on M&As

When Cytokinetics parted with the aficamten’s royalties, it led to a drop in share prices by a fifth. It also signaled to investors that the drug developer was no longer in the market to be bought up after it had been in talks with, but was eventually dropped by pharma giants like Novartis, AstraZeneca, and Johnson & Johnson. 

Royalty deals can have a profound impact on mergers and acquisitions (M&As), Ward explained. “They influence valuations, deal structures, and strategic decisions, providing companies with the flexibility to monetize assets, manage risks, and finance growth through M&A. Properly managed, these deals can enhance the financial and strategic positioning of both buyers and sellers in the competitive biotech landscape.”

Selling royalty streams could help companies de-risk their balance sheets.

Ward said: “This can make them more attractive to potential acquirers who prefer targets with less exposure to the uncertainties of future drug sales. Companies with strong royalty streams can leverage these predictable cash flows to finance acquisitions, providing a competitive edge in bidding for attractive targets.”

And for smaller biotechs looking to get bought up or secure further funding through debt financing, “the stable revenue from royalty streams can improve a company’s credit profile,” Ward pointed out.

Challenges of royalty financing

While royalty deals can offer biopharmas money immediately regardless of a volatile stock market, it may not bode well with investors who factor in royalties when valuing a company as it would bring down valuations. Besides, biopharma companies incur debt in a royalty agreement because future sales of a product, which could have been used for R&D, would have to be set aside for the royalty acquisition company.

“Overestimating future sales can lead to overpayment while underestimating can result in undervaluation of valuable assets. Moreover, the future revenue from royalty streams is subject to regulatory approvals and patent protections with changes in regulations or patent expirations impacting projected cash flows,” said Ward. 

“Ultimately, the success of royalty-stream deals hinges on the commercial success of the underlying products with market competition, pricing pressures, and changes in treatment standards all having the potential to affect sales performance.”

Royalty deals: effect on R&D

As small biotechs struggle with limited funding, royalty deals provide them with money to continue R&D, and stay in the healthcare ecosystem. They aid partnerships among smaller biopharmas, multinationals, and research and academic institutions.

“Also, by selling future royalty streams, biotechs can mitigate the financial risk associated with the uncertain outcomes of drug development, allowing them to focus on innovation without the pressure of potential future revenue volatility. Moreover, biotech firms can also use proceeds from royalty deals to diversify their R&D portfolios, spreading risk across multiple projects rather than relying on a single drug candidate’s success,” said Ward.

While these deals aren’t without risk – like any investment – the biopharma sector seems to be looking beyond equity deals to fuel innovation.

Ward said: “Pharma royalty-stream deals can have a significant impact on the R&D industry and have had a crucial role in shaping the biotech industry by providing critical funding for R&D, facilitating strategic partnerships, and enhancing the overall innovation ecosystem. Such deals help manage financial risk, support early-stage research, and overall industry dynamics by contributing to the long-term growth and stability of biotech firms.”

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