WASHINGTON _ The unrelenting bear market for biotechnologystocks has begun changing even the traditional behavior of venturecapitalists (VC) in 1994. Prices have gotten so low that some arebuying stocks on the open market.The key to VC firms' lucrative investing strategy _ buying stock inprivately held start-ups at pennies or dollars per share and selling themat 10 times that after the companies complete initial public offerings(IPO) _ has been turned on its head of late. The current drought in thepublic equity markets and the low valuations of some public biotechcompanies has forced a reexamination of the VC profit paradigm.As a result, some firms are betting they can reap richer rewards bybuying shares in public biotechnology companies than by starting upnew ones. (See the chart on p. 3 for a list of top VC buyers of publicbiotechnology company stocks in 1994)."The imperative for high internal rates of return compel VCs to lookvery carefully for where they can get a return on their investors'money," said Mark Edwards, principal of the financial consulting firmRecombinant Capital in San Francisco. "The fact that some are findingthose opportunities in public stocks should send a strong signal to therest of the market about the short- to medium-term potential of thosestocks."Edwards even ventured to guess that the aberrant VC behavior maysuggest that biotechnology stocks have hit the ever-elusive "bottom"that could halt their slide into oblivion. "Perhaps the bottom is not aplace or a specific value anymore but rather a change in perspective. Ifthat's so, one of the signals that we've hit bottom would beknowledgeable, return-sensitive insiders buying public stock," Edwardstold BioWorld.Genetic Therapy Inc. (GTI) CEO Jim Barrett offered a somewhatsimpler explanation for VC behavior: common sense. "There's amethod to this madness," said Barrett. And the method is that used byany bargain hunter. GTI is a gene therapy company based inGaithersburg, Md.Buying On Open Market Like GangbustersVC firms have been buying GTI stock on the open market likegangbusters this year. New Enterprise Associates (NEA) headquarteredin San Francisco and Oxford Bioscience Partners, of Stamford, Conn.,snapped up about $1.3 million worth of GTI shares between the two ofthem in the first six months of 1994. The two firms paid about $9 pershare."When a market gets trashed as badly as biotech has, it's notunreasonable for VCs to look at public companies," Barrett toldBioWorld. "Our cash resources alone are worth $5.60 a share. Thatmeans the technology value of this company is hovering around $5 pershare right now. That's a spectacular bargain. That's a public securityat a private stock valuation."Barrett added that VC firms get some big bonuses from buying stock inpublic companies they know well. First, they get to skip the torturousprocess of due diligence that they must perform on all private companycandidates for funding. (Public companies must disclose all materialinformation publicly.) Second, the stock is liquid from the start, notlocked up for pre-specified periods as are the shares of privatecompanies.NEA general partner Charles Newhall, based in Baltimore, said thatNEA buys stock in public companies only rarely, when extraordinaryopportunities present themselves. "We did it after the stock marketcrashed during '87 and in the depths of the Desert Storm depression,"Newhall told BioWorld. "This is the biotech equivalent of thosecatastrophes."Oxford general partner Alan Walton said his firm has only boughtpublic securities twice in the 13-year history of its partnership. "It's avery unusual occurrence," he conceded.Take the case of CoCensys Inc., an early-stage company in Irvine,Calif. that is developing neuropharmaceutical products for centralnervous system disorders. The company went through a relativelystandard series of step-ups in selling its stock when it was still private:a Series A round at 0.25 cents per share in 1989; a Series B round at$1.50 per share in 1990; and a final Series C round at $5 per share in1992. The company debuted on the public market in January of 1993 at$9 per share.Two of the original VC investors in CoCensys were SanderlingVentures of Menlo Park, Calif., and Domain Associates of Princeton,N.J. Both firms bought shares in the early rounds and both boughtshares in the pre-IPO Series C round (Sanderling bought 200,000 at $5per share and Domain bought 600,000).In total, Sanderling poured $1.85 million into CoCensys while it wasstill private in exchange for 1.1 million shares (14.5 percent of thecompany post-IPO). In the first six months of 1994, Sanderling hasbought another $921,641 worth of stock on the open market (a total of191,414 shares). The firm paid between $4.56 and $5.10 per share forthe stock, about the same price it paid pre-IPO.The bargain basement prices weren't lost on Domain either. ThePrinceton firm has bought 79,438 shares (also for between $4.56 and$5.10 per share) so far in 1994 for a grand total of $382,487."We bought this company three years ago for $5 a share and thecompany has made phenomenal progress since then," Domain generalpartner Jim Blair told BioWorld. "If we thought it was worth $5 threeyears ago why isn't it worth at least that today?"Blair said it's become increasingly clear that the real returns onbiotechnology investing come only after a company's products havereached the marketplace. "The real win for us, if we were right on theoriginal investment, is going to come when these products hit themarket. If that's so, why sell the stock now? Why not wait?" n

-- Lisa Piercey Washington Editor

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