Biotech Story: Products, Not Promise, Is What Matters –

Two years ago biotechnology seemed poised to improve everything it came into contact with, raking in exorbitant amounts of funding with the promise that projects like the human genome would transform an industry with revolutionary products and breakthrough pharmaceuticalws.

More recent history, however, indicates the life science stratosphere incurred a similar fate as the technology bubble. Headlines that once trumpeted exciting new drug discoveries now tout clinical trial failures. And early hopes for a renewed IPO exit strategy in 2002 were effectively derailed in April, as investors trained-wrecked two biotech-related pricings.

Most troubling still, some of private equity’s biggest money-wielders, like Warburg Pincus, haven’t invested in a private biotechnology company for over a year.

Yet it appears the biotech story goes as deep as its science fiction roots, constantly reinventing itself. This places the industry in an interesting predicament. IPOs are down, but not entirely out; mergers and acquisitions loom on the horizon, say experts, with 2003 and 2004 looking strong.

And while some private equity investors complain that valuations for most private companies remain too inflated to be attractive, others argue the entire industry has been painted with too broad a brush, that the high valuations in some areas, say therapeutic biotech products, are justifiable.

The air needs to be cleared on one point – disbursements aren’t all that diminished from two years ago. This year, the average amount a biotech company received has been $10.5 million, according to VentureXpert; last year that figure was $11 million and in 2000 it was $12.6 million.

Investment focus this year has shifted in favor of companies with tangible products, not “promising” genome technology. For example, of the 103 companies that had received just over $1 billion in funding through April, therapeutic biotech product makers and analytical instruments and apparatuses related to life sciences benefited the most. The 29 companies pulled in $399 million in funding, according to VentureXpert. By contrast, just five human biotechnology companies have been funded this year, compared to 27 in 2001; last year 13 DNA/RNA probe companies received $96.5 million in funding while this year there’s been zero.

As it turns out, there aren’t that many companies touting a product-driven story, meaning that more capital is chasing fewer candidates, which has helped valuations remain steadfast. But this, coupled with the hurt that public investors have put on stock prices throughout the industry, has some PE firms sowing new ground to fund.

Take Warburg Pincus, which closed its latest fund, Warburg Pincus Private Equity VIII L.P, in April at a beefy $5.3 billion. The private equity firm has 30 companies in its health-care portfolio, which includes biotechnology, with a value of almost $1 billion, according to Managing Director Jonathan Leff, who heads up the firm’s biotech investing. Out of the new Fund XIII, Leff stated the firm is looking to invest $20 million to upwards of $100 million in individual biotech companies. Yet the first two biotech investments made through the new fund were both public companies, Synaptic Pharmaceutical and Triangle Pharmaceuticals.

“At any given time certain parts of the financing markets will be overheated, and right now that’s the private markets. The mezzanine investing opportunities, we think, are overheated and as a result, we’ve not made any private investment in biotech since 2000,” Leff says. The firm’s current perception is that valuations have not come down all that much since the bubble burst two years ago. “We’re still seeing private deals for late-stage companies being done at valuations that are far in excess of what comparable public companies are valued at. And that, as a sustainable proposition, doesn’t make a lot of sense.”

The two pharmaceutical companies in which Warburg Pincus invested carried valuations comparable to, or less than, when they were very young private companies being financed, according to Leff. Synaptic, for example, had an enterprise value of $40 million when Warburg Pincus cut its check, despite well over $150 million of capital that had been invested in the company over 14 years.

But the punishing stock market story is being wielded against almost all private biotech companies a bit too ruthlessly, say others.

In walking the triangle among the clients of his management consulting firm – which include pre-IPO companies, investment banks and venture capital firms – David Webster, president of Webster Consulting, believes the venture capital community has done its best this year to exploit the jittery market.

“The VCs are like sharks now, they smell blood in the water,” says Webster, noting biotech issues are unjustly being slammed because of the general distaste investors have for all public companies without profits. “These biotech companies are somewhat desperate so the VCs can feed them stuff like the public markets are closed’ and use that to drive down valuation,” Webster adds.

Word is out that the so-called “Big Pharma” industry is on the hunt for products to replenish its diminished pipeline. This has contributed to private valuations remaining high, even though the IPO market is out of range.

“The terms of deals have totally changed. Big Pharma is getting desperate and that’s good for companies that haven’t licensed or partnered at rates seen in the late 90s, which were very low. Biotech [companies] got 3%,” Webster says. “These recent rates are up to 50%, and some are getting their cash up front.” A company taking a product through Phase II testing on its own will benefit much more from Big Pharma, than from venture capital, Webster believes. “CEOs need to have some khutspah’, which is tough if you’re running out of cash and you keep hearing all these horror stories.”

Why are big pharmaceutical companies entering the biotechnology picture this year? Because its previous spending aimed solely at growth, less money went into R&D. Pipelines are now running dry of new drugs just as patents on older drugs are running out.

“People historically believed that bigger is better from a pharmaceutical perspective, to have scale for scale’s sake,” says Russ Hagey, managing director at Bain & Co. in Los Angeles. “The surprise [from the study] was that the companies who were most successful from a growth, profit and market value standpoint were more narrowly focused. There is more value to focus than there is to scale.”

The consulting firm recently completed a six-month study, “Trends in Biotechnology,” which found that scale and focus are major drivers of profitability. It went on to say that for medium size pharmaceutical companies, in particular, focus on the therapeutic area and/or value chain step will be inevitable for future survival. Furthermore, biopharmaceuticals constitute almost half of the newly approved new medical entities. Up to now, proteins in replacement therapy have been a major portion of biodrugs. However, the use of biopharmaceuticals in direct therapy will increase. In addition, conventional drugs benefiting from genomic research will lead to increased competitive pressure in all therapeutic areas.

More Focused Story

For companies expecting to seek a capital infusion in the near future, the operative word is focus.

Take Silico Insights, a Woburn, Mass.- based company that two years ago received seed funding to leverage the wealth of data being put out by genomics researchers, said Dr. Nandan Padukone, Silico’s president. Today, however, Silico is working with the University of Utah’s Huntsman Cancer Institute on skin cancer, specifically melanoma, its most dangerous form.

“Customers pushed us early 2001 into expanding into research and in the middle of last year we got a lab in place that focused on the protein side of research,” says Dr. Padukone. “Now our business model is based on being technology driven small business, and the bulk is attracting alliances rather than all in-house. We bring our proteins, they [Huntsman] have cancer experts and by combining the two sets we hope to get to these answers,” Dr. Padukone adds.

Initially backed by $2 million in a Series A round led by Moss Forest Ventures, in May of 2000, Silico will launch a formal campaign in the coming three to six months, seeking to raise $10 million to $15 million.

Despite its proteomic roots, Dr. Padukone believes investors will be attracted to Silico because the company has evolved with the changing climate. “Computational tools will never go away, it’s how you add value, that’s the question. Investors are looking to put more money in later stage deals and companies are pressed to show a pipeline full of prospects. We were able to create a story that was very credible with computational tools and a focused research plan. It’s a very specific oncology focus,” he says.

Contact Colleen O’Connor at: