Washington Editor

A number of signs point to some promising new and continuing trends for the biotech industry in the year ahead, observers are saying, with myriad financial opportunities available to companies and investors alike.

For one, mergers and acquisitions are likely to remain popular in the wake of several noteworthy buyouts made last year at healthy premiums. That has been driven by large pharmaceutical firms' pipeline needs, as well as the growth of large biotech firms into new areas.

Most of the M&A activity has centered on smaller company buyouts, said Matt Geller, the head of health care investment banking at Rodman & Renshaw LLC in New York. He attributed such deals to venture capital investors' desire for quick returns sans dilution.

Going forward in the coming year, expect large drug firms to continue to look to their smaller brethren to bolster their portfolios and technology platforms. Further M&A activity, coupled with clinical progress, should "drive appreciation" for small- and midcap biotech shares this year, said Joel Sendek, managing director and biotechnology senior analyst at Lazard Capital Markets LLC in New York.

"There are still a lot of companies out there that make great strategic sense for larger companies to buy, both from research and commercial standpoints," added Chris Raymond, senior biotech analyst at Robert W. Baird & Co. in Chicago.

Along similar lines, there will be no slow down in partnering deals, said Steven Burrill, CEO of Burill & Co. in San Francisco, and those agreements will continue to shift to earlier-stage deals, giving smaller companies more leverage.

Such predications already are playing out. Just last week, biotech heavyweights Amgen Inc. and Genentech Inc. inked potentially lucrative partnerships to access early stage product candidates for cardiovascular disease and cancer, respectively. The latter deal is centered on a kinase inhibitor, one of several classes of small-molecule cancer compounds that should generate continued development interest in the next year.

Deal making among smaller firms also is on the upswing, Geller said, with a "huge demand" for in-licensing as these companies seek to import late-stage products that could reach the market quickly. He also predicted that about a dozen small-cap biotech companies are on the verge of getting their first product approvals, which could make for compelling investments this year and help the industry attract money more broadly.

Burrill said he expects more biotech companies to introduce their first drugs to the marketplace this year, in many cases, products that target "the individualization of medicine." He also predicted more businesses will become profitable for the first time and foresees biotech product sales growing in general.

Generally Positive Investment Climate

Burrill is bullish on the industry's ability to raise money this year, projecting that U.S. biotech firms would raise more than $40 billion to increase the industry's market cap to an all-time high of $575 billion. Last year, $25 billion was raised through financings, he said. He added that U.S. biotech companies also will look overseas to access capital, especially in public markets.

In contrast, Raymond admitted a bit of concern about small-cap companies' ability to raise funds in the year ahead. He noted that the financial flow into dedicated biotech and health care mutual funds was "ugly" in the last quarter despite recent financings and initial public offerings in the same period.

"I would not be shocked if we saw a breather in the financing window here," he said, noting a "mixed bag" of macro indicators that could weigh on the investment climate.

Because some of that is attributable to regulatory and policy question marks on the horizon, largely related to the reauthorization of the Prescription Drug User Fee Act, Raymond is recommending an emphasis on large-cap biotech stocks early this year.

He called such shares a relative bargain for buyers right now. The sector was outperformed by small- and midcap biotech last year, as well as large pharma, an "anomalous" happenstance. "This is a good time to probably be thinking about new money in large caps," Raymond added. "Commercially, for the most part, a lot of these names look pretty good."

Similarly, Sendek pointed to strong earnings growth prospects among profitable biotech firms.

Geller spoke of a generally positive economic environment for attracting investors seeking growth. In addition, he said biotech companies likely will continue to file more shelf registration statements to allow for flexible financings, followed by an increasing number of registered direct offerings. As a result, there is less of a need for running around on the usual "road show" circuit to attract investments, a sign of industry maturation and investor sophistication.

Among more unusual financing vehicles growing in popularity are equity lines of credit, he said, as well as late-stage private investments from larger hedge funds and institutions.

Opinions Differ On IPO Popularity

A number of companies are staying private longer, and avoiding initial public offerings for a couple of reasons. Post-IPO premiums are down - public markets are being more discerning, Raymond said - and regulatory rigors on public companies have proven burdensome. In addition, private investors are more flush with cash right now.

"Going public is not necessarily a liquidity event," Geller added, noting that because private company valuations have increased substantially, there could be delays in some companies going public. As a result, he pointed to the possibility of a few IPOs at "spectacular pre-money valuations."

Burrill expects an uptick in IPOs, forecasting the completion of 30 such deals, 50 percent more than last year. In addition, he expects most of the 71 biotech IPOs that have closed since the window opened in 2003 to be trading above their offer prices, a nice turnaround from the present in which half remain "underwater."

Regulatory, Policy Issues Persist

Industry progress in the next year will come in the shadow of an increasingly strict regulatory environment. The perception that the approval process has slowed is "frustrating," Geller said, though he added that such delays don't necessarily portend an overly negative investment climate.

Nevertheless, such regulatory hurdles stem largely from drug safety worries and those concerns aren't going away. The Institute of Medicine's report on the subject mirrors a number of legislative proposals in the offing that could restrict advertising and mandate more post-approval requirements. Those bills could find their way into PDUFA's reauthorization, a must-do in this year's congressional calendar.

Other legislative activity could give the federal government power to negotiate payments on Medicare Part D drugs, part of a broader movement to put pressure on growing drug costs. But relative to Part B drugs, especially in oncology, Raymond said he doesn't foresee any major new changes in product use because physicians have learned to maneuver within the existing system.

On the whole, Sendek said the Democrats' congressional takeover appears more troubling for big pharma than biotech.

Further down the road, Burrill said, the industry could find itself in the center of health care-related debates that arise in early campaign efforts ahead of next year's presidential election.

Be Prepared For Surprises

Despite this range of predictions, something unforeseen and surprising could alter the landscape. "You never know," Geller cautioned.

A high-profile drug collapse or problems in one of the well-known biotech companies could be a drag on the rest of the industry, he added. Conversely, the approval of a new drug with blockbuster potential, or the emergence of another biotech firm into the large-cap ranks could benefit investments by demonstrating "how large the upside can be," he said.