M&A Exits Prevail In Life Sciences –

With the tech boom over and done, an increasing number of venture capitalists have refocused their attention toward the life sciences sector. Last year the industry captured $5 billion, or one-fourth, of all 2002 venture investments, according to the PwC/VE/NVCA Money tree survey. That compares with just 12% in 2001. And this year, experts are predicting that life sciences companies will gain even more venture capital funding, as many feel it’s the only area that never really goes totally out of favor.

But while life sciences companies may be collecting more venture dollars than other sectors, they’re still trudging along with the rest of the pack when it comes to the IPO market. Like all venture-backed companies, life sciences startups are withdrawing more IPOs than they’re completing. In fact, only two venture-backed life sciences companies made their way to the public market last year: BioDelivery Sciences International Inc. (Nasdaq: BDSI) landed with an opening price of $3.30 and is now trading at $2.78, and Zymogenetics (Nasdaq: ZGEN) debuted last year at $12 and is now trading at $9.40. Across all sectors, just 24 venture-backed companies went public, according to Thomson Venture Economics and the National Venture Capital Association.

In contrast to the virtually nonexistent IPO exit, there were about 40 venture-backed life sciences M&A transactions done in the U.S. last year, valued at $1.9 billion. (The venture-backed M&A market as a whole saw 300 transactions valuing $7.2 billion last year.) Part of that has to do with big pharma companies determining that current valuations are low enough to justify buying a startup to help broaden its product line or increase its revenue. The largest domestic life sciences acquisition of last year came when health care provider AmeriChoice withdrew its $115 million IPO from the calendar and was acquired by UnitedHealth Group Inc. for $530 million.

“I really don’t think there has been a surge of M&A activity, but those are the only kind of deals that are getting done,” says Luci Staller Altman, a partner with Troy LLP’s securities and technology’s corporate department. “However, like the IPO market, the pricing has changed and companies are acting much more measured. It may seem like life sciences is seeing all this great activity, but it’s just because it wasn’t always a high flyer. I think the life science buzz started when some big investments got made into genomics, proteomics and nanotech.”

An investment banker who focuses on life sciences agrees that an M&A exit is the most logical move given the market conditions. “M&A makes the most sense right now and life sciences is back in the spotlight because, let’s face it, we will always need new drugs. Now is a great time to buy companies. We’re not seeing this huge surge in M&A activity, but these types of deals are definitely getting done. You used have to spend $800 million or even $1 billion to pick up a company. Now a big company can get good drugs for $250 million. It’s a drop in the bucket for them.”

Indeed, plenty of big companies in this space are doing acquisitions. Boston Scientific, a Natick, Mass.-based maker of devices that treats vascular problems, last year acquired: Inflow Dynamics, a stent-flow technology based in Munich, Germany; Smart Therapeutics Inc., a San Leandro, Calif.-based company that makes devices designed to treat brain aneurysms; Enteric Medical Technologies Inc., a Foster City, Calif.,-based company that designs, manufactures and markets a liquid polymer technology for the treatment of gastroesophageal reflux disease; and BEI Medical Systems Co. Inc., a Teterboro, N.J., maker of therapeutic products focused on gynecology.

Johnson & Johnson was active as well, acquiring: Tibotec-Virco, a Mechelen, Belgium-based developer for the treatment of infectious diseases including HIV; Obtech Medical AG, a Swiss company that markets the Swedish Adjustable Gastric Band (SAGB); OraPharma Inc., a Warminster, Pa.-based pharmaceutical company focused on the development and commercialization of unique therapeutics; Yardley, Pa.-based 3-Dimensional Pharmaceuticals Inc., a company with a technology platform focused on the discovery and development of therapeutic small molecules; Scios Inc., a Sunnyvale, Calif.-based biopharmaceutical company with a marketed product for cardiovascular disease and research projects focused on auto-immune diseases; and Orquest Inc., a biotechnology company focused on developing biologically-based implants for orthopedics and spine surgery.

“Things are pretty bad right now, but late-stage technology and drug companies are doing okay, because big pharma will buy them out. We are seeing lots of biotech and life sciences companies popping up every year, so consolidation isn’t bad. On the other hand, a company like Scios could have gone public if the markets had permitted,” says Rodney Ferguson, a partner with JPMorgan Partners’ life sciences team. “At any rate, the big pharmaceutical companies are willing to buy almost anything that gives them a product. They don’t do much product development themselves, so they need to acquire late-stage companies, and they are more than willing to pay.”

However, while big pharma is perhaps benefiting from the stingy exit market, venture-backed life sciences companies are selling out for a lot less than if they had been able to go public. “The money that these small private companies is losing on their sales is enormous, but they get to a point that they are strapped for cash, and that’s how it goes sometimes,” says the investment banker. “But even when the IPO market does come back, we won’t see the valuations that we did during the tech bubble.”

Even so, having more than one way out of an investment would certainly make VCs feel a lot more secure. Robert Liptak, a general partner and chief financial officer with MPM Capital, says that his life sciences venture firm has seen more M&A activity than ever before and accepts M&A as the only option right now. Epic Therapeutics, a drug delivery company that collected $11 million from MPM, was just recently acquired by Baxter. “We always just assumed Epic would be public one day…[as well as] Indenix Pharmaceuticals, which we were the largest shareholders in, but you can’t assume that anymore,” says Liptak.

With Indenix, which develops antiviral therapies for AIDS and HIV, Liptak says his team took a look at where it was and decided that selling it to Novartis was the only way to get the company to the next level. “At this point it was really in the company’s best interest,” he says. “If the IPO market doesn’t come back soon, it is going to be a problem. A lot of life sciences companies have raised a lot of money and are going to need to exit in 2004, [and] if they can’t lots will be lost.”

Spending Vs. Selling

MPM is not alone in its decision to sell off their life science portfolio companies rather than put more money into them. Just this year, Charter Ventures sold Eos Biotechnology Inc. to Protein Design Labs Inc.; assets of Orquest Inc. to Johnson & Johnson; and Centaur Pharmaceuticals to Renovis in $35M cash/stock deal.

“When we fund a company we want to make sure they have enough money to last them, but you can’t just indefinitely put money into companies. We have decided that certain portfolio companies won’t even try to go for the public markets, and there are advantages to that,” explains Barr Dolan, a partner with Charter Ventures. Instead of building out massive public companies all the time, Charter has taken another route that Dolan says nets them a good return. If Dolan knows a company is going to be an acquisition target, the venture firm won’t let the company waste money on adding full-time employees, a long-term lease for a large R&D space or a sales and marketing team.

“We’re practical. And for the past 15 years VCs have been saying that the industry needed to be consolidated. This market is forcing that because companies need the cash and big pharma is willing to pay,” says Dolan.

Furthermore, David Gerhart, managing director with Capital Network Events, a venture advisory firm, thinks venture firms have no choice but to take whatever exit is available to them. “There’s no doubt that the best option for VCs is a direct sale to either a biotech company or big pharma. VCs are making tough decisions, they can’t just keep hanging on to company and they will exit as they can. It might not be what they prefer, but if that’s all that’s available then they will do it,” says Gerhart.

While many agree that the IPO market will return soon for venture-backed life sciences companies, it may not been soon enough for venture capitalists. “It’s hard to say right now because the war threw an additional crank in the system, but at the very earliest, the IPO market could open up again by the third quarter and I think life sciences will be one of the first ones the market comes back for,” the investment banker says.

Many others think 2004 is more realistic. “We’re not going to see one a week, but by next year the market should be there again,” Liptak says.