If there's one thing for sure in biotechnology, it's uncertainty.

And volatility, occasionally tilting into chaos.

And hysteria, practically at the drop of a hat.

Last week's hat blew off the head of Cephalon Inc., swept by winds gusting from a storm over doomed energy trader Enron Corp.'s woes a tempest that was agitated further by news from Elan Corp. plc about its accounting practices, and probably even fed by the turbulence that surrounds ImClone Systems Inc., over its handling with the FDA of yet-unapproved Erbitux (cetuximab), the colorectal cancer drug partnered with Bristol-Myers Squibb Co.

Batten down the hatches, once again.

Congressional scrutiny of Enron's dealings was in full swing when Dublin-based Elan found itself up against shareholder class action lawsuits. In a press release early this month about its financial results for 2001, Elan acknowledged the "current market concerns relating to off-balance sheet arrangements through [Qualified Special Purpose Entities] structures."

Elan allowed that it "has two QSPEs which it has not consolidated in its financial results as presented under U.S. generally accepted accounting principles." That disclosure followed by about a week a Wall Street Journal story about how Elan established research and development outfits, and then took back their funding by way of a licensing fee, which went on the firm's books as revenue.

Elan's stock price dipped about 17 percent the day the newspaper story was published, and lost more than 50 percent after the financial results were disclosed. Having traded upwards of $40 at the start of 2002, the company's stock was worth only about $13.50 per share late last week.

Regarding the class actions, Elan said only that it would "vigorously defend" against them. By Friday, the company said it had been notified that the Securities and Exchange Commission had begun an investigation, and Elan said it "welcomes the opportunity to resolve all matters raised by the SEC in light of recent allegations made against the company in the media and in shareholder lawsuits."

In the meantime, Cephalon's turn had come inexplicably, at first. Monday, Feb. 4, the company's stock also dropped, 13.4 percent, ending the day at $55.99. Late last week, it was hovering in the $55 to $57 range.

What apparently sparked the market reaction against Cephalon was a short report by Sterling Financial Investment Group, of Boca Raton, Fla. which echoed (in condensed form) a paper in January by the Center for Financial Research and Analysis, said Andrew Gitkin, an analyst with UBS Warburg.

The reports questioned Cephalon on three counts: its purchase in December for $450 million in cash of the French pharmaceutical company Group Lafon; its potential $32 million deal in December of last year with Sanofi-Synthelabo to co-develop and co-market angiogenesis inhibitors for oncology; and its forming of a joint venture to boost U.S. sales of Provigil (modafinil, a sleep disorder therapy to which Cephalon got worldwide rights in the Lafon buy) and Gabitril (tiagabine, an epilepsy treatment gained in the Sanofi-Synthelabo deal). The two-year JV was funded by $50 million from two institutional investors.

A bit of old news also got resurrected: $40 million in potential liability related to another JV, this one dating back to the early 1990s, for developing Myotrophin, injectable insulin-like growth factor-1, to treat amyotrophic lateral sclerosis, or Lou Gehrig's disease. Cephalon's partner in the joint venture is Chiron Corp.

"I saw the original report a month ago and laughed at it," Gitkin told BioWorld Financial Watch. "For whatever reason, the market took it seriously, and [Cephalon] basically tanked. Probably, the report was able to engender such a response because the market was finicky" as a result of Enron, Elan and ImClone, he added.

The Myotrophin JV hardly seemed worth bothering with. FDA advisory committees turned the drug down twice, and marketing was a condition of paying the $40 million to Cephalon Clinical Partners (the investors). When last heard from, the FDA called Myotrophin "potentially approvable" but wanted more data. Cephalon has quit working on the drug.

Eric Ende, an analyst with Banc of America Securities, told BioWorld Financial Watch: "If by some miracle it did get approved, I'm sure they'd be more than happy to pay the $40 million."

Ironically, as the mainstream media scrambled to find the cause for Cephalon's stock dip, the name of Gitkin (who favors the company) showed up in an Associated Press, noting Gitkin had issued a report declaring prescriptions for Provigil were off 4.3 percent for the week ending Jan. 25.

"I put that out every Monday," Gitkin said. "We say whether they're up or down. It was probably the only thing on the wire that morning," and thus was seized upon as the likely culprit in Cephalon's fall.

Sparking more interest than the apparently irrelevant $40 million "debt" was Cephalon's JV for post-marketing studies of Provigil and Gabitril. But Gitkin, in a research note called the deal "transparent," "kosher" and "a legitimate use of off-balance sheet financing." Anyway, Gitkin wrote, "$50 million over two years is not particularly meaningful compared to the $225 million to $250 million that Cephalon will spend on its own."

What about the Group Lafon buyout? It's also "straightforward," Gitkin said, and gets Cephalon out of paying the 15 percent manufacturing fee on Provigil sales it would otherwise pay, thus pushing Cephalon's cost of goods sold from 22 percent of sales to 7 percent a good enough reason for the acquisition.

With Sanofi-Synthelabo, Gitkin pointed out, Cephalon actually has two deals. One outlicenses Cephalon's angiogenesis inhibitor for cancer, which is in Phase II trials, and includes up to $32 million in research and development payments. The second arrangement has Cephalon paying $20.5 million to Sanofi-Synthelabo for worldwide rights to Gabitril; Cephalon previously had rights only in the U.S. Neither of the Sanofi-Synthelabo agreements are JVs.

Michael King, an analyst with Robertson Stephens, said in a note that concerns about the "so-called two-way relationship with Sanofi-Synthelabo" have no ground.

"The Gabitril arrangement is a pure sales and marketing transaction, whereas the [cancer drugs] partnership is a standard R&D collaboration similar to hundreds of others in the biotech industry," King wrote, adding that allegations about the $50 million JV also are "baseless."

At the center of the cancer deal is CEP-7055, a vascular endothelial growth factor (VEGF) kinase inhibitor. Other compounds involved in the deal are in the preclinical or research stage.

Ende, for his part, stopped short of talking about Elan, but said all of Cephalon's arrangements "are different from the other transactions you've seen that are not legitimate. These [other] companies are fabricating revenues financing cash flows and turning them into operating revenues, paying themselves with their own money."

While even such arrangements as Genzyme General's assorted "tracking stocks" have been the topic of casual scrutiny by some observers, Cephalon is doing fairly ordinary business, Ende said.

"Are they moving expenses off their [profit and loss accounting]?" he said, referring to the $50 million JV. "Yes, temporarily, but you're talking about a company that has drugs on the market, and they don't want their P&L to be hit right now. In my mind, although this doesn't match with accounting rules of capitalizing [research and development], Phase IV studies to generate data so you can have greater marketing material are not true R&D. The money is from outside investors, and [Cephalon] is not doing anything to inflate revenue."

Gitkin, for his part, pointed out that the JV "will be making investments in marketing activities that should drive prescription growth for Provigil and Gabitril, and at the end of the day, it will be hard to discern whose marketing efforts are generating the revenue. But this is not nearly like an Elan JV, where you're taking money out of one pocket and sticking it into another."

Saying he is "very suspicious" about off-balance sheet accounting, Gitkin recalled previous work in the assisted-living and nursing home industries.

"They were notorious for shielding income statements from losses, and unduly inflating revenue," he said. "I'm very schooled in that area of accounting, and [Cephalon] is about as plain vanilla, as benign, as one can get."

Just the same, Gitkin said, "I'm sure if Frank Baldino [Cephalon's chairman and CEO] had seen this back in December, he wouldn't have done" the JV, especially for such a relatively small amount of cash, dedicated to follow-up studies of approved drugs.

Baldino told BioWorld Financial Watch that "there are no problems." "There's nothing wrong with the way these things are accounted for. They satisfy all the SEC rules, and they're fully disclosed."

Chip Merritt, director of investor relations for Cephalon, said the company told analysts about details of the JV in December and "everybody yawned. Nobody cared," since the deal is so simple.

"It's $50 million in, $72 million out that's the price to pay off the investors, if we want to buy back the joint venture," he said. "It's very simple, very small."

Short sellers, he added, have only "questioned" accounting practices which might have been enough to excite the mainstream media, but wasn't enough for Cephalon to respond to.

"We ask them to give us something specific, and they don't," he told BioWorld Financial Watch. "We can't fight the phantom."

Jeff Mustard, director of communications for Sterling, shrugged off Merritt's argument.

"That's usually what happens when people get slammed, and they have nowhere to run and nowhere to hide," he said. "Our report was pretty strong."

Gitkin disagreed, but said the whole episode "has got to hit [Cephalon] very hard. A lot of this has to do with nothing specific to the company; it's nervous investors shooting first and aiming later." Cephalon will report its earnings Feb. 19, he added.

"It's their second profitable quarter," Gitkin said. "Cephalon will come back."

Ende's note cites the "cockroach theory" of momentum investing, which holds that news good or bad means more is on the way.

Just as powerful in the months ahead may be the scrutiny that biotechnology undergoes, fueled by the Enron, Elan and ImClone probes. Although no allegations have been made against ImClone regarding its bookkeeping, oversight generally is likely to increase, Ende said.

"People weren't looking at biotechs as companies that were inflating revenues," he said. "People chose not to look. That wasn't the story. Now, all of a sudden people are saying, 'What's the quality of these revenues?'"

As for Elan, an insider who asked not to be identified pointed out that the company has been open about its JV activities; only the scrutiny is new. "Everything they're doing has been known for years," he said. "They've been anal about disclosure."

Cephalon, too, has disclosed all that was necessary, and regulatory agencies are satisfied.

Baldino said he "feel[s] sorry for investors who were affected, but I'm not worried about it" in the long run, noting that Cephalon's stock already was recovering late last week.

The future will bring much more caution by any wise company, he added.

"You have a lot of people who are 'closet accountants' now," he said, as well as trigger-happy momentum investors. "It's probably not wise in this environment to do [JVs that are open to question in any way]. They're ordering vanilla, we're going to give them vanilla."