By Jennifer Van Brunt
Perhaps biotechnology is still too young of anindustry to be able to ascertain exactly what constitutes a “normal“ or“average“ year in terms of financing. But if one compares the very rich harvestof 1996 with the drought of 1994, then the cash raised by biotech and biotech-relatedfirms in 1997 looks about average. That's not to call it unremarkable, for 1997 was a yearfilled with events that signaled the beginnings of the maturity of this sector of theeconomy. One of those may well be the attitude that investors now have towardbiotechnology stocks: They are being more selective about where they put their cash thesedays. Since biotech is still a high-risk investment, investors tended to shun stockofferings that happened to coincide with other, external events in the market and theeconomy that caused investor jitters. On the other hand, there were plenty of months in1997 when these same investors were more than willing to pour cash into selected offerings— especially follow-on stock offerings from companies with products in late-stagedevelopment, assuming that such an investment carries much less risk than buying stock ina start-up.
Those biotech companies that timed their roadshows for follow-on stock offerings to coincide with the release of extremely positiveproduct news managed to reap bountiful harvests. In August, for instance, it was AvironInc. (NASDAQ:AVIR) of Mountain View, Calif. that cashed in on positive product news,garnering $64.8 million on the strength of the much-reported Phase III clinical trialresults of its influenza vaccine. In July, both Incyte Pharmaceuticals Inc. (NASDAQ:INCY)and Zonagen Inc. (NASDAQ:ZONA) sailed through their follow-on stock offerings, eachbolstered by significant corporate developments. Zonagen, of The Woodlands, Texas, whichhad just completed successful Phase III trials on its male impotency treatment Vasomax,reaped close to $78 million from its follow-on offering. And Palo Alto, Calif.-basedIncyte, which is largely considered to be one of the top biotech players in the fiercelycompetitive genomics game, walked away from its stock offering with $80 million to add toits coffers.
And earlier in 1997, Vertex PharmaceuticalsInc. (NASDAQ:VRTX), of Cambridge, Mass., Human Genome Sciences Inc. (NASDAQ:HGSI),of Rockville, Md., Protein Design Labs Inc. (NASDAQ:PDLI), of Mountain View,Calif., PathoGenesis Corp. (NASDAQ:PGNS) of Seattle, and SangStat Medical Corp.(NASDAQ:SANG), of Menlo Park, Calif., among others, all took advantage of upbeat news tosell more shares to investors.
Big Pharma Deals Strengthen Biotech Firms
But investors also liked some of theyounger companies that decided to become public entities in 1997. Here, the perceived riskwas no doubt tempered by the presence of strong corporate partnerships. For the majorityof the members of the IPO Class of 1997 went into registration with the open backing of atleast one major pharmaceutical partner, which company was willing and ready to buy sharesin the biotech firm – either directly in its IPO or in a private placementconcurrently with the IPO.
In fact, biotech companies have been able touse their big pharma alliances as collateral. For these partnerships lend credibility tothe biotech's technology – as well as its science and management. On the other hand,it's also obvious to everyone by now that big pharma's interest in biotech is crucial forits own success, as well. The major drug houses are in dire need of new drug leads to filltheir pipelines – and biotechnology provides the wherewithal to get those leads.
The frenzied partnering activity between largepharmaceutical houses and biotechnology companies has proceeded without a noticeable hitchfor almost five years now. Even though the global pharmaceutical industry has experienceda series of major mergers and acquisitions during that same time period, theoreticallyreducing the number of potential big pharma partners for biotech firms, there seems to beno end in sight to the potential combinations and permutations of collaborativerelationships between the two sectors of the global community. In fact, not only are theremore new deals with every quarter that passes, but they're becoming noticeably richer. Bigpharma is increasingly willing to spend top dollar to tap into new biotech-based drugdiscovery technologies, especially those that have demonstrated the ability to speed theprocess of identifying new targets or lead compounds or those that are ready to exploitthe flood of raw genetic information that's pouring from efforts to sequence the genomesof humans and other species. There's an awesome amount of information available – thetrick is being able to harness it in some meaningful way. And in its earnestness ofpurpose, big pharma is plunking down huge amounts of cash (now or later) to try to assureits future success.
Asian Market Crisis Caused Stir
Despite the gyrations of the stockmarket in response to the Asian monetary crisis that struck in late October 1997 –which caused reverberations that will be felt for some time to come – biotech stocksmanaged to weather the bumpy ride without suffering too much abuse. But they certainlydidn't outperform any of the major market indicators in 1997; in fact, the average biotechstock managed no price gain at all from year-end to year-end. If anything, the averagestock actually lost about 2 percent of its value between Dec. 31, 1996 and Dec. 31, 1997.This is in marked contrast to the previous two years, when the biotech stocks performedexceptionally well as a group. In 1996, for instance, the stocks gained 18 percent inprice (on average) from year-end to year-end, and in 1995 they gained an average 96percent over the course of the year.
Still, biotech companies were able to raise arespectable amount of money in the year just past. Overall, they garnered about $5.34billion from the public markets, private placements, and other traditional sources offinancing (not counting the amounts raised through milestone payments and equityinvestments from ongoing corporate collaborations). This was a much better record than in1995, when biotechs gleaned a mere $3.86 billion from the same sources, but much lowerthan in 1996, when companies raised $7.55 billion.
Much of that cash raised in 1996, of course,was in the form of public stock offerings, both initial and follow-on. Biotech andbiotech-related firms harvested $4.49 billion from public offerings in 1996; in contrast,they reaped only $2.35 billion in 1997, with 24 companies completing IPOs and 35 firmsraising cash in follow-on offerings. This is just a hair better than in 1995, when initialand follow-on stock offerings raised $2.16 billion.
Although there were 24 companies that camepublic in 1997, the market was not always receptive to biotech IPOs. For the first sixmonths of 1997, only seven biotech firms successfully completed initial public offerings,while an additional 12 completed follow-on offerings.
Much in line with the ups and downs of thestocks over the year, there were periods of time when one IPO-hopeful after another endedup postponing its offering or just canceling it all together. By mid-1997, the volatilityin the public offerings market for biotech stocks had wreaked havoc with the plans of manya young biotech firm hoping to go public.
IPOCandidates Experienced Rough Times
One of those, ChemGenicsPharmaceuticals Inc., formally withdrew its IPO after it received a takeover bid from MillenniumPharmaceuticals Inc. (NASDAQ:MLNM) of Cambridge, Mass., in January 1997. And AlanexCorp., of San Diego, which had filed for an IPO in August 1996 (which it laterpostponed, in October 1996, due to market conditions) was subsequently acquired by AgouronPharmaceuticals Inc. (NASDAQ:AGPH) of La Jolla, Calif., in May 1997. Some IPO-hopefulsfrom 1996 – including Introgen Therapeutics Inc. of Austin, Texas, and ImmusolInc., of San Diego — have yet to try their luck a second time. Yet others –including Cell Therapeutics Inc., of Seattle, and Transcend TherapeuticsInc. of Cambridge, Mass.,– jumped into the offerings game again in 1997 and cameaway successful. But another biotech company that debuted on the public markets was not solucky: in March, Apollo BioPharmaceutics Inc. of Cambridge, Mass., had theexceedingly rare experience of watching its IPO fall apart at the last minute – evenafter the securities had been traded.
By the late fall, after the Asian currencycrisis hit, the markets again became much too inhospitable for many an IPO-hopeful andeven some companies that were considering follow-on stock offerings. The first to react tothe down market in the fall was Affymetrix Inc. of Santa Clara, Calif., whichpulled its follow-on stock offering (NASDAQ:AFFX) in October. But in December, ApollonInc., based in Malvern, Pa. Centocor Diagnostics Inc., also of Malvern, OsirisTherapeutics Inc. of Baltimore and RTP Pharma Inc. of Montreal all postponed orwithdrew their IPOs – each citing unfavorable market conditions. And SciClonePharmaceuticals Inc., based in San Mateo, Calif., which had been planning to sellregistered stock to institutional investors, pulled its offering as well.
As 1998 unfolds, it appears that it will besome time before the public markets open their arms to biotech stock offerings. So, in theinterim, biotech companies are once again turning to creative financing structures, asthey have in previous periods when traditional sources of cash were not readily available.
In fact, the bulk of the cash flowing intopublic biotech companies by the beginning of February 1998 has come not from the publicmarkets but rather from alternate financing vehicles, especially private placements ofconvertible preferred stock.
Creative Financing Structures
Even in 1997, there was strong evidenceof the cash-generating potential of alternate financing schemes. One unique twist came inthe form of the royalty interest transaction that Xoma Corp. executed with NewYork-based Pharmaceutical Partners LLC. This type of financing structure, which hasbeen used successfully in the entertainment and gold mining industries, allows Xoma toexchange uncertain future product royalties for immediate cash. The Berkeley, Calif.biotech firm (NASDAQ:XOMA) raised $17 million at the end of December by selling its rightsto royalties from sales of the anticancer drug Rituxan to Pharmaceutical Partners, a firmcomposed of ex-PaineWebber employees. Xoma had licensed the exclusive rights to itsanti-CD20 antibody patents to South San Francisco-based Genentech Inc. in May 1996;Genentech then sublicensed those rights to Idec Pharmaceuticals Corp., of SanDiego, for use in the firms' recently approved chimeric monoclonal antibody productRituxan for treating non-Hodgkin's B-cell lymphoma. Together with the $3 million upfrontlicensing fee it received in 1996, Xoma has realized $20 million off this license. Thefuture royalties from product sales of Rituxan now go to Pharmaceutical Partners, which istaking the risk. Of course, if the product is a real blockbuster, Xoma could lose in thelong-term, but in the short-term, it's got the cash on hand to fund further development ofits own core products.
Biotech companies have also turned to anotherfinancing vehicle that's worked for other industry sectors – the undervalued sharetransaction. This type of financing involves buying and selling options on stocks;although there are variations on the theme, in general, the structure allows a company toprofit from an increase in the price of its stock without an upfront cost.
In 1997, three biotech companies arrangedundervalued share transactions – Lexington, Mass.-based InterneuronPharmaceuticals Inc. (NASDAQ:IPIC) in May, Idec Pharmaceuticals (NASDAQ:IDPH) inSeptember and Salt Lake City-based Myriad Genetics Inc. (NASDAQ:MYGN) in October.All three biotech firms dealt with the same financial institution – SBC WarburgDillon Read Inc. of New York. According to managing director Eric Roberts, “thesetransactions are well suited to companies with a market capitalization of greater than$250 million.“ But they also depend on an active trading volume to make the deal workcorrectly. “An options contract becomes less valuable if there's not active tradingbecause the financial institution can't offset its position easily,“ Roberts added.
There are a number of biotech companies thatfit this bill and these days, there's little doubt that their stocks are down. It shouldcome as no surprise that Dillon Read has received enormous interest from other biotechfirms regarding this type of financing alternative.
Undervalued Share Transactions Gaining Popularity
Although the details of the individualtransactions vary, all three have a similar overall structure. The biotech company buysand sells call options of its own stock with no net expense to the company. The calloption that the company buys gives it the right – at expiration – to purchasefrom Dillon Read a defined number of shares of its own stock at a specified strike price,which is above the market price of the stock when the transaction was initiated. Thebiotech company will probably settle this first call option in cash (the differencebetween the price of the stock and the option strike price), with a cap on the totalproceeds it is entitled to receive. If the price of the stock at expiration closes belowthe strike price of this first call option, then the biotech company gets no money –but it hasn't spent any, either.
The second call option, to be sold by thebiotech company, gives Dillon Read the right, at option expiration, to purchase a defined(often identical) number of newly issued shares of the biotech firm's stock at a specifiedstrike price, which again is significantly higher than the biotech's stock price at thebeginning of the transaction. Should this call option be exercised, the biotech firmdelivers shares to the financial institution in exchange for an amount per share equal tothe strike price. Should the biotech's stock close at expiration above the strike price ofthe second option, Dillon Read gets the shares at a discount to market. Should thebiotech's stock close below the strike price, however, the company would neither delivershares to the financial institution nor receive or spend any cash.
“This type of financing takes advantageof the volatility in stocks, and volatility is one of the biggest drivers of value [inoptions trading],“ explained Dillon Read's Roberts. And the financial institution iswilling to pay for that volatility because it's more than likely that the options will be“in the money“ at some point in the future, he continued. However, Robertscautioned that the undervalued share transaction is not the right structure for everycompany. It's a good way for a company to raise money at a lower cost to itself (nounderwriting fees, for instance, as in a public offering), but it's not an alternative fora company that is in desperate need of cash, he said.
The new collaborations and licensingagreements – which are focused mainly on drug discovery and development and for thisanalysis do not include marketing, manufacturing and distribution agreements –between biotech firms and big pharmas have grown from a mere 69 new alliances in 1993 to226 nascent relationships in 1997. That's an increase of more than 225 percent in justfive years. Likewise, the total value of these new alliances has surged from about $1.38billion in 1993 to $4.36 billion in 1997 – an increase of more than 215 percent. Butbecause only about half of all announced collaborations each year for the last five yearshave ever disclosed the potential pre-commercialization worth of the transaction to thebiotech partner, there's not necessarily a direct relationship between the two measures.
There's another caveat that goes with thesefigures: They apply to new, R&D-based alliances only. Not only do these numbers nottake into account biotech-big pharma relationships that can be classed as strictlymanufacturing, supply, marketing, sales and distribution transactions (which have alsogrown considerably over the last few years), but also they do not include alreadyestablished research collaborations that have been renewed, expanded or extended by thebig pharma partner. They also do not include the 14 new agbiotech-related research anddevelopment collaborations that were formed in 1997 (those deals are included in the 1997charts in this report, however).
Nevertheless, over the span of five years,biotech firms, both private and public, have forged a total of 757 new drugdiscovery-based partnerships with big pharmaceutical companies. Those deals lumpedtogether are worth a stated value of $13.7 billion in pre-commercialization payments(assuming, as always, that the terms and specific goals of any individual collaboration asoriginally outlined stand up to the test of time). Of those 757 new deals, a handful standout merely because they are so exceptionally rich. These are the individual collaborationsthat are worth at least $100 million in pre-commercialization payments to the biotechpartner. >
Millenium, Monsanto Deal Among Biggest
There's no doubt that the $218 millionbroad-based genomics collaboration struck between Millennium and agricultural giant MonsantoCo. (NYSE:MTC) of St. Louis in October is the most deluxe deal of all times in thebiotech partnering arena. But since Monsanto's focus is on agricultural biotechnology,does it even qualify? Most assuredly so – after all, it's the technologies that takethe lead, whether they are applied to improving drought resistance in wheat or creating adrug for treating obesity. Plus, Monsanto gets use of Millennium's technologies across allareas of the life sciences, including pharmaceuticals, the focus of its G.D. Searle& Co. subsidiary, which is located in Skokie, Ill. And since Millennium has therights to use any technologies developed by Monsanto's new subsidiary – which it isestablishing in Cambridge just for this collaboration – in areas outside the plantand agricultural fields, there's no telling what new human health applications couldemerge from the partnership.
Ligand Pharmaceuticals Inc.'s October dealwith pharmaceutical giant Eli Lilly and Co. of Indianapolis, also is ripe withprospects. Not only is it worth as much as $194 million to San Diego-based Ligand(NASDAQ:LGND), but also it's been structured such that Ligand can tap into Lilly's arsenalof drugs if it so chooses. The alliance also gives Ligand a strong partner to continue thedevelopment of drug candidates that were under the aegis of its former joint venturecompany Allergan Ligand Retinoid Therapeutics Inc.
Biogen Inc. has also struck gold throughits $145 million partnership with Merck & Co. Inc., of Whitehouse Station,N.J., on drugs for treating asthma and other inflammatory diseases. The deal, signed inDecember, is the first major R&D based collaboration that Biogen, of Cambridge, Mass.(NASDAQ:BGEN), has signed with a big pharma company in years. (The others have been mainlylicensing deals, which by themselves have proved to be a reliable source of income forBiogen through royalty streams.) Importantly, Biogen has not only kept rights to itstechnology (which involves inhibiting VLA4 receptor molecules found on the white bloodcells that migrate to sites of inflammation) for smaller indications of its choosing– especially multiple sclerosis, where it already has a marketing presence – butalso it has established a presence in the Japanese market through an arrangement with anaffiliate of Lilly's.
Another new member of the 100 Million DollarClub is Aurora Biosciences Corp., of La Jolla, Calif. – a relative newcomer tothe biotech scene but already facile at the art of productive partnering. In December,Aurora (NASDAQ:ABSC) inked a $100 million deal with Merck, giving the big pharma partneraccess to its ultra-high-throughput screening system (UHTSS) as well as its other drugdiscovery technologies. In fact, Merck will help foot the development costs for UHTSS– along with Aurora's other UHTSS syndicate partners Bristol-Myers Squibb Co.,of New York, Lilly, and the Parke-Davis division of Warner-Lambert Co., ofMorris Plains, N.J.
Even an occasional marketing arrangement canhit the 100-million-dollar-mark, as evidenced by the fact that Immunex Corp.'smajority owner American Home Products Corp., of Madison, N.J., through itspharmaceuticals division Wyeth-Ayerst Laboratories, announced in September that itwas going to shell out $100 million for the North American marketing rights toSeattle-based Immunex's (NASDAQ:IMNX) promising rheumatoid arthritis drug Enbrel. Asuccessful drug to treat this debilitating disease, which afflicts 2.5 million individualsin the U.S. and twice as many worldwide, could be a huge seller – as much as $1billion annually, according to analysts. It's no wonder that American Home Products iswilling to spend so much for the marketing rights.
There were many other super-rich alliances in1997, those that hit the 100-million mark – or more. Details regarding all these canbe found in the collaborations charts that follow on pp. 101-199.
But all together, a total of 25 out of the 757 newR&D-based biotech-big pharma collaborations signed between 1993 and 1997 qualified tojoin the 100 Million Dollar Club. That's only about 3 percent of the total, but it appearsthat the number of qualifying deals has begun to escalate in the last year – so lookfor bigger and bigger deals in 1998.