LONDON ¿ Low share prices and the paucity of new funding are likely to lead to a surge in mergers and acquisitions (M&A) in the biotechnology industry as cash-rich companies use the opportunity to acquire new technologies and pharmaceutical companies find that buying biotech companies costs less than doing licensing deals.

This is the conclusion of the third annual study on M&A in health care, by the firm Andersen Consulting. The study reports an increase of 40 percent in the number of M&A transactions in life sciences in the year to June 2001 over the previous year, and predicts this trend will increase despite the difficult economic circumstances. Such a surge would be in contrast to all other sectors, where M&A activity has fallen sharply in the face of the current downturn.

The number of acquisitions reported across life sciences globally was 669. However, the value fell from $217 billion in 1999/2000 to $71 billion, largely because there were no mega mergers of the Pfizer/Warner-Lambert size. In biotechnology, there was a 24 percent increase in deals worldwide, with the value fairly constant at $9.9 billion, compared to $10.2 billion a year earlier.

Richard Williams, Andersen partner in charge of health care corporate finance in London, said, ¿We are confident that investment stories in the sector will continue to be highly attractive to investors and that M&A activity will continue to be an important element in strengthening and developing those investment cases.¿

One of the key drivers of continuing M&A activity in biotech is the huge amount of money raised by some companies during the 1999/2000 public funding window. The report notes that investors poured over $20 billion into biotech in 1999/2000 but that did not make the sector universally cash rich. ¿For some companies the public financing window came too early in their development, while others failed fully to exploit the opportunity,¿ it said.

In 2001, with the equity markets broadly closed, and with less support for biotech valuations, new drivers for M&A activity have emerged as companies realigned their business models in an effort to create longer-term value. ¿Opportunities now exist for those companies that raised significant sums during 1999/2000 to consolidate the sector and enhance their businesses through creative M&A.¿

In the year to June 2001 biotech valuations were in the main too high to attract big pharma and there were few pharma/biotech transactions during this period. But the report forecasts that the fall-off in biotechnology valuations, combined with the depletion of cash in underfunded biotechs, will encourage more pharma/biotech deals to go forward.

¿Underfunded companies in newer technology areas such as proteomics, structural genomics or human antibody development may attract the attention of larger players,¿ the report said.

There also will be an increase in defensive transactions as companies with low valuations and poor liquidity fall beneath the threshold that makes them of interest to institutional investors. This problem is being exacerbated by the skewed distribution of finance in biotechnology, with the higher valuations and substantial cash reserves of the cash-rich companies raising the threshold to which cash-poor companies must aspire.

This will propel smaller players towards consolidation. ¿As a byproduct they may reach the kind of critical mass they need to regain institutional coverage.¿

Cash-poor companies also will divest noncore businesses to generate funding for core activities.

Strategically sound merger activity will not be impacted by the current depressed valuation levels, as relative values are not impacted.

The year 2000/2001 also saw a shift in perception of value in biotech away from platform technologies and service-oriented businesses toward product development. ¿Rather than being a whim of the capital markets, we anticipate this trend to continue,¿ the report said.

The best way to create long-term value from a technology platform is to generate a proprietary product pipeline. ¿Consequently, a number of companies have looked to integrate forward in the drug discovery value chain,¿ the report said.

An example is the acquisition by the German company Rhein Biotech of Green Cross Vaccines. Prior to the transaction, Rhein revolved around a technology platform for expressing proteins in yeast. ¿The acquisition transformed it into a fully integrated vaccine company with a set of marketed products.¿

Another example is Celera Genomics, the genomics company that raised nearly $1 billion in a secondary public offering and bought Axys Pharmaceuticals for its downstream drug development technologies.