The biotechnology industry and those investing in it are maturing. That s not necessarily good news for the many companies still in their adolescence.

No longer will start-up companies and those still in their formative years be able to raise capital as easily as they did in the early years of the industry, based solely on promising preclinical science or early clinical results. Analysts following the industry speak of a bifurcation of companies in the sector, a separation of the proven companies and those with near-term prospects vs. those still seeking validation of their platforms. Investors in early-stage companies have been burned often enough to grow wary of that risk.

At the same time, there now are dozens of biotechnology companies with strong track records of earnings growth or on the verge of turning profitable, so those who want to invest in the industry no longer must take such risks.

That trend is seen in various industry indices.

The 100 biotech companies in Paine Webber Inc. s index were up 45 percent on the year, but a breakdown by size show the stocks of large-cap companies were up 69 percent in 1998, mid-cap companies were up 3 percent and small-cap companies lost an average of 2 percent of their share value.

Contributing to the overall number was growth of 79 percent for companies such as Amgen Inc., Biogen Inc., Agouron Pharmaceuticals Inc. and Genzyme Corp. It was apparent there was bifurcation, where the large-cap names were the ones driving the performance, said Elise Wang, first vice president of Paine-Webber.

Jon Alsenas, a managing director of ING Baring Furman Selz LLC, said the small-cap biotech companies in his index were down 10 percent to 15 percent for the year.

The good news for biotech was primarily in the large caps, Alsenas said. The reality is people can make money in the safe investments. The question becomes, What happens to small companies that now need cash?

Investors now have a bigger set of late-stage and commercial biotech companies to choose from, said Peter Ginsberg, senior research analyst at U.S. Bancorp Piper Jaffray Inc. You can now develop a biotech portfolio based on those companies. Why should we take the risk of an earlier-stage company?

The consensus reluctance against investing in small-cap companies also carried over into those trying to join the ranks of publicly traded companies. For the second year in a row, it was difficult to take a biotech company public, as only about a dozen related to the industry came onto the market in the U.S. in 1998. As of early January 1999, the average percentage change in those companies from the offering price was down 24.6 percent, and the median price was down 46 percent for 10 companies Ginsberg examined.

Analysts don t expect the difficulty seen in bringing a biotech company public over the past two years to change much in 1999.

One area of the industry that does appear constant, however, is its seasonal nature. Biotech companies rallied out of their summer 1998 doldrums in the fall, continuing a cycle seen in years past.

In looking back to the industry s inception in the early 1980s, Ginsberg saw the months of November and January consistently as the best for biotech stock. That s not surprising, he said, in light of the amount of activity at the FDA late in the year and the many medical conferences early each year.

There still is room, though, for risk takers, as all agree that there are plenty of undervalued companies from all tiers of the biotech industry. The key these days, analysts say, is being selective.


That new paradigm of selectivity extended into financing. The amount raised in public, private and follow-on offerings in 1998 was similar to that raised in 1997, but still much less than in 1996.

Companies in the BioWorld Financial Watch newsletter s biotech universe raised $5.4 billion in 1998, just under the $5.5 billion raised in 1997 (both figures exclude money coming in from collaborations). But the amount was 31 percent less than the $7.8 billion raised in 1996.

Paine-Webber s numbers show a fair amount of money raised in the sector, with biotech companies bringing in $5.2 billion, about the same as in 1997. Only $1.1 billion of that, however, was from public offerings, less than half of the $2.3 billion raised in that manner in 1997.

Many small and mid-sized companies in need of money are going to have to be creative, to find ways of raising capital outside the traditional venture and public means. Survivability becomes a key concept with scarce cash.

It s a bit strange, said Matt Geller, senior biotech analyst at CIBC Oppenheimer Corp. We re in a Catch-22 situation in that the only companies that can raise money are the ones doing well and those are the ones that don t need the money. There are a lot of small- and mid-cap companies that need money.

Rachel Leheny, executive director at Warburg, Dillon, Read LLC, doesn t see that scenario changing much in the near term.

The capital markets have not been accessible and probably will continue to be difficult to access, she said. Our estimates are as many as two-thirds to three-quarters of companies will be running out of cash in 18 months or less. We expect to see a number of companies hit the wall in the next year so. We wouldn t be surprised to see a number go out of business, scale down or be bought.

Those that are really strapped, she added, are more likely to be bought at asset value, which may represent a discount to current market values.

Ginsberg said while companies once could do an initial public offering upon entering Phase II trials, they now usually need significant Phase II data and a partnership.

It s a very changed paradigm, that I think it is changed for the good, Ginsberg said. I don t think you ll see investors investing in companies in early stages of development.

That change, Ginsberg said, adds a financing gap of about two years, really changing the financing structure of the whole sector. What do companies do between their mezzanine round and their IPO?

BioWorld Financial Watch noted that 22 biotech-related companies worldwide went public in 1998, half of them in the U.S. They grossed $622 million from those offerings, not far behind the 24 worldwide companies that went public in 1997 and raised $781 million. Those numbers pale when compared to 1996, when 50 biotech-related companies raised $1.6 billion in IPOs.

Alsenas expects there will be some IPOs completed in 1999, but not in the numbers seen in the peak financing years such as 1996.

Primarily, it will be the better-quality stories, Alsenas said. There s going to be closer scrutiny of the science. We were way too permissive in taking companies public in years past. Plus, there are other places now to speculate in hopes for larger returns.

The small companies are going to have to face the music, Alsenas said. Not everyone is beautiful, and not everyone is going to be a star.

Companies with valuable science, but lacking capital, might have to make changes to ensure survival, he said. Those could include mergers between similarly situated companies, or cutbacks on certain programs to focus on the strongest.


Many of the small and mid-sized public companies struggling to access capital also are seeing their stocks pay the price.

Analysts don t see significant changes for most of those money-burning companies, but do believe the downturn across that part of the sector provides selective buying opportunities.

There seems to be very much a bird in the hand mentality, Leheny said. The market continues to be focused on companies with products on the market.

Wang agreed. We generally think the trend will continue. The focus will be on companies with products on the market or that are expected to receive approvals and get launched in the next year or so.

Our general feeling is that small-cap stocks will not rally until the general market conditions for small-cap companies improve, Wang said. When small caps start to rally, it s typically led by the technology group, and biotech is one that follows.

Several companies are undervalued, Wang said. The difficulty is that they would be categorized best as venture opportunities. Until the sentiment shifts back into small caps, they may sit at the levels they are at for some time, particularly if they don t have any products in later stages of development.

Alsenas said portfolio managers, who often are graded each month or quarter, are reluctant to put money into risky biotech investments when there are so many safer yet still profitable bets out there. Also, some funds are prohibited from investing in smaller-capitalized companies.

It takes a long time for the stories [of emerging companies] to evolve, Alsenas said.

The later stage company you invest in, the less risk there is in getting your products on the market, Ginsberg said. It appears that roughly 50 percent of products that get into Phase III will eventually get onto the market. But less than 20 percent of those going into Phase I will make it.


Despite the overall struggle faced by small- and mid-cap companies, there will emerge some that successfully make the transition into profitability, or the move from preclinical results into fully validated technology.

Geller said, There are many early-stage companies with excellent technology, and some with products in Phase III trials that have been virtually ignored. We think there are some of the best opportunities we ve seen in the sector right now with small-cap companies that have not participated in the narrow rally.

Even excellent clinical results, however, don t always translate into buying opportunities, Geller said. A competitive environment, or a company with one product that quickly peaks out sales, could mean an eventual downturn for a stock that appeared to be poised for takeoff.

Many of the traditional tier-one stocks have moved so strongly and are fully valued, Ginsberg said. The goal is to find the next companies that will join that group.

Leheny estimated about 10 biotech products will be approved in 1999. These companies will be the focus, she said. Products that have line extensions are also going to be very interesting and provide good growth.

The market will reward predictability of growth and predictability of earnings, Leheny said.

Some of the analysts favorite companies for 1999:

Jon Alsenas

Trimeris Inc., of Durham, N.C., which has a fusion inhibitor, T-20, that represents a new way of attacking HIV. It had good Phase II results.

Gilead Sciences Inc., of Foster City, Calif., which could have filings for approvals on two products by the end of the year: Preveon for HIV and GS4104, an oral influenza drug being developed with F. Hoffmann-La Roche Ltd. Both are expected to receive priority review.

Transkaryotic Therapies Inc., of Cambridge, Mass., which is in Phase III trials, along with Hoechst Marion Roussel Inc., with a gene-activated erythropoietin product called GA-EPO. Success depends on overcoming certain legislative and legal hurdles.

Centocor Inc., of Malvern, Pa., which Alsenas said could have significant growth if Remicade, a human-mouse antibody that blocks TNF-alpha, shows sales momentum.

Matt Geller

Protein Design Labs Inc., of Mountain View, Calif., which he expects will have eight products in the clinic by the end of the year, licensing deals on a few dozen others, and be profitable in 2000.

Progenics Pharmaceuticals Inc., of Tarrytown, N.Y., which is developing vaccines for melanoma with Bristol-Myers Squibb Co.

Guilford Pharmaceuticals Inc., of Baltimore, which entered one of the largest milestone-based collaborations in the industry when it licensed rights to neuroimmunophilins, an early-stage program for Parkinson s disease and other neurological disorders, to Amgen Inc.

Peter Ginsberg

PathoGenesis Corp., of Seattle. He said the company was ramping up well on its approved TOBI (tobramycin solution for inhalation) product, and sales are exceeding initial expectations. The product also is in late-stage studies for bronchitis.

IDEC Pharmaceuticals Inc., of San Diego, which showed its first year of profitability in 1998 through sales of its monoclonal antibody-based cancer product, Rituxan, which was selling better than expected.

Pharmacyclics Inc., of Sunnyvale, Calif., which is in Phase III trials of its lead product, the radiation sensitizer Gd-Tex, in patients with metastatic brain cancer.

Coulter Pharmaceutical Inc., of Palo Alto, Calif., which plans to seek approval of Bexxar, a radioactive monoclonal antibody therapy to treat non-Hodgkin s lymphoma. It will jointly market the product with SmithKline Beecham plc.

Rachel Leheny

SangStat Medical Corp., of Menlo Park, Calif., which is launching two new products in the transplantation market.

IDEC Pharmaceuticals Inc., of San Diego, which showed its first year of profitability in 1998 through sales of its monoclonal antibody-based cancer product, Rituxan. She is looking for line extensions to further increase revenues.

Trimeris Inc., of Durham, N.C., which had good Phase II data with its novel HIV drug, T-20.

Elise Wang

Amgen Inc., Biogen Inc. and Genzyme Corp., which she believes will continue to have momentum based on solid products, good earnings growth and upside in pipelines.

Alkermes Inc., of Cambridge, Mass., which she expects will have positive news flow in 1999 from its ProLease technology, its deal with Johnson & Johnson, and other areas.

Gilead Sciences Inc., of Foster City, Calif., which could have filings for approvals on two products by the end of the year: Preveon for HIV and GS4104, an oral influenza drug being developed with F. Hoffmann-La Roche Ltd. Both are expected to receive priority review.