By Nancy Volkers

Special To BioWorld Financial Watch

Adolescence is a difficult time, and the adolescence of biotech is no different. As the industry grows and matures, investors' knowledge of what makes a good risk increases. After a long, hot and dry summer, the financing picture is improving, although the obstacles to "adulthood" still exist.

One obstacle has been the tightness of the public markets, which has caused more than a few companies to hold off on initial public offerings (IPOs) and follow-on offerings. This has left companies that need money looking for private sources, but many private investors have tightened the purse strings as well. Two types of private financing popular in a tight public market are equity deals involving direct investments and convertible preferred financing vehicles.

"There hasn't been an IPO market for awhile now," said Thomas Dietz, senior managing director at Pacific Growth Equities Inc. in San Francisco, "and most of the financings that have happened have been registered-directs or convertible deals. We haven't even seen standard follow-on offerings."

Smaller companies rely primarily on private financings to get them to the next developmental milestone. The company sells securities to a handful of institutional or venture-type investors. The securities are usually sold at a discount sometimes as high as 20 percent. After the deal, the stock is registered, and the shares are tradable. By selling the stock without advertising the sale, the company minimizes the chances of a drop in market price due to expected dilution.

Mid-cap companies often use convertible preferred financing vehicles, which can garner more money than straight equity deals. In 1998, convertibles accounted for 35 percent of all private financings by public companies.

"A lot of the leading companies have been able to raise money in the past, so they don't need a lot of money right now," said Jay Silverman, senior analyst at BancBoston Robertson Stephens in New York. "We did a sizable convertible offering for Cephalon that was in a tough convertible market. Since then the stock has done well and the buyers are very happy. That could lead to a trigger in converts in companies that have cash flow."

Currently, the public markets seem to be opening, and the goal again becomes public financings, whether through an IPO or a follow-on offering. Pharmacyclics Inc. and CV Therapeutics recently proposed major secondary offerings of about $41 million and $70 million, respectively and analysts say that the window is opening, although it's probably not wide enough yet to feel the breeze.

"With the resurgence in prices there's obviously a better financing environment," Silverman said. "You're starting to see IPOs get filed, and a couple of secondaries, too. Investors basically want to own these stocks and they want to own a good story."

Dietz doesn't see the market changes as affecting certain funding mechanisms.

"[Private financings] aren't going to wear out they'll keep going for companies that want to raise money a little more quickly and are not willing to risk a valuation hit by announcing a full-blown secondary or follow-on," he said.

Other analysts agreed. "I think we'll see an increase in 'plain vanilla' equity financings," said Peter Ginsberg, senior research analyst at US Bancorp Piper Jaffray in Minneapolis, "but we'll also see more exotic financings. We'll see a much more active financing market in September and October than we've seen throughout the rest of the year. I don't think there will be a spate of IPOs, but we should see a couple filed this fall, probably more activity than we saw earlier in the year."

Market May Open For Service, Later-Stage Companies

The idea that the market might be accepting IPOs is significant. Recent history has not been kind as only a dozen or so U.S. companies went public in 1998, and even fewer may go public this year.

And even if the market does open itself to IPOs, a company that wants to go public will find that completing an initial offering is an entirely different animal now, compared with just a few years ago. The maturation of the industry means that companies further along in development are the ones most likely to have successful IPOs.

"Companies gearing up for IPOs are going to tend to be later-stage companies, probably with efficacy data," Dietz said. "Also, I suspect there'll be some companies that are more service-oriented like genomics companies with more near-term business models that will be able to get out [into the public markets]."

However, he added, "People have become selective, and valuations have gotten very high I think some companies will take advantage of that and go out and try to raise money with more standard equity financing."

Ginsberg agreed. "The typical institutional investor has become a lot more picky about IPOs," he said, "so it's only going to be the special companies that will make it into the public market."

For an IPO to happen now, Silverman said, "Something has to be reasonably quantifiable in the near term a new drug approval or a royalty or license revenue stream. The [follow-on offerings] too it has to be a good story."

It has to be a good story because there's already a fleet of public biotechs for investors to choose from, with household names like Amgen, Genentech and Biogen, among others. There needs to be a compelling reason to take the risk of going with an earlier-stage company, and many investors who want to take risks have switched to Internet stocks and away from biotech.

However, the biotech rally in the stock market is here, Silverman said, and it's broad-based. Stocks have risen after earnings announcements, drug approvals, and the announcement of new technologies. "It hasn't been just one group we've had over 30 stocks more than double this year," he said.

After 13 years of watching biotech stocks, "I've seen a couple of rallies, but nothing like this," he added. "It used to be the gauge [for a top company] was a $1 billion evaluation, now we have several companies above $3 billion. There are lots of good reasons for that new drugs, deals with pharmas, pharmas buying [biotech] companies, sales figures going up, and pipelines look good."

What can stop the rally, though, is what Silverman called a "tidal wave" of consolidation. As biotech heads into a traditionally active time with lots of FDA activity late in the year and many medical conferences scheduled for early next year it may be that the "awkward phase" of biotech's adolescence is coming to a close, and the industry could emerge next year unrecognizable from what it's been since the glory days of 1996. *