A Biotech Start Up Forgoes VC money

Venture capitalists should pay attention to a development brewing in the medical world.

The Children’s Hospital of Philadelphia last week funded a new gene therapy business called Spark Therapeutics. The move was notable because it’s unusual for a research institution to launch a promising biotech company and to cut venture capital firms out of the process.

While the hospital’s $50 million investment is a one-off deal, it could herald a world where well-funded institutions find creative ways to grow without VC money. It comes as other research centers, like Stanford University, also have been getting into the for-profit game.

The Children’s Hospital is investing in gene research just as the overall biotech investment landscape is shifting. Venture funding in that sector peaked near $6 billion in 2007, bottomed out in 2009 and 2010, and then began a slow march upward, hitting about $5 billion in 2011, according to data from BIO, the Biotechnology Industry Organization. After sliding a bit, investment is on track to hover between $4 billion and $5 billion this year.

The Children’s Hospital isn’t just another institution allocating endowment money to a VC firm’s biotech vehicle. The hospital didn’t even co-invest alongside an investment fund, a practice that has become increasingly common as limited partners, particularly private equity LPs, seek bigger returns and more favorable fee structures. Rather, it bootstrapped a for-profit company, a move that Travis Blaschek-Miller, a spokesman with the life science association Bay Bio, says is highly unusual.

The story of Spark, in a nutshell, goes like this: About a decade ago, Katherine High, a doctor, clinician, scientist, and adviser to many gene therapy start-ups, convinced the Children’s Hospital of Philadelphia to help fill a research void. Her field had been promising. Throughout the 1990s, scientists had explored the idea of treating damaged genes, which often cause diseases, rather than treating the illnesses caused by flawed genes. The new approach was often referred to as “gene therapy.” But when a teenage boy died in 1999 due to complications related to an experimental treatment, VC money dried up and companies closed down.

The hospital supported a cellular and molecular therapeutic research unit with research funds. The work yielded a potential cure for a rare form of inherited blindness. To get the treatment through clinical trials and, hopefully, to obtain Food and Drug Administration approval, Ms. High’s team would need a serious capital injection. It seemed likely that they would travel a well-worn path—seek early stage funding, spin out from the hospital, and effectively give up the biggest piece of the equity and the potential upside.

But in a move announced last Tuesday, the hospital used money that would normally have gone toward research to form Spark around the work done by Ms. High’s team.

“Now the hospital and the researchers are in a position to retain the biggest slice of the enterprise value pie,” says Spark chief executive Jeffrey Marrazzo. He adds that academic organizations and research hospitals usually license their work to other companies and get low-single-digit royalty rates. The gene therapy for blindness is in Phase 3, the final phase of trials before FDA approval. It’s vying to be the first-ever FDA-approved gene treatment. The enterprise value could be big.

Not every research center will be able to follow Spark’s lead, since many hospitals and foundations don’t have the same money and flexibility as the Children’s Hospital. But Spark is a notable case study for well-capitalized institutions. Venture firms are patient money to a point, but they made their priorities clear in the late 1990s and early 2000s by leaving the gene therapy sector. For Spark, the hospital is a financial partner with a shared mission that will hopefully be around longer than early-stage investors. “The Children’s Hospital, which has existed for hundreds of years, is not going anywhere,” Mr. Marrazzo says.

Inasmuch as the Children’s Hospital seeks to reap financial benefits from homegrown talent, the Spark investment resembles Stanford University’s decision to invest in tech companies developed by the school’s students.

But there are two important differences. Stanford uses endowment funds, whereas the Children’s Hospital essentially owns a for-profit company. And Stanford, which says it has deployed millions of dollars over the past couple of months via the Stanford-StartX Fund, is always a follow-on investor in companies that have already raised financing rounds. The hospital, by contrast, has bypassed venture capitalists entirely for now.

It appears to be a good time for the Children’s Hospital to make this bet. The public markets are embracing biotechnology. The NASDAQ biotech index has nearly tripled since 2009. There have been 35 initial public offerings in the sector this year, including gene therapy company BlueBird Bio. BIO reports that those stocks have posted a median gain of 56%. Of the companies that held IPOs, five were working on drugs that were in pre-clinical or Phase 1 testing, showing investors’ willingness to take more risks. “VCs are getting a liquidity event even if their companies haven’t sold a product,” says Mr. Marrazzo. “The public markets have helped get venture capital money back into gene therapy and other biotech companies,” he says.

As investors look for opportunities in sectors like medicine, it’s good to see a hospital have the confidence and resources to bet big on its own product. If the Children’s Hospital’s investment pays off, it will be a lesson to other players in the field that they don’t have to cede all the upside to the financial professionals.

In Perpetual Reinvention, SoftBank Eyes Shift to Mobile Content

by Katie Benner

When Japanese telecom company SoftBank Corp. announced two big acquisitions last week – a $1.5 billion deal for Finnish game maker Supercell on Oct. 15 and a $1.3 billion deal for hardware distributor Brightstar on Oct. 18 – it seemed like just another tech giant shopping around for ways to diversify and grow. But SoftBank is no ordinary company when it comes to M&A. The latest moves of its CEO Masayoshi Son show that the company is looking for ways to become a force in mobile content, an interest that could someday spark a corporate makeover.

Over the past three decades Mr. Son has used acquisitions to anticipate secular changes in the tech industry, a pattern that is evident in the company’s annual reports, executive letters, and earnings results. The architect of SoftBank’s M&A and investment strategy, Ronald Fisher, did not return calls for this story, but company documents show how investments have spurred prescient shifts in corporate strategy and big changes to the core business.

SoftBank is currently the world’s third largest wireless carrier, but that has not always been the case. Mr. Son has transformed his company about every decade thanks to acquisitions that were, at first, ancillary to the core business. In the mid-1990s, the company was a publishing company. By the mid-2000s, it was an Internet powerhouse. “Through investing in information industry-related businesses we gather intelligence about transformative opportunities and new future trends,” Mr. Son wrote in the latest annual report.

It’s not common to see a corporation constantly reinvent itself, but those that do so successfully are among the world’s best, most exciting businesses. General Electric was once a light bulb maker and now it’s one of the country’s largest issuers of consumer credit. IBM made typewriters and now it runs data analytics for large companies. A few much younger companies are trying to be chameleons, too. Amazon is still an online merchant, but it’s making big bets on digital media and hardware. Google is still a search company, but it is also a serious software maker.

Before we consider what Supercell and Brightstar could mean for SoftBank, it’s important to understand how acquisitions have led to corporate change. SoftBank was established in 1981 as a PC software distributor in Japan. In order to expand into the United States, Mr. Son bought PC trade show operator COMDEX in 1994, and technology trade magazine publisher Ziff-Davis in 1995. The deals got SoftBank into the U.S., and put the company squarely in the flow of information about emerging technology companies.

Information from COMDEX and Ziff-Davis convinced Mr. Son that the Internet, not hardware, would fundamentally change technology. The CEO of Ziff-Davis arranged for Mr. Son to meet with Yahoo founders Jerry Yang and David Filo, and in 1996 SoftBank became Yahoo’s largest shareholder and got a controlling stake in the new venture Yahoo Japan.

By 1998 SoftBank was a media company. Publishing and events accounted for about 71% of income. Yahoo Japan and investments in online properties like E*Trade and GeoCities led Mr. Son to believe that everyone would someday be online. So he invested in broadband and fixed-line telecom companies from 2000 through the middle of the decade, in anticipation of a need for high-speed connectivity.

By the mid-2000s, SoftBank was an Internet company with nearly all of its operating income coming from Yahoo Japan, online commerce sites, and online advertising. At the same time it was using acquisitions to become a telecom company with a presence in mobile. The media division barely registered in terms of revenue or income.

This history brings us to the SoftBank of today, a wireless operator that became a global player when it completed a $21.6 billion acquisition of Sprint this June. The company generates 64% of revenue and 62% of earnings from the mobile communications business. Last week’s deal for Brightstar — a device middle man between hardware makers, retailers, and wireless companies — could increase SoftBank’s influence with manufacturers by combining the purchasing powers of SoftBank and Brightstar. That’s a good position to be in given that a lot of consumers (and, presumably many SoftBank wireless customers) are hunting for phones. Research firm eMarketer says only 20% of the world currently uses smart phones.

But the Supercell deal shows that SoftBank is preparing for a future where wireless may not dominate the company’s financial picture. Marc Einstein, a consultant with Frost & Sullivan, said the deal illustrated that “mobile operators need to be more forward looking.” He predicted that revenues from mobile services will fall in the next four or five years.

Supercell strengthens SoftBank’s subsidiary GungHo, a company that began as an online auction site and morphed into a game maker several years ago. GungHo makes one of the world’s best selling mobile games “Puzzle & Dragons.” The app generates more than $3 million a day, according to Macquarie analyst David Gibson, and has been popular in Japan. Now GungHo can reach players in Europe, where Supercell’s games “Clash of Clans” and “Hay Day” are among the most popular.

“Games are a way to access growth,” says Andrew Hawn, who works at the consulting firm the Futures Company. Citing data from eMarketer, he says about 40% of mobile device users will play games on their devices this year, a number expected to hit nearly 60% in four years.

SoftBank’s VC funds have invested in lots of companies that — like Supercell and GungHo — reach consumers through mobile devices. Familiar names include Gilt Group, RebelMouse, Mobile Day, FitBit, and Paper.Li. There are also lots of media companies in the portfolio like BuzzFeed, the Huffington Post, Rap Genius, and Now This News. While other VC investors in these companies are hoping for big returns, SoftBank is also using information from these investments to figure what kind of company it will become next.

With the Sprint deal so recent, it’s hard to imagine a world where wireless is no longer SoftBank’s most important business. Supercell doesn’t necessarily mean that SoftBank will be the next Nintendo (though we shouldn’t rule it out). But it does show that Mr. Son is trying to figure out how consumer adoption of mobile content will change his company, even though the world simply sees him as the operator of a global wireless powerhouse. For those who want to understand the next phase of tech and anticipate SoftBank’s next core business, keep an eye on the company’s acquisitions. They’ll do much more than just support a wireless giant.

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