"Biotech's Small-Cap Sickness May Be Catching" From The Street
By Jesse Eisinger
Senior Writer
SEATTLE -- Amid the fog of Internet wealth off Puget Sound, it's easy to
lose sight of the true state of the biotechnology industry. At the
Biotechnology Industry Organization meeting, here in the hometown of
Immunex (IMNX:Nasdaq) (it of the fat $11 billion market cap), industry folk
have brought their microcapitalizations hoping some of Seattle's magic mist
will rub off.
But if they listen closely to the money people, they won't like what they
hear. Investors aren't particularly interested in anything to do with
start-up biotechs. This is, after all, Amazon.com's (AMZN:Nasdaq) hometown,
too. Amazon and its brethren among information technology companies have
the power to cloud men's minds.
"It's hard to argue that it's not a crisis" in biotech, says Dennis
Purcell, Hambrecht & Quist's head of health care banking. "There is nothing
on the horizon that suggests the investment community will dramatically
change its view" and start bidding up shares of small- and mid-cap biotech
companies. Purcell, an industry veteran, says one-third of the public
biotech companies have about one year of cash left and have few options to
raise dough.
"The biotech industry needs to raise around $8 billion to $10 billion a
year [to fund research and development]," he says. "Big Pharma has been
keeping up its end of the bargain, with about $3 [billion] to $4 billion a
year. But in the first five months of the year, only half a billion has
been raised in the public equity markets."
And Big Pharma can only do so much. Between 1994 and 1998, the
pharmaceutical industry participated in about 200 investments per year on
average with the biotech industry. "That leads us to believe that the
pharmaceutical industry can only do so many deals a year," he says.
The IPO market is moribund and straight equity deals for already publicly
traded early-stage biotechs are as scarce as Seattle millionaires are
plentiful. In other words, Big Pharma isn't going to bail out biotech and
neither is the stock market.
Things got bad because of countless unanticipated blow-ups -- drugs that
didn't work in late clinical trials, drugs not approved by the Food and
Drug Administration or drugs that didn't sell well. Considering all this,
Purcell doesn't think this is simply a case of biotechs being out of
fashion.
"Given what we've learned about the risks, it's probably unlikely that
things will swing back" to where they were in the early '90s, when a
company putting its first product into human trials might be worth several
hundred million dollars. "Smart companies assume the equity markets won't
bail them out," says Purcell.
Purcell says that over the last several years, the world changed while
biotechs were in the lab.
For one thing, many mutual fund managers have more money these days, as
investors have thrown cash at funds. So they have less interest in
small-caps because they have little impact on the performances of their
bigger funds. Small-caps are now defined as $500 million to $1.5 billion,
when it used to go down to $250 million. This leaves most biotechs as
"nano-cap" orphans.
Also, the pharmaceutical industry is consolidating, especially in Europe.
That has distracted them and inhibited their ability to make deals with
biotechs. And the strong stock performance and growth of big
pharmaceuticals means they need bigger acquisitions and bigger drugs to
make a financial impact. There aren't many biotech companies or products
that fit that bill.
And then there has been consolidation on Wall Street. Many boutique
emerging growth investment banks have been swallowed by big commercial
banks. They've subsequently not covered smaller companies and need to do
bigger deals to make an impact on the bottom line.
No one has an answer. But many companies will go out of business. The ones
that remain will need to cut programs and spending. There are some
imaginative solutions. Tracking stocks, private placements into public
companies, convertible deals. Purcell has even mused about leveraged
buyouts, but these haven't happened.
What's left is buying each other. "The lack of capital makes M&A
inevitable," Purcell says. But he says there are problems -- sigh -- to
overcome.
Big Pharma's not acquiring smaller companies; it has found it cheaper to
"rent than buy," he says. The big companies hold much of the power in
negotiating product deals. They get good terms on the products they want
without having to buy the infrastructure.
The big biotechs feel intense pressure from Wall Street to deliver steadily
growing earnings. That means they are unlikely to do dilutive deals for
their early-stage colleagues, says Purcell. "They haven't figured out how
to take the financial risk out of the equation," says Purcell. If the big
biotechs buy another money-sucking biotech, they haven't solved any of
their problems.
However, the old problem -- CEO ego -- is dissipating, say the bankers.
"People are tired, the stocks aren't going up and they have to answer their
boards," says John Rumsey, Purcell's West Coast deputy.
"We have a few guidelines for a CEO," says Purcell. "If you need to be the
CEO, you probably shouldn't be in the [merger] meeting. If you need all of
your products, you shouldn't be in the meeting. If you need all of your
infrastructure and overhead, you probably shouldn't be in the meeting."
Nevertheless, H&Q keeps the biotech faith. Purcell points out: "There are
very few industries that if you are right, you can make 20 times your
money." |
