By Jennifer Van Brunt
Never in the 20-year history of the biotechnology industry has there been such a sharp distinction between the ¿haves¿ and the ¿have-nots.¿ As 1998 progressed from what looked like a good year for the funding of biotechnology companies to what became a severe financing crisis, it widened the chasm that separates the companies at the top of the sector from those at the bottom.
On the one hand, mature, large-cap biotech companies with revenues from product sales have seen their balance sheets turn forever from red to black and their stocks appreciate handsomely. For instance, Amgen Inc.¿s stock gained 93 percent in value between Dec. 31,1997, and Dec. 31, 1998, Immunex Corp.¿s shares rose by 133 percent, Biogen Inc.¿s stock soared 128 percent, and Agouron Pharmaceuticals Inc.¿s stock gained 100 percent in value.
Wall Street has made it quite clear that it will reward biotech companies that perform up to or beyond expectations. But, increasingly, investors are impatient with anything less. Thus, younger firms with still-negative balance sheets and products in early-stage development have often suffered real damage as investors have fled those stocks in search of firmer or at least more predictable ground.
The majority of public biotech companies are still of the second variety they have no product, they have no sales (although they may have revenues from corporate collaborations), and they have very little chance of raising extra cash. Even at the beginning of 1998, they were considered small-capitalization stocks; by the end of the year, they had either become micro-cap stocks or in some cases ceased to exist at all.
Moreover, the lack of financing alternatives for these established biotech firms has even forced some members of the venture capital community to reassess traditional strategies for growing startup outfits. Where once the goal was to grow a young company to the point where it could be taken public at which point the venture capital investors make their money today that exit route simply does not exist. Instead, one alternative is to structure fledgling businesses to partner their platform technologies with other biotechs or with big pharma or even to be acquired. Not all venture capital companies have adopted this approach, but they all seem to be searching for new investment strategies that work within the confines of the current biotech crisis.
Small Biotechs Face A Critical Juncture
Woefully undervalued stocks are ripe for the picking, and in fact, many are trading at such low levels that they have dropped off Nasdaq because they can¿t meet minimal listing requirements. A substantial number of the companies whose stocks are dragging bottom are actually poised for scientific or regulatory break-throughs this year if they can garner enough cash to keep the business running. If they¿re unable to raise the cash, then they will turn to internal cost-cutting measures layoffs, sale of non-core assets, abandonment (temporary or permanent) of early-stage research programs. But when even those fail to do the trick, these cash-strapped firms face serious consequences.
In fact, there are few remaining choices. One of these is bankruptcy, but in the 20-year history of the biotech industry only a handful of companies have taken this route. A more appealing path as evidenced by the frequency with which companies chose it in 1998 is survival through consolidation.
Increasingly, one biotech is merging with or being acquired by another. But also, for the first time there are indications that the major pharmaceutical houses have stepped up the pace of biotech acquisitions. That message came in loud and clear in late January 1999, when Agouron Pharmaceuticals made the stunning announcement that it had agreed to be acquired by Warner-Lambert Co. for $2.1 billion. If the crystal-ball gazers are correct, the merger and acquisition activities that came to the fore in the second half of 1998 will only become more prominent as the sector undergoes a broad consolidation.
What makes this whole situation so perplexing is the fact that the basic fundamentals underlying the biotech industry have never been stronger. The Food and Drug Administration approved a record number of biotech-derived products in 1998, and there are many more waiting in the wings.
Given the current financing crunch, what can biotech companies look forward to in 1999? According to Dennis Purcell, a managing director at Hambrecht & Quist LLC and head of its life sciences investment banking division, there¿s every reason to be optimistic. The proposed $2.1 billion acquisition of Agouron Pharmaceuticals by Warner-Lambert is a ¿very positive sign for biotech,¿ he said. It signals that biotech products especially approved ones with sales records are still very valuable to big pharma. And this positive message should impact the second-tier biotech stocks including MedImmune Inc., BioChem Pharma Inc., SangStat Medical Corp. and Idec Pharmaceuticals Corp. Those companies, among others, have made significant advances including having at least one product approved for sale yet their stocks haven¿t reflected the value that lies therein.
¿Investors like success,¿ Purcell continued, and by the end of January institutional investors had already begun to show renewed interest in the biotech group. But for the smaller companies, with very low market capitalizations and not much liquidity, 1999 is a crucial year. ¿One of two things will happen,¿ he surmised. ¿Either the equity markets will become more accommodating [to small companies¿ needs for cash] or we will see radical changes in [those companies¿] business plans.¿
Farah Champsi, a managing director and co-head of life sciences investment banking at BancBoston Robertson Stephens Inc., agreed that ¿1999 looks like a pretty tough year in general, but especially for IPOs.¿ She said that ¿there will be lots of private placements and ongoing consolidation, especially for companies with market caps of less than $500 million.¿ She predicts that investors will warm up to an occasional IPO, but only from a company with a solid business model that includes a product or products in late-stage clinical trials, as well as a technology platform that can be used in partnerships and licensing agreements to generate cash in the short term.
Public Financing Dries Up
Biotech and biotech-related companies raised about $5.2 billion in 1998 from the public markets, private placements, and other traditional sources of financing (not counting the amounts raised through milestone payments and equity investments from ongoing corporate collaborations). This amount was strikingly similar to the $5.3 billion that the sector raised from these same sources in 1997 but pales in comparison to the $7.6 billion raised in 1996. To keep things in perspective, however, it¿s important to remember that biotech firms raised a mere $3.9 billion from these sources in 1995 and even less $2.2 billion in 1994.
At first glance, then, it appears that 1998 was a relatively normal year for biotech financing. But upon closer scrutiny, it becomes apparent that the sources of this money have changed dramatically. In 1998, almost all the public offerings, both initial and follow-on, occurred in the first half of the year. By the time the July 4th holiday had come and gone, the financing window had slammed shut once again and remained so through Christmas and into the new year. Even these numbers can be misleading, for about half of 1998¿s initial public offerings took place on foreign exchanges, not ¿at home¿ on Nasdaq or even the New York or American stock exchanges.
This shift does not necessarily imply that the markets are more receptive to biotech stock offerings outside the U.S., either, for companies in the U.K. and on the continent have also experienced a troubled financing environment over the last year or so. It does, however, reinforce the fact that the U.S. markets were colder than usual in 1998 especially when you add in the 10 or so companies that had to withdraw their prospectuses, or at least postpone their IPOs, because the climate was so chilly.
Still, 21 biotech and biotech-related companies made their public debuts in 1998. On top of that, another two companies started trading publicly by alternate means. Cell Pathways Inc., based in Horsham, Pa., came public through a reverse-merger with Tseng Labs Inc. And Genzyme Corp., of Cambridge, Mass., distributed the tracking stock of its cancer division, Genzyme Molecular Oncology, to its shareholders, at which time the stock started trading on Nasdaq.
In 1997, there were 24 biotech IPOs, again making the past two years comparable in many respects. But in 1996, 50 biotech and biotech-related companies came public.
Follow-on stock offerings in 1998 were even rarer than initial stock offerings. All told, only nine follow-on offerings were completed last year, which together raised about $403 million in gross proceeds. The latest, completed in mid-December, was by Salt Lake City-based Anesta Corp. That had been the first follow-on offering since July. In fact, there were no follow-on or initial public offerings at all in the months of August, September and November 1998. In 1997 and 1996, on the other hand, companies raised considerable amounts of cash through follow-on stock offerings. In 1997, 35 follow-on offerings reaped close to $1.6 billion in gross proceeds. In 1996, 66 follow-on offerings garnered almost $2.9 billion in gross proceeds.
Convertible Preferred Stock
Although biotech companies found the public markets less than receptive to their needs, they did manage to round up considerable amounts of cash from other sources. In fact, the leaner the public markets became, the more money flowed from alternate financings. Due to the harsh financing environment, however, many biotechs had to continue to scramble for money throughout the year, resulting in multiple small deals, on the order of several million dollars or less for each.
In 1998, public biotechs raised more than $3 billion from private placements, rights offerings, loans, debt offerings, exercise of warrants and PIPE financings. This is significantly more than the $2.2 billion they raised from these sources in 1997.
One alternate financing vehicle that came to the fore in 1998 was the convertible preferred stock offering. The idea behind a convertible preferred stock offering is to allow the company and its investors to profit from an upturn in its stock price while protecting them both from downside surprises. In an ideal world, the stock price of a company with positive news to announce should go up. If convertible stock were converted at that point, profits would ensue. As well, many convertible offerings have been structured to provide an increasing discount for conversion the longer the investors wait to exercise their prerogative. This facet is meant to encourage investors to hold the stock for extended periods of time. And, in fact, many deals are structured so that the investors cannot convert their holdings for the first 90 days or so. Moreover, savvy companies will structure these deals around upcoming milestones. If the company is expecting to announce preliminary results of a Phase III trial on its lead product in the first quarter of 1999, for instance, it would include a provision that the investors could not convert until the beginning of April. This should work, as long as the clinical trial results are positive and the stock pops up as a result. The risk, of course, is that investors who are interested in short-term gains may decide to sell rapidly when good news hits the wires, thus profiting from the discount. This is also fertile ground for short sellers, who might be tempted to short the stock, forcing its price down so they can buy it back at a lower value.
Of course, if the news is bad, the stock will crash. If the investors have a reset option on the conversion price, they will be protected. The company, however, might not be so fortunate. If its stock has already been trading at precariously low levels, a negative event could be the death knell whether or not there¿s any preferred stock to be converted.
But while convertible preferred stock offerings may be in vogue right now, some industry watchers are concerned that these transactions are not necessarily good for the biotech company since there is a great temptation for short selling and quick profit taking on the part of momentum investors.
The financial institutions that participate in these deals, however, claim that there is every reason for them not to short the stock if they want to preserve their good reputations. As well, these institutions are conservative by nature. Their mandate is to protect their capital investments in the long-term, even when putting cash into very high-risk stocks like biotech. And, according to several fund managers, with close to half the publicly traded biotech companies in need of cash which they are unable to get through the public markets the private placement is the only alternative left.
Even the fund managers who handle these financings claim that they¿re not the correct alternative for every company. But for those willing to place their bets, it could be a gamble worth taking.
According to BancBoston Robertson Stephens¿ Champsi, convertible stock offerings will become ¿an important financing tool for biotech in 1999, especially for those companies with market caps between $500 million and $1 billion.¿ But she warned that not all convertible preferred stock financings are the same: There are those done by ¿quality companies and those done by desperate companies.¿ The former, used successfully in 1998 by firms with market caps of at least $750 million, generally raised sums of $75 million to $450 million. The terms are ¿typically attractive,¿ she continued, and the conversion price is fixed. The latter, which are structured to bail out desperate companies, have gained the nickname ¿toxic converts.¿ Here, the conversion price is not fixed; the holder can thus benefit when the stock price goes down. ¿This type of convert is the financing of last resort,¿ Champsi said. ¿The company has no other way to raise money.¿
Collaborations Sustain Biotech Companies
Big pharma partners provided substantial sustenance to the biotech sector in 1998. For the struggling companies, in particular, these partnerships have proved the saving grace. For through those deals, when structured appropriately, biotech companies are assured of enough money to support at least some of their research projects. They might also have received hard cash up front or an equity investment from the big pharma partner.
Unlike financing from all other sources, however, the money coming to biotech companies from their big pharma partners is harder to quantify. While the up-front cash payments, equity investments or licensing fees are ¿hard¿ numbers, the remainder of the monetary value of these alliances is tied to goals and thus intangible. While one single collaboration could be worth as much as $200 million in pre-commercialization payments to the biotech partner, for instance, that total will only be reached if all milestones are met on schedule and to the big pharma¿s satisfaction. At some point, the pharma company may decide to restructure its research priorities to the exclusion of its ongoing biotech alliances. Or a product in the clinic could fall far short of expectations, thus negating the whole point of the collaboration. There are a number of other conditions that could also prevail to change the original terms or scope of an agreement.
Still, if one looks at the total announced, pre-commercialization value of these collaborations to biotech companies, it¿s easy to see that they represent a substantial source of financing for the biotech industry. In fact, the major pharmaceutical houses have demonstrated unflagging support for biotech companies and their technologies for at least the last five years.
A total of 221 new pharmaceutical R&D-based collaborations were signed in 1998. Together, these had a pre-commercialization value of more than $3.7 billion, not much less than the money that public biotechs raised from public offerings and other sources of financing. On top of that, biotechs received about $260 million in milestone payments and equity investments from ongoing collaborations with the big pharma partners.
Although the amounts attributed to big pharma alliances may reflect best-case scenarios, they also only represent about half the new deals. The other half never discloses the financial details of transactions.
These numbers also don¿t include the large number of ongoing collaborations that were modified in some way during the course of the year. Most modified alliances were either expanded in scope to include more targets or renewed for another year or two some for the second, third or even fourth time. In all, 80 alliances fit this category in 1998, up from 69 in 1997. But there are always a few collaborations that come to an end for one reason or another. In 1998, 24 deals were terminated. This compares to 26 in 1997. Year after year, the attrition rate remains fairly constant at 10 to 11 percent.
And, as biotech companies and their products mature, many more are forging marketing, sales and distribution, or manufacturing agreements. In 1998, biotech companies signed a total of 104 agreements in this broad category, as compared to 83 in 1997. Not all the deals center on the biotech product, however, as some biotech firms are gaining co- or exclusive marketing rights to a traditional pharmaceutical product from a big pharma partner.
And while the majority of partnering deals concern pharmaceutical product development, the agricultural biotech collaborations came into full force in 1998. There were a few alliances between biotech firms and agibusiness giants in 1997 14 new deals with a total stated value of $61 million. But by the end of 1998, the number of new collaborations had jumped to 29, with a total stated value of about $224 million. Like their drug industry counterparts, the giant agricultural conglomerates are tapping into biotech companies¿ capabilities in the fields of functional genomics, combinatorial chemistry, bioinformatics and other new discovery tools, to aid them in creating new crop variants as well as novel insecticides and pesticides.
The landscape for biotech-big pharma alliances continues to evolve, however, and there may be some big changes coming in 1999. For one thing, the merger activity in the traditional pharmaceutical industry shows no sign of abating. As those huge companies undergo restructuring, their priorities will change including alliances with biotech companies. Also, it¿s becoming apparent that many big pharmas are looking for alliances with biotech firms that can offer them a range of discovery and development technologies and services under one corporate umbrella. If so, then many of the small, sharply focused biotech companies could find themselves coming up short in the partnering game and in search of a new sort of shelter.
Big Ticket Deals
Biotechnology companies looking for strong partners from the pharmaceutical industry signed more big-ticket deals in 1998 than in any previous year. While 1997 set the record for the number of drug development and marketing deals that hit the $100 million mark, 1998 will be remembered for those that flew well past this benchmark. Cambridge, Mass.-based Millennium Pharmaceuticals Inc. had already raised the hurdle in October 1997, when it signed a $218 million, broad-based agrigenomics collaboration with Monsanto Co., based in St. Louis. At the time, that deal was the richest partnering arrangement in biotechnology¿s short history. But Millennium broke its own record in 1998, when it signed a $465 million alliance with German giant Bayer AG in late September. Although the eye-popping value of that arrangement stands outside the norm, 1998 still recorded a significant number of collaborations that grazed the $150 million to $200 million point. Among these were Seattle-based Corixa Corp.¿s $200 million vaccine deal with SmithKline Beecham Biologicals SA in late October and Cell Genesys Inc.¿s $153 million alliance with Japan Tobacco Inc. in December.
Other big-ticket deals in 1998 included:
The $111 million expansion in January of La Jolla, Calif.-based Advanced Tissue Sciences Inc.¿s joint venture with U.K. firm Smith & Nephew plc to commercialize wound-healing products Dermagraft and Dermagraft-TC;
deCode Genetics Inc.¿s $200 million gene-discovery collaboration with Swiss giant F. Hoffmann-La Roche Ltd. in February, meant to exploit the unique population database found in Iceland;
The $100 million agreement finalized in March between Cytel Inc.¿s subsidiary Epimmune Inc., of San Diego, and Monsanto Co.¿s subsidiary G.D. Searle & Co. to develop cancer vaccines;
Malvern, Pa.-based Centocor Inc.¿s $335 million purchase of the U.S. and Canadian marketing rights to Retevase, a recombinant plasminogen activator, from Swiss company Roche Holding Ltd. in March;
Oxford, U.K., firm Powderject Pharmaceuticals plc¿s $321 million deal with London-based Glaxo Wellcome plc, signed in March, which is aimed at developing needleless delivery systems for a wide variety of DNA vaccines for infectious diseases;
Palo Alto, Calif.-based Caliper Technologies Corp.¿s $100 million agreement with Hewlett-Packard Co. in May to jointly develop miniaturized lab-on-a-chip technology; and
Coulter Pharmaceutical Inc.¿s $132 million alliance with SmithKline Beecham plc, of London, signed in December, to commercialize the Palo Alto, Calif., biotech company¿s monoclonal-antibody-based therapy, Bexxar, for non-Hodgkin¿s lymphoma.
The pre-commercialization price tag of these deals, however, is not their only distinguishing feature. Importantly, biotech firms are starting to take a much more active role in the partnership ranging from co-development of product candidates in the clinic to co-marketing, or even sole marketing, of approved products and profit-sharing in place of the standard royalty arrangement.
The alliance between Cell Genesys, based in Foster City, Calif., and Japan Tobacco is a prime example. The companies, which have inked an agreement to develop selected products from Cell Genesys¿ GVAX cancer vaccine program, will share equally both the product development costs and the profits. Not only does Cell Genesys get guaranteed funding of $45 million over two years to support the development of vaccines for prostate cancer and one other disease target, but it also gets marketing rights to those products in North America. Thus, Cell Genesys has established a 50-50 profit-sharing agreement worldwide, as well as control over marketing in its primary territory.
In its $51 million alliance with German pharmaceutical giant Schering AG, Myriad Genetics Inc., of Salt Lake City, reserved the right to co-promote all new therapeutics in North America. The partners are exploring the use of Myriad¿s protein interaction database, ProNet, to unravel the biochemical pathways of major diseases. If Myriad exercises its option, it will also reap 50 percent of the profits but it has to pay for half the drug development costs. If, on the other hand, Myriad opts to let Schering handle all the marketing and sales, then the biotech firm has negotiated a ¿substantial¿ royalty arrangement.
Coulter Pharmaceutical, too, is sharing profits with SmithKline Beecham on sales of its anti-cancer drug. The deal is set up so that the partners will jointly market the product in the U.S., as well as share profits equally.
New York-based ImClone Systems Inc. also stands to benefit from the marketing arrangements it has worked out with German partner Merck KgaA. The companies, already partners on ImClone¿s cancer vaccine BEC2 (an anti-idiotypic monoclonal antibody that has been tested in malignant melanoma and small-cell lung cancer patients), signed a second collaboration in December on ImClone¿s cancer drug C225. This product, a chimeric monoclonal antibody that inhibits activity of the epidermal growth factor receptor (which is implicated in more than one-third of solid tumors), is about to enter Phase III trials in squamous cell cancer. The new deal, which is worth as much as $90 million pre-commercialization to ImClone, also gives the biotech company marketing rights in North America. As well, ImClone will control worldwide manufacturing of the product, which it will sell to Merck.
Genomics company Hyseq Inc. is also intent on keeping more rights to products developed with its technology. The Sunnyvale, Calif., company structured its October alliance with Kirin Brewery Co. Ltd. so that it can retain 100 percent of all North American profits and 50 percent of European profits. Under the agreement with Tokyo-based Kirin, Hyseq will use its Gene Discovery platform to target particular genes involved in cell growth regulation from specific cell lines provided by Kirin. The partners intend to co-develop and co-market any pharmaceuticals that result.