Pharmaceuticals have figured that out that if they can't be as innovative or nimble as biotechs, the next best option is to pay for their good ideas with licensing deals and acquisitions.
And what better way to identify those potential deals than to cozy up to the biotechs?
Invite them into your homes
Earlier this year, Johnson & Johnson (NYSE: JNJ ) opened an incubator within its San Diego campus to house biotech startups. Janssen Labs -- named after one of Johnson & Johnson's drug divisions, Janssen Pharmaceutical -- is a no-strings-attached affair with startups free either to develop the products on their own or partner with Johnson & Johnson or another company.
Even if there isn't a formal tie-up, having the startups in close proximity will certainly be helpful in identifying the potential targets and figuring out the best time to engage in talks.
And the incubator format, with shared equipment and common areas, lowers the cost for the startups, which should help them survive longer, resulting in more products being developed and more licensing and acquisition options for pharmas.
Bayer also announced plans to house three to four startups at its research center in San Francisco earlier this year. The program, called CoLaborator, is a little more hands-on, with Bayer expecting preferred access to partner with the startups.
Feed them dinner
Last week, GlaxoSmithKline (NYSE: GSK ) and Johnson & Johnson joined a venture capital firm, Index Ventures, in setting up a new fund to invest in startups. The pharmas contributed $50 million each, while Index is adding $100 million, and will be in charge of making the investment decisions. The pharmas will have a seat on the fund's advisory board.
Like Johnson & Johnson's incubator, the fund doesn't give Glaxo or J&J any entitlement to the products developed by the startups they fund; they'll have to bid just like everyone else. But being on the advisory board of the company funding the startups should give them an advantage in correctly valuing the products. And if someone outbids them, they'll make more money on their venture investment.
Similarly, Eli Lilly (NYSE: LLY ) pledged up to $150 million to three venture capital firms to invest in startups. But unlike the Glaxo-J&J fund, Eli Lilly would have the right to buy some of the molecules at fair market value before competitors could get their hands on the drugs.
Merck (NYSE: MRK ) isn't calling its investment venture capital, but that's essentially what it is. Earlier this month, the pharma announced that it was helping to establish the California Institute for Biomedical Research, a.k.a. Calibr, to fund the transition of basic medical research being done by academics into the clinic. Merck's investment of up to $90 million over seven years gets the company an option to obtain drug candidates supported by Calibr.
Get married -- someday.
Make no mistake -- these are long-term plays. Preclinical startups being funded by pharmas now won't have products through proof of concept for a few years. Pharmas could license the products earlier and pay less, but I think leaving the risk in the hands of the innovators through phase two development is a good strategy for balancing risk and reward.
Whether pharmas should try to get an exclusive deal (call it a "long engagement") or fund without strings attached, while keeping an eye on them (a "protracted dating period") probably doesn't matter that much, since there are advantages to both. The lack of strings results in a larger pool of potential investments, which could increase quality. What's most important is that there's funding going to these startups, which will benefit pharmas down the line.
Might it be a waste of money? Biogen Idec (Nasdaq: BIIB ) seems to think so. The big biotech has apparently decided that identifying companies directly is easy enough without having to fund them early in their development. Of course, that only works if someone is funding the companies. Don't be surprised if you're called a mooch at the next big drugmaker dinner party, Biogen.
Fool analysts think they've found a health-care company with plenty of upside. You can read about it in their new free report, "Discover the Next Rule-Breaking Multibagger." Get your copy for free by clicking here.