Staff Writer

The biotech industry tends to be somewhat resistant to macroeconomic forces, given the constant demand for healthcare. But the industry isn't totally insulated from the recent events on Wall Street, including Lehman's bankruptcy, Merrill Lynch's acquisition by Bank of America and the news that Goldman Sachs and Morgan Stanley are moving into commercial banking.

Long-term outcomes are difficult to predict given the pace at which things continue to change: the financial industry bailout is still evolving (as of this writing, anyway), each day brings more consolidation, the FBI and SEC have launched investigations and rumors are flying about what regulations the industry could face - all beneath the ever-present black cloud of negative investor sentiment.

So this week's Financial Watch focuses on the short-term, taking a look at the more immediate biotech impact of the changes in investment banking, analyst coverage, boutique banking, financing for mergers and acquisitions, the proposed government bail-out and fluctuating foreign exchange rates.

Investment Banks: Less May Be More

Adam Goldston, senior vice president of investment banking with Jefferies & Co. Inc., predicts the Wall Street shake-out could result in less investment banking firms interested in servicing the biotech industry.

"A month ago we were the 11th largest independent investment bank; now we are the second largest," he said - though he noted that Jefferies is well-capitalized with a low net leverage ratio and virtually no short-term debt.

The investment banks that have moved into the commercial realm "need bigger and bigger fees to move the needle," Goldston said, adding that small biotechs not looking for a large senior secured credit facility may have a tough time getting the banks' attention.

George Montgomery, managing director with Montgomery Marshall Healthcare Partners LLC, said having fewer underwriters could result in some "near term dislocation" for biotechs looking to do public financings.

Banks with private investment arms also are causing some dislocation: Last week, KaloBios Pharmaceuticals Inc. found its Series D financing delayed when Lehman, which had led the biotech's Series C round, went belly-up.

Overall, Michael Brinkman, managing director of health care investment banking at Piper Jaffray & Co., predicts that changes in the investment banking structure won't make much difference to biotechs.

"The deck chairs get moved around, but the number of people on the boat stays relatively the same," he said, adding that there are a healthy number of small and mid-sized banks available to step in to fill the gap in servicing small- and mid-cap biotechs.

The bigger issue, everyone agreed, isn't fewer bankers but fewer deals being done as investors remain skittish.

Research Cutbacks Hardest on Small-Caps

Across the Chinese wall (and on another floor inaccessible except with an escort) in the research department, the overall impact of the last few weeks' events is expected to be minimal for biotech.

Here too, the overall state of the markets is the more important factor, according to Montgomery.

With the challenging markets providing fewer underwriting commissions, some banks have trimmed their research departments. While large-cap biotechs wouldn't be hurt by losing a few analysts, small-cap companies would feel "a more dramatic effect," Montgomery said, although he added that small-cap biotech has suffered ever since the separation of research and banking.

Overall, Robert W. Baird & Co. analyst Christopher Raymond predicted that the remaining analysts will have "plenty of capacity to service the industry."

New Boutiques May Favor M&A Over Capital Markets

Consolidation of larger companies often leads to the birth of start-ups, and the biotech industry owes much of its own genesis to talented entrepreneurs emerging from deals like Eli Lilly and Co.'s mid-1980s acquisition of Hybritech Inc., which ignited San Diego's growth as a biotech cluster,

Rodman and Renshaw LLC analyst Vernon Bernardino predicted the same may hold true in the banking world, with veteran teams spinning out of the large banks to form new boutique institutions.

Yet Montgomery noted that large banks serving as the lead manager on a financing still take "the bulk of the profit." With overall deal volume down, new boutiques could have a hard time devising a model that allows them "to do sales/trading and research profitably," he said.

Goldston agreed that starting a boutique investment bank can be an expensive endeavor, but he predicted boutique M&A shops may emerge to advise small-cap and mid-cap biotechs.

M&A Keeps on Rolling

Brinkman said that while the "drying up of credit will have a major impact on all deals of all kinds, biotech is one of the few exceptions."

That's because most big pharma and big biotech acquisitions of smaller biotechs are financed with cash, and many biotech-to-biotech deals are all-stock.

For big pharmas that do need deal financing, Montgomery said banks are "falling all over themselves" to lend to that industry. Other life science companies are getting financed too: Invitrogen Corp. announced on Sept. 16 - in the midst of the Wall Street meltdown - that its $2.65 billion underwritten bank facility for its purchase of Applied Biosystems Inc. was substantially over-subscribed.

Yet some of the mega-mergers in biotech may feel the credit crunch. Raymond speculated that "concerns over the ability to obtain debt financing and the cost of debt financing" for Roche Holdings AG's proposed $44 billion acquisition of Genentech Inc. may have caused the recent decline in Genentech's shares.

Bailout to Benefit Everyone, Eventually

Raymond also said Genentech may stand to gain the most, as far as biotechs go, from the proposed financial system bailout. "If a credible bill is produced in the near term, the expectation of a return of liquidity and potentially lower cost of debt financing could restore investor optimism that a deal north of $100 [per share] may still be in the cards," he wrote in a recent report.

But for most biotechs, Brinkman predicted the bail-out would not have "tangible short-term benefits."

For now, Goldston said the hedge funds scrambling to cover their losses are putting pressure on biotech stocks, since biotechs often were part of the overall portfolios that are now being sold, irrespective of any individual stock's performance. He added that the poor performance of small- and mid-cap biotech this year was "a run-up to what we're seeing now," as investors started to sell less liquid names, though he noted it wasn't a cause-and-effect relationship.

Brinkman said hedge fund activity in biotech stocks could be curbed further by a scarcity of available credit and potential disclosure requirements for short positions, both of which could lead to fewer trades and less liquidity.

Yet outside of the hedge funds, Goldston said Jefferies is seeing "investors interested in biotech." He believes that overall, the bailout will increase liquidity and relieve the pressure on biotech stocks.

"We're hoping it will put the overall calm back into the markets, the confidence back into the markets, and the liquidity back into the markets," Goldston said.

Stronger Dollar May Hurt Big Bio in Q3

Beyond the chaos on Wall Street, it's worth noting that the dollar has recovered some ground against foreign currencies this quarter, which could negatively impact third quarter results for big biotech companies with significant international sales.

In a recent report, Raymond noted that the weak dollar benefited Amgen Inc. by $72 million in the first quarter and $93 million in the second quarter. He predicted that the dollar's rebound could lower Amgen's third quarter top-line by $80 million and nick 5 cents off bottom-line earnings per share.

Other large-cap biotechs that have benefited from "a nice f/x tailwind" could also be affected, Raymond wrote, although he expects the impact to be "very company-specific."

He predicted that Genzyme Corp. will see as much as a four percent hit to the top-line but a limited effect on the bottom-line, Celgene Corp. will post "minimal but still palpable" declines, and Biogen Idec Inc. will report only a modest impact.