January 27, 2003
Volume 81, Number 4
CENEAR 81 4 pp. 41-44
ISSN 0009-2347

A shortage of capital is driving cost cutting, deal-making, shutdowns, and consolidation


Biotechnology companies have always relied on outside money to support R&D until they become self-sustaining. And they raised more than $10 billion in 2002, making it the fourth most prosperous year ever for industry financing. Still, the operating environment of the past year has been extremely harsh. The companies' response has been unprecedented cutbacks in staffing and R&D programs, increased consolidation, and even outright bankruptcy.

On the surface, cash flow into the industry looked great, but further inspection proves otherwise. Two companies--Amgen and IDEC Pharmaceuticals--raised over 30% of the total through convertible debt offerings. Whereas these two companies were funding the expansion of already successful biopharmaceutical businesses, a few other profitable companies and many more small, unprofitable ones raised another $2 billion in debt.

Debt offerings were on the rise, but private and public investment declined; stock offerings in 2002 brought in half as much as in the previous year and just 7% of what was raised in 2000. In that record year, $32 billion poured in around the time the human genome sequence was being completed. A bright spot in 2002 was venture-capital investing, up 12% to $2.7 billion.

"The industry is going through some pretty significant restructuring and revaluation as a result of prolonged bear markets," says G. Steven Burrill, chief executive officer of the merchant bank Burrill & Co. Biotech, he notes, has not been immune to broad economic issues, corporate scandals, concerns over Iraq, and movement out of technology stocks.

THESE CIRCUMSTANCES have broadly marginalized the industry, Burrill explains. For example, nearly 40% of biotech companies have stock values below $2.00 per share, and 20% have values below $1.00 and face delisting. Some 25% of companies are trading at a value less than their available cash per share. And many have less than a year's worth of money to fund operations.

"From a market perception, the industry's at a value point that's possibly the lowest it's ever been," Burrill points out.

However, macroeconomic factors, rather than sector-specific issues, have depressed biotech stock values the most, Burrill and other analysts contend. Larger market trends beyond the industry's control are driving investment behavior, leading to lower trading volumes and money being pulled out of the market, particularly from higher risk investments such as biotech.

"The gap between apparent value and actual value is extremely high, but the industry has probably never been stronger," Burrill concludes. He and others hold this opinion based on the number of products on or coming to the market, the maturity of management, the state of technology, the number of disease targets, and an improving regulatory picture.

Biotech companies are falling into different camps--the "haves" with product sales or capital reserves left over from the 2000 financing bubble, and the cash-starved "have-nots" looking for financing. However, even the successful or more financially comfortable companies are paring down operations to conserve resources, because the general expectation is that a recovery will not occur until 2004 or beyond.

The industry has gone through cycles before, but this one differs in how quickly the financing window closed and how prolonged the downward trend has been, explains Scott Morrison, U.S. director for life sciences at the consulting firm Ernst & Young.

"What's also unique is how aggressively companies have taken action to reduce their cash burn rates," he adds. "Almost every publicly traded company that's not growing extremely rapidly--all but the Amgens and the Gilead Sciences of the world--is involved in reductions in force and cost control." He says that more than 60 companies announced cutbacks in the second half of 2002.


"Almost every publicly traded company that's not growing extremely rapidly ... is involved in reductions in force and cost control."

"THE REACTION HAS been to act quickly and assume it's going to be a tight couple of years," Morrison says. To decrease spending, many companies are focusing on their lead projects and compounds while cutting out earlier stage research programs. They have also slowed investment in new laboratory facilities and manufacturing.

"There isn't adequate risk capital to invest in high-risk projects," Morrison notes. "They have to prioritize and do what's practical."

For example, Incyte is trying to eliminate $88 million in expenses this year by cutting 37% of its 700-person workforce and consolidating facilities. It has not, however, changed plans to expand in drug R&D and has launched its first fully staffed discovery program.

Incyte is actually in the enviable position of having ended 2002 with more than $400 million in cash reserves. It even struck a $42 million deal to acquire Maxia Pharmaceuticals late last year. Maxia is a privately held small-molecule drug discovery company that was looking for outside partners and investors.

"Last year was clearly a transition year for many of us in the life sciences business," Incyte CEO Paul A. Friedman told attendees at the recent JP Morgan health care conference. It was "a year in which Wall Street skepticism overwhelmed optimism and where corporate management had to take hard looks at business plans and make tough decisions."

Celera Genomics, in a position similar to Incyte's, has also tried to shrink spending by cutting staff on the DNA sequencing side of its business. Likewise, Millennium Pharmaceuticals--with about $450 million in 2002 revenues, about $1.3 billion in the bank, and $680 million in long-term debt--laid off about 100 researchers in December to be more "product-driven."

Despite having substantial partnerships, CuraGen has restructured to curtail early-stage work, reducing staff by 25% (128 people) and postponing construction of a new lab. It has cash and investments worth about $430 million.

The list of those with at least some cash that nonetheless are tightening their belts includes Inhale Therapeutic Systems (now Nektar Therapeutics), Alkermes, ArQule, and Texas Biotechnology. Not surprisingly, companies facing a cash shortage--such as Deltagen, GenVec, Incara Pharmaceuticals, and EntreMed--have been trimming operations as well.

What Incyte, Celera, Millennium, and CuraGen also have in common are stock values under $10 per share. These are only 4% of their peak share prices in 2000 for all except Millennium, which is at a still paltry 11% of its peak. Even Amgen, the most successful biopharmaceutical firm, hit a low in 2002 at 60% below its 2000 high of $78.


BY THE END OF 2002, the industry's market capitalization was off at least 40% from the start of the year and off more than 50% from its 2000 high, Burrill reports. Consequently, biotech companies have been unable to turn to the stock market to raise money. In 2002, only three companies had initial public offerings (IPO), compared with 67 in 2000.

Morrison suggests the biotech market will open again after the shares of established companies recover. "When the flagship companies like Amgen have a bad year, it's hard for investors to think about investing," he says. "It takes a while for them to get accustomed to coming back into the market.

"First we'll see the later stage companies come back gradually, then there will be follow-on stock offerings, and then an opening in the IPO market," he explains. "It could easily take 12 months before we see any rebound, and maybe longer, depending on what happens with Iraq, the U.S. economy, and the broader markets."

Burrill is a bit more optimistic about a nearer term--although probably still volatile--recovery. "The overhang of Iraq is keeping the general equity markets very tentative," he says. "If those issues are resolved in the next few months and people realize that the underlying economy is actually stronger than they think, we'll have a much more positive second half this year." He believes the industry could raise between $12 billion and $15 billion in 2003.

Meanwhile, biotech companies have been turning to other financing sources. Anticipating that stock values will rise, many companies issued debt that will convert into equity. But analysts express concern about the rising number of debt offerings and whether some firms will be able to pay down their debt when it comes due in a few years.

"If companies don't improve their profits or cash flow, there may be problems in restructuring their debt," Morrison warns about the 40 or 50 companies possibly in this position. In the second half of 2002 and early 2003, about half a dozen companies went bankrupt and shut their doors, he adds, nearly as many as had in the past 20 years.

"To have liquidations in companies that fail is actually positive," Morrison proposes. "It helps to cull out the companies that can't prove their business model." He believes the number shutting down will continue to increase this year.

IN SUCH TOUGH financing environments, partnerships with larger drug firms have usually been a given. However, that's not true today, analysts say, and conditions are even more challenging because the pharmaceutical industry itself is in a weakened state and undergoing restructuring.

Even so, major alliances brought in the promise of more than $5.5 billion in combined fees, equity, and potential future payments for drug discovery firms. Pfizer, GlaxoSmithKline, and Roche were the most active major drug companies making selective investments.

"Some deals are being done at 10% of the value of a couple years ago," Burrill points out, "and clearly the power's in the hands of those with money."

On the plus side, some venture capitalists still find the biotech sector attractive, not only for backing start-ups, but also for funding later stage companies whose depressed stock prices offer good values. "There certainly are some extremely attractive opportunities, with many very good companies that might have looked to the stock market looking instead for private financing," says Ansbert K. Gadicke, founding general partner of MPM Capital.

MPM recently closed a $900 million fund it believes is the largest dedicated to health care and the largest raised fund of 2002. Last year, Burrill & Co. also raised an initial $67 million toward what it hopes will be a $250 million life sciences fund.

Whereas Burrill likes to invest in early- to mid-stage companies, MPM intends to spread its capital all the way from private start-ups to already public later stage companies using PIPEs, private investments in public equity. PIPE investors must make two investment decisions: when to buy and when to sell. In contrast, with start-up investments, venture capitalists often have more control over the business and a clear exit strategy when a company goes public.

Gadicke says MPM looks primarily at companies that have strong underlying technologies offering very straightforward paths to getting products into the clinic or that already have early-stage clinical results. "There are two advantages," he explains. "The first is risk reduction, and the second is a clearer path to a business model that we know really works."

Gadicke offers two examples from MPM's portfolio. One is Idenix Pharmaceuticals, an antiviral company that on its own has driven product development as far as Phase III clinical trials using venture dollars alone. His second example is ViaCell, which maintains a cash-flow-positive cord-blood-stem-cell banking business that supports its therapeutics work.

IN A RARE TWIST, the successful biopharmaceutical company MedImmune took $100 million from its $1.2 billion cash reserves in July 2002 to create a venture-capital fund. MedImmune Ventures is focusing on later stage, product-based companies, and more specifically on ones similar to its parent in both therapeutic interest and business approach, says Wayne T. Hockmeyer, MedImmune chairman.

"We've been approached by a lot of companies looking for financing, but I don't think we're unusual," Hockmeyer says. MedImmune Ventures made its first investment as part of a group putting $54 million into vaccine delivery company Iomai.

In addition to deploying the company's money in a way that benefits it and its shareholders, the venture fund has two strategic objectives. "We're also staying aware of what entrepreneurial companies are doing and where technology is headed," Hockmeyer says. "And we want to develop relationships with smaller companies that long term could, for example, lead to becoming a partner for them or even acquiring new products."

During the genomics bubble of 2000, hype and investor buying into the momentum of the market drove up stock prices. Companies based on platform technologies, such as gene sequencing, were extremely popular. But sentiments have shifted, and now product-focused companies are finding it easier to raise capital than are technology companies, Gadicke and others say, because assessing value can be simpler.

Nevertheless, valuation has become problematic and investors are more tentative in the aftermath of the debacle surrounding ImClone, its partner Bristol-Myers Squibb, and the drug Erbitux. "It wasn't the insider trading and colorful things with [then] CEO Sam Waksal and Martha Stewart," Burrill says. "That's interesting, but it was a sideshow to what it really did to biotech."

That, Burrill says, was "to destroy the value structure in which biotech has existed for 30 years."

INVESTORS TRUSTED in what Burrill calls "surrogates of value" in ImClone's case, only to lose 70% of their investment as the company, its alliance, and the drug's prospects unraveled over just a few weeks. Thus, faith in those treasured surrogates--a long-standing biotech company with a prominent management team, a stellar board of directors, a promising late-stage product in an important therapeutic area, and a record-setting financing deal with a leading pharmaceutical company--has evaporated.

"Investors owned that dream a year ago, lost it, and now don't want to own the risk of uncertainty," Burrill concludes. "They want results-oriented growth in value--based on 'real stuff,' like product sales and earnings--and not perceptions."

Gadicke cautions that biotech investing is complex and investors must work hard at understanding all the factors at play. "A good venture-capital fund should also have patience," he adds. "But what's most important is that it has enough firepower to sustain its companies."

MPM is keeping significant capital reserves to help the companies in its portfolio until the stock market recovers. "If there was a bull market right now, we might exit investments earlier," he admits, "but we have the luxury of waiting."

Gadicke and others actually see some positive aspects emerging from the current financing environment. One is a stronger focus on sustainable business models centered on product development rather than sexy technologies. Another is that companies are thinking more about creating critical mass and greater value through mergers and acquisitions--a trend that's expected to continue this year.

"It's unlikely that the industry will be more successful with several thousand tiny companies around," Gadicke concludes.


With the drug industry pressed to find new paths to innovation, the tension between large- and small-molecule therapeutics takes center stage

A shortage of capital is driving cost cutting, deal-making, shutdowns, and consolidation


Chemical & Engineering News
Copyright © 2003 American Chemical Society