At the recent JP Morgan/H&Q Healthcare Conference, the mood of the attendees was somber. This is a reaction to the fact that 2002 was one of the most difficult years in the history of the biotechnology industry. The Amex Biotechnology Index (BTK) was down more than 40%, which is its worst percentage loss since 1992. As every participant in the biotechnology space knows, it has been a continuous tale of woe in biotechnology since the year 2000. Amplifying this dismal environment is the statistic that almost half of the public biotech companies have a negative enterprise value. The question in the hallways at the conference was: “Is the worst behind us and have we rectified the problems that created this dramatic downturn?”
One might ask how we got to where we were in the past year. The first factor that stands out is issues at the Food and Drug Administration. There is no other business that is as dependent upon a regulatory body as the biotech sector is upon FDA actions. The FDA has been leaderless for the last two years and has adopted a less accommodating attitude at a time when product submittals were at a peak. Whereas the FDA was turning around applications on a 10 to 12 month basis in 1998 and 1999, the process slowed to 18 to 24 months in 2001 and 2002. Exacerbating the lengthy application process was the fact that the number of clinical failures experienced in 2002 was above normal, reflecting more conservatism at the agency. The good news is that we now have a very qualified FDA commissioner, and the pipeline of new products that will be reviewed in 2003 looks very promising.
Let’s Get Real
The second problem area has been unrealistic expectations of the impact of the sequencing of the human genome. The fact is sequencing the human genome does not mean that we will immediately see new products. The announcements that were made in late 1999 and early 2000 resulted in a windfall for biotech mutual funds, a flourish of new startups, and an Internet-type herd mentality that drove up public stocks and private valuations. In 2001 and 2002, the realization occurred that expectations were unrealistic and genomic companies suffered a major setback. There is no question that there will be products produced as a result of the genomic era and that the practice of medicine will experience a dramatic and positive change, but this will not happen overnight.
Image Consultant, Please
The third negative overhang had to do with the corporate scandal at ImClone that damaged the creditability of the heretofore “lily-white” industry. This made a lot of public investors believe that biotechnology is too risky, and they departed from the sector.
So, where are we as we enter 2003? There is absolutely no denying that there are many positive attributes in the biotechnology sector. This is a young industry, a little older than 25 years. There has been significant progress in these 25 years. For example, many of the biotechnology companies created by venture capitalists have turned profitable. There are more than 150 products on the market that have been created by biotechnology companies and another 915 products in the pipeline. Annual biotechnology sales exceed $20 billion and are growing at a rate of close to 20% per annum. From the standpoint of EPS growth, the five most successful biotech companies are outperforming the five most successful pharmaceutical companies. Pharmaceutical industry pipelines are bare and they are very dependent on biotechnology for innovation. As an example, the average size of an alliance between a biotech company and a pharmaceutical company has increased from about $40 million in the early 1990s to about $100 million in the new Millennium. The major technology breakthroughs in the genomic and post-genomic era have come from venture-backed companies.
These fundamentals lead one to believe that 2003 won’t be a banner year in the sector, but it will definitely be an improvement over 2001 and 2002.
Among the challenges facing venture capital biotech investors is the question of whether there is too much money in the segment. A lot of new funds were raised in the last couple of years and a lot more money has been allocated to biotechnology. In a typical year in the early 1990s, 100 to 150 companies received funding, with the overall amount invested in that decade totaling about $1 billion. In the current decade, about 200 to 250 companies are getting funded annually, and the annual investment total is close to $3 billion per year. Limited partners are asking if there is too much money chasing too few biotechnologyh good deals.
There is also evidence that “me too” companies are being funded, which is not a positive sign. We have seen some excesses but nothing close to what was done in information technology. The more experienced biotech venture capitalists tell me that they have “raised the bar” and become increasingly more selective. Another challenge for venture capitalists and young venture-backed biotech companies is that the pharmaceutical industry is facing its most difficult economic period in its history. Big pharmaceutical companies need the innovation created in biotechnology companies, but decision-making in those corporations has slowed and there have been major delays in closing alliances.
In summary, 2003 will be challenging, and the cyclical nature of the business will impact company performance. This year will test a venture capitalist’s conviction, persistence and ability to keep companies financed during a difficult period. In the long run there is no question that this is a profitable sector.
Samuel Colella has been a biotech investor for the past 17 years and is a co-founder of life sciences firm Versant Ventures, which manages more than $650 million. Colella previously spent 17 years with Institutional Venture Partners (IVP). He funded and helped take public Argonaut Technologies, Aviron, CV Therapeutics, Onyx Pharmaceuticals, Pharmacopoeia, Symyx Technologies, Tularik, Vivus and others.