Pharma and biotech: is there love?

(Fortune) -- For at least a decade, anyone following the life sciences industry has noticed two naked truths.

One is that the biggest pharmaceutical companies are struggling to replenish research development pipelines as their billion-dollar blockbuster drugs go off patent and in-house programs falter, all despite having spent billions on research and development.

The other is that biotechnology companies often have the best ideas for new drugs but are constantly short of cash.

This is hardly new. Since the 1980s, pharma and biotech have forged relationships, most of them driven by the expedience of pharma companies trying to fill in what they considered short-term gaps in their own internal R&D. Lately, though, the relationship is getting serious.

The world's drug development pipeline is becoming a real couple. That key message emerged from the annual mega-meeting of the Biotechnology Industry Organization (BIO) last week in Chicago.

"We're recognizing that we don't have the expertise to do everything," says Barry Gertz, senior vice president for global clinical development at Merck (MRK, Fortune 500), a company whose revenues dropped after withdrawing the painkiller Vioxx from the market in 2004. Like other companies, Merck also has had drugs either fail to pass muster during human testing or they have fallen off patent. "There is a lot of science going on outside of Merck," says Gertz. "We have more chances of success if we go external."

"The vast majority of new ideas are going to come from outside of pharma," says Jay Siegel, chief biotechnology officer for Johnson & Johnson (JNJ, Fortune 500) -- a recently created position at the company.

The biotech sector's knack at innovation seems to come from the small size of most its companies, which reduces bureaucracy and complications, and a chronic underfunding that drives companies to be more nimble and creative in the research and early development phases. At the other end of the pipeline -- late-stage human clinical trials and manufacturing, sales, and marketing -- Big Pharma tends to be more adept.

That's the basis of the marriage, and of the redesign in the pipeline, that's been de facto for several years, but now is being more formally consummated.

"If we're honest, we were driven to tactically look outside when we had some slips in our production line," says Shaun Grady, vice president for corporate development at AstraZeneca. "Now it's an acknowledged strategy by our board."

Pharma showed its love at the BIO event by deploying small armies of business development people to hold thousands of speed-dating sessions with biotech hopefuls during the four-day meeting.

For instance, GlaxoSmithKline (GSK) brought 35 people who held 300 meetings. "A few years ago, we were nowhere with biotech," says Adrian Rawcliffe, head of business development for GlaxoSmithKline. "Now we have 100 people doing deals worldwide." Merck says they brought 40 people who heard 400 pitches, and AstraZeneca (AZN) brought 30 people to hold hundreds of meetings.

For many deals, the courtship began during meetings at the big biotech financial meeting held every January in San Francisco by JP Morgan (JPM, Fortune 500).

Rawcliffe says that his company has been spending hundreds of millions of dollars a year on biotech partnerships and acquisitions -- 10 to 20 large deals, 15 to 20 milestone deals, and an average of one major acquisition per annum. "This is likely to stay about the same for the foreseeable future," he says.

Pharma also has been making deep cuts in their R&D expenditures after a decade of steep increases. Pfizer (PFE, Fortune 500) has announced plans to eliminate thousands of jobs and slice their R&D budget by $2 billion to $3 billion by 2012. And AstraZeneca says it will cut back by $1 billion in the next four years. This comes as the cost of developing new pharmaceuticals for some of the largest companies is approaching $4 to 5 billion dollars per drug. (This number comes from dividing the number of successful drugs by the total R&D budget, including failures).

For biotech, this fresh ardor couldn't come any sooner. The industry has been battered by capital shortfalls in the current economy. While dozens of companies have failed, others have sold themselves for fire-sale prices. The big BIO bash itself has seen attendance fall from over 17,000 a few years back to about 15,000 this year.

"Pharma is definitely doing more deals," says Mark Litton, chief business officer at Seattle-based Alder Biopharmaceuticals. His company recently completed a $1 billion milestone and licensing deal with Bristol-Myers Squibb (BMY, Fortune 500) -- including $85 million up front for an innovative rheumatoid arthritis drug that just finished phase-two human trials.

"Given the public markets, it's hard to raise funds," says Litton. "This cash helps and we don't have to go back to venture capitalists and further dilute our shareholders."

Pharma-biotech deals seem to be favoring partnerships at the moment in part because buying biotechs and absorbing them into the mothership has not always worked. Also, Pharma is mostly interested in late-stage drugs with the highest chance of success. But these deals are more expensive, pushing some pharma companies to embrace riskier early- stage projects as well.

There is a danger in too much love, however. "I think there's too much hype about the biotech industry," says George Poste, former president of R&D for the old SmithKline Beecham and now a professor of health innovation at Arizona State University. "If Pharma trims too much, it might not solve the problem. Biotech has a great deal of innovation, but it's not a panacea."

We won't know for years if this marriage will last, since it typically takes a dozen years to develop new drugs. I suspect, though, that this new relationship will increase the odds that more innovative drugs will emerge. Poste believes this might take 10 to 20 years. Let's hope the offspring of this new marriage will emerge sooner rather than later.