Assistant Managing Editor

(Editor's note: This is the second of two articles on one of the tactics biotech companies are employing to access capital and the public markets - reverse mergers. The first article appeared in Friday's issue.)

Reverse mergers, like the one proposed by privately held ARCA Biopharma Inc. and publicly traded Nuvelo Inc. last week, are becoming a more popular route to the capital markets, especially in the stalled initial public offering market, even if they might not be investors' first exit choice.

Small biotechs with promising compounds certainly would prefer the acquisition path, which have been happening at increasingly impressive premiums. But for those advancing technologies that are a little outside of the coveted big pharma targets, reverse mergers tend to be a much more realistic option.

Firms that attract the high-dollar M&A deals are those that play "relatively close to the center of the fairway," in terms of drug development activities, Bruce Robertson, managing director at Atlanta-based H.I.G. Ventures, said during a panel session at last week's Georgia Life Sciences Summit meeting in Atlanta.

Robertson offered one of H.I.G.'s portfolio firms as an example. That company, he said, had promising midstage data from a second-generation antisense pipeline, but despite obvious M&A interest, suitors remained leery of antisense as a workable drug development technology, and the company ended up agreeing to a reverse merger, "which is sort of the exit of last resort."

Whereas, "if it had been an antibody or small-molecule firm, it probably would have been acquired," he added.

Robertson did not identify the company, but one of H.I.G.'s portfolio firms is Canadian company OncoGenex Technologies Inc., which is doing antisense work and recently agreed to merge with Sonus Pharmaceuticals Inc., a public Bothell, Wash.-based firm that was seeking to rebuild shareholder value after it lead drug, Tocosol Paclitaxel, missed its endpoint in a Phase III trial. That transaction, signed in May, is expected to close this quarter. (See BioWorld Today, May 29, 2008.)

Steven Damon, vice president of business development for privately held Altea Therapeutics Inc., of Atlanta, said his firm "would not be opposed to accessing the public markets" through a reverse merger, but the public firm would have to bring more than a listing to the table. It also should come with some cash to help advance the pipeline.

That was a clear need of Point Richmond, Calif.-based Transcept Pharmaceuticals Inc., which signed a reverse merger deal with troubled Novacea Inc. earlier this month. South San Francisco-based Novacea's prostate cancer drug Asentar fizzled in pivotal studies, but the firm is expected to provide about $84 million in cash at the close of the merger, expected around the end of this year, which will support Transcept's NDA filing for sleep drug Intermezzo. (See BioWorld Today, Sept. 3, 2008.)

Pending the completion of that merger, the combined company plans to focus solely on Transcept's pipeline, which includes drugs for psychiatric and sleep disorders, with no further development anticipated of Novacea's Asentar.

The need for capital also presents good opportunities for companies like Novacea, which had the type of cash to attract a private firm. It also was relatively new to the market, having only gone public in May 2006 with a $40 million offering. (See BioWorld Today, May 11, 2006.)

But other firms have opted for a strategy similar to that of ARCA's and Nuvelo's; that is, to combine the most promising assets of each company. Upon close of that deal, expected late this year or early next year, the combined company - to be renamed ARCA Biopharma Inc. - will focus on ARCA's heart failure drug, bucindolol, as a near-term prospect and look to Nuvelo's promising NU172, an earlier stage direct thrombin inhibitor, as a long-term growth driver.

Sonus and OncoGenex took a similar approach in their merger agreement. Combining the firms would create a pipeline of three clinical-stage oncology products. Two come from OncoGenex: OGX-011, a clusterin inhibitor for which the firm recently secured a special protocol assessment for a pivotal trial in prostate cancer, and OGX-225, a Phase 1-stage candidate. Meanwhile, the third compound, SN2310, stems from Sonus' pipeline and is in Phase I testing in cancer.

And in July, privately held VGX Pharmaceuticals Inc., of Blue Bell, Pa., agreed to merge with Inovio Biomedical Corp., a San Diego-based firm with a public listing and an electroporation technology for delivering DNA vaccines. The goal is to combine that delivery technology with VGX's pipeline of DNA vaccines in preclinical and clinical development. The transaction is set to close in the fourth quarter. (See BioWorld Today, July 9, 2008.)

Is it Possible to Fill the IPO Gap?

There's no doubt reverse mergers will remain a popular trend, even as the high-dollar acquisitions remain the favorite exit of investors. In the absence of an IPO market that seems like good news, but industry experts maintain that the recent flurry of M&A activity won't help biotech in the long run.

"It's not a sustainable model," H.I.G.'s Robertson said.

There simply aren't enough acquisitions being done to offset the closed IPO window, and that's especially hurting the companies that are in or moving into late-stage development. "The public markets have historically financed that costly late-stage" work, he added.

Without M&A options and no chance at an IPO, companies have to resort to some less than desirable financing activities to stay afloat.

"Because of the lack of liquidity, you're seeing [some companies] taking pretty oppressive vehicles to survive," such as bridge loans or monetizing royalty streams, said John Sharkey, vice president of business development at Atlanta-based Sciele Pharma Inc., which is in the process of being acquired by Japanese firm Shionogi & Co. Ltd.

And from there, it becomes a vicious cycle. Firms with those types of encumbrances often are less attractive acquisition targets or are received with much lower valuations, he added.

But more and more companies might be faced with those tough choices as the industry waits for the IPO drought to end.

Randy Guggenheimer, of Burrill & Co. in New York, said he doesn't see the IPO market "coming back any time soon," especially for biotech. First, "we need the market to stabilize," he said. "Then we need to start seeing tech IPOs, then we'll get to biotech [IPOs]." So it's really a matter of taking the long-term view.

"We need to get growth investors back into biotech," he added. "And that's going to be hard, because that's not where they're looking."

But many still remain optimistic, like Altea Therapeutics, which still is considering an IPO in the short term, said Damon. "We're still believing that we need to keep our financing in place" and wait it out.

"But I don't think it's a matter of years" before it gets better, he added.