By Nancy Volkers

Special To BioWorld Financial Watch

The Dow broke the 10,000 barrier and Internet stocks continued to sizzle, but biotechnology companies struggled through another lackluster quarter, in which public offerings were few and far between. The players who drive small-cap investment trends seem to have settled elsewhere, making the private market integral to the success of small and mid-size companies looking for capital.

"The biotech salad days are over," said analyst Jon Alsenas, managing director at ING Baring Furman Selz LLC, in New York. Part of the reason may be the maturation of the biotechnology industry, but the Internet stock boom can't be helping. Though many are waiting for the other Internet shoe to drop, investors continue to back "dot-com" stocks such as Amazon, Yahoo, Lycos and e-Bay.

Large-cap biotechnology companies are rolling right along; it's the smaller biotechnology firms that are in ever more difficult straits. Alsenas said this growing dichotomy between the "haves" and the "have-nots" of biotechnology is what drives consolidation part of the natural progression of an industry.

"Consolidation happens," he said. "It's like the companies that used to make personal computers. The Commodore 64 used to be the standard. The winners win. The losers lose; they consolidate."

The Nasdaq Biotechnology Index climbed 14 percent during the first quarter, while large-cap stocks such as Amgen Inc. (up 44 percent) and Immunex Corp. (up 32 percent) continued to out-perform the market. Mid-tier stocks were up 3 percent, but in line with the broader market. Small-cap biotechnology firms were up 10 percent, as investors looked for value in this beaten-down sector.

According to accounting firm Ernst & Young's annual report, the 1,283 companies in the U.S. biotechnology sector collectively lost $5.1 billion in 1998, on total revenues of $18.6 billion. In contrast, Merck & Co. profited $4.6 billion last year on $24 billion revenue. In the first quarter of 1999, the industry raised $832 million, roughly the same amount as the fourth quarter of 1998 ($886 million) but 53 percent less than the first quarter of 1998, when biotechnology raised $1.76 billion.

Ernst & Young said investors are now increasingly unwilling to invest in the smaller biotechnology companies because of lower-than-expected returns in the past. This leaves smaller, private biotechnology companies unable to go public successfully.

Small companies already in the public sector are also being shunned by many investors. "The small-cap stocks have sharply under-performed," said Peter Ginsberg, senior research analyst at U.S. Bancorp Piper Jaffray, in Minneapolis. "The Dow is not reflective of the overall market. [Difficulties in obtaining financing] have been exacerbated by the weak overall performance of biotechnology stocks, outside the largest companies."

While there were several public offerings during the first three months of 1999, only two biotechnology companies completed initial public offerings (IPOs), both in February. Invitrogen Corp. raised $45 million, and Albany Molecular Research Inc. raised $50 million. As of last Wednesday, neither's stock had closed above its IPO price.

If that's not enough, Albany and Invitrogen are not "traditional" biotechnology companies. Albany Molecular offers chemistry research and development services to biotechnology and pharmaceutical companies; Invitrogen markets tools that improve gene cloning, expression and analysis.

Silverman said that "based on the activity in the last five or six quarters, clearly there's no IPO window. For your tried-and-true [company, that says], 'I'm going to develop this drug and I'm going to be losing money for awhile,' an IPO isn't going to happen."

Alsenas said the "days are long gone where you can do an IPO for a company with nothing in the clinic or only Phase I products. This is a continuation of a trend we've seen for awhile now. You have to have most, if not all, of the pieces present to do [an IPO]."

Analysts agree the market is still open to late-stage companies and recently commercial ones, but those without sales and earnings, or the promise of them in the near future, must exercise other options, such as partnering with a pharmaceutical company or a larger biotechnology firm. Over the past three years, Ginsberg said, biotechnology-to-biotechnology deals have increased from 50 per year to 50 per quarter.

Other companies completed successful follow-on offerings during the first quarter.

Cerus Corp. raised $46.2 million March 31, in a public offering of 2.2 million shares of newly issued common stock, priced at $21. Last week, the stock sold at $18.50, well off its 52-week high of $33.875.

In March, Abgenix Inc. raised $45 million, and Aronex Pharmaceuticals Inc. raised $13 million. In England, PowderJect Pharmaceuticals plc garnered about $89 million in mid-February through a placement and public offering.

Silverman said Abgenix has raised about $90 million in the last 18 months. "That's unusual," he said. "If you make money, you can raise money, but most of the companies coming out have not done that."

In Abgenix's follow-on offering, shares sold for $15 each; the stock sold for $8 in July 1998, when Abgenix went public. Late last week, its shares sold at $14.25. In contrast, Inc., which sells airline tickets, new cars, home mortgages and hotel room rentals, went public March 29 at $16 a share, and last week hovered around $75, off its high of $81.25.

In spite of the beating that biotechnology takes, alternate funding sources exist. Venture capitalists are "in" on the industry, and with institutional investors turning to large-cap companies, small and mid-size stocks are often undervalued, making these companies attractive, said Ginsberg.

Private placements remained a popular financing vehicle. At least 10 companies completed private placements during the first quarter, including Triangle Pharmaceuticals Inc. (to raise $48 million), Aradigm Corp. ($25.5 million), and Sugen Inc. ($28 million).

Sugen placed 12 percent senior convertible notes due in 2002, which gives the company needed cash without the stock dilution that would have come with a public offering.

Cephalon Inc. opted to raise $30 million through the private sale of revenue-sharing notes, in order to support further commercialization of Provigil (modafinil), a treatment for narcolepsy. The notes, repayable in cash in February 2002, have an annual interest rate of 11 percent. Investors also receive a six percent royalty on U.S. sales of Provigil for up to five years. Cephalon has the right to redeem the notes at a premium prior to maturity, which would reduce the royalty period to four years. At no time are the notes convertible into common stock.

The offering also included the issuance of 1.92 million five-year warrants to purchase shares of common stock, with an exercise price of $10.08, which is a 25 percent premium to the average market price for the five trading days prior to Feb. 24. Last week, Cephalon stock hovered around $9.50.

Igen International Inc. avoided dilution by private debt financing. The company raised $30 million from sole buyer Boston-based John Hancock Mutual Life Insurance Co. The debt carries a seven-year term with an 8.5 percent interest rate and is interest-only for the first two years. The debt is secured by a series of royalty payments from Roche Diagnostics, a division of F. Hoffmann-La Roche Ltd., on sales of Roche's Elecsys immunodiagnostics, which are based on Igen's Origen technology. Igen plans to use some of the proceeds to help launch its M-Series High Throughput Screening System, which has commitments from 10 biotechnology and pharmaceutical companies, including giants Pfizer Inc. and Amgen Inc.

Even private financing is not a sure thing, says Alsenas, though there have been relatively healthy private investments in public entities, and other private investments. "[Private investments] are a lot of work," he said, and investors must be given an attractive valuation.

Ginsberg said the situation is likely to improve, "because it couldn't get much worse." But even in economically robust times, this is a difficult season for biotechnology stocks; traditionally, fall and winter months are the strongest months.

The Ernst & Young report said biotechnology will continue to be a strong industry, boosted by the needs of an aging U.S. population and the sequencing of the human genome. Others are less sanguine, and say that investors have now learned where to get the most for their money and it's not in biotechnology start-ups.

Silverman said that, "for awhile, biotechnology was the place to be. But it's a lot more difficult to come up with cancer cures than it is to put up a good website."

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