BioWorld International Correspondent

MUNICH, Germany - Among concerns about consolidation and valuation, biotechnology companies and investors at the Sachs Bloomberg Investor Forum in Munich last week looked at financial trends shaping the industry.

First, the generally difficult market is having some important salutary effects. Second, by historical standards, there still is a substantial amount of money being invested in biotechnology. The present situation is negative compared with the boom times of 1999-2000, but the market is still stronger than the early and mid-1990s. Third, the biotech pipeline is both more mature and growing, and management experience in many companies is stronger than in previous years.

For younger companies, however, the investment climate is distinctly chillier.

Michael Lytton, general partner with Oxford Bioscience Partners, based in Boston, observed that "money is clearly moving to later rounds, even post-second rounds of investment. In the U.S., 80 percent of venture investing is now going to second and later rounds."

Holger Mueller, investment director with 3i Deutschland GmbH, said that "70 [percent] to 80 percent of venture capitalists' funds are going into their existing portfolio, and the investors' strategy is to support those companies with sustainable businesses. This necessarily reduces funds available to look for new companies."

The increasing size of venture funds in the life science field means that syndicates are compelled to seek larger deals, increasing the challenges for companies seeking seed and first-round funding.

Lytton described the tightrope that companies have to walk. "You need to raise enough money to reach the next financable milestone and leave adequate runway to raise the next round. But do not raise too much, so that the pre-money valuation of the next financing round will still be reasonable."

Andre Lamotte, a founder of NMT Management AG in Basel, Switzerland, found several positive elements in the current situation. "This is my fifth bear market," he said, "and I am delighted that we are in a bear market because companies need another two or three years to mature. It is better in the long run that companies have more solid data and maturity before they become public companies."

Expanding on his optimism, Lamotte added, "The No. 1 lesson [from experience with bear markets] is that venture capital only succeeds through people. If you squeeze too much, you will never be successful. In a bear market, it is very important to remember to take risks. We are in the risk business. The worst thing that happens is that when the next bubble comes, you don't have any good companies."

Although most investors who spoke said the pathway for biotechnology companies to raise capital in public markets eventually will be clear, few said that they thought that would occur in 2003. Most were cautious about expecting IPOs to become probable again in 2004. Mueller said that he thought the "shakeout in public markets still hasn't really happened." When it does, he added, there will be a time when "only private equity and big pharma are there for final funding."

Nick Lowcock, managing director on the European Healthcare Team for E.M. Warburg, Pincus & Co. International, said he is "100 percent sure there will be an IPO window again, and that far too many companies will try to squeeze through." Explaining some of the dynamics driving consolidation in the sector, he asked, "Why aren't mergers and acquisitions happening? Cash-rich companies can't accept that their technology has negative value and think that tech-rich companies will get cheaper. Meanwhile, tech-rich companies are hanging on for better valuations before their money runs out." The contradiction between those positions is holding back consolidation that could create stronger companies.

Bernard Gilly, a partner with Sofinnova Partners in Paris, also expressed caution about mergers. He said, "Consolidation is not a short-term solution. Many companies deserve another round, even if it means accepting a down-valuation." Investors also were concerned about the practical effects of mergers.

"Mergers in general are extremely difficult, cross-border deals even more so," said Karen Hitschke, a principal with Apax Partners. "Post-merger management is very difficult. It is very much a question of reaching critical mass before doing a merger, to say nothing of a cross-border merger."

Expanding on Lowcock's ideas about valuations, Gilly said that there is a trend to drive valuation down, and he expects that to continue in 2003. "There is an upside in the very early stage, but problems in Series C and later financings are driving valuations down." He expects this direction to continue over the next 18 months. Mueller noted that over the past year, companies have been much more willing to negotiate on valuation, a trend that he found stronger in Britain than in Germany.

Despite all of the challenges, Lamotte remained optimistic. "This is a golden age for drug discovery," he said.