Friday, June 26, 2009

Inside Biotech

Biotech consolidation: Is there light in the tunnel?

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The last 15 months has been witness to seismic changes and turmoil in the biotech industry. Cash is constrained, liquidity is nonexistent, venture investors are funding fewer companies.

Of the 350 public biotech companies, approximately 120 were trading with less than six months of cash on the books. Private biotech companies seeking access to the public markets for growth capital and liquidity for their venture capital investors, have seen market windows shuttered. Indeed, 22 biotechnology and medical device companies pulled their initial public offerings in 2008, and countless more likely chose to sit on the sidelines. A decade of healthy IPO exits was followed by a moribund market last year.

Capital raised by U.S. biotechs declined from over $2.1 billion in the fourth quarter of 2007 to under $700 million in the fourth quarter of 2008, a drop of 68 percent. Furthermore, the number of biotech acquisitions fell to its lowest level in a decade. The 30-year symbiosis among biotech companies, backed by venture capital investors, supported by pharma partnering programs, with ultimate access to capital markets for growth and liquidity, suffered an alarming setback in 2008.

While the public capital markets have been an important ingredient to biotech’s success, the “Big Pharma” sector has been an integral element of that symbiosis. That market also suffered reversals in 2008. Industry consolidation among Big Pharma continued at breakneck speed, as pharma companies confronted dwindling new product pipelines, weak R&D productivity, patent expirations and longer development and regulatory cycles. In that rush to consolidate among the leviathans, the number of licensing deals forged by Big Pharma with biotechs plummeted.

The fallout of declining licensing deals is disturbing. The number of U.S. licensing deals performed by the top 20 global pharmaceutical companies declined by 28 percent between the first quarter of 2006 and the third quarter of 2008. With biotechs commanding higher prices, Big Pharma was deterred from entering partnership agreements. As a consequence, the pharma new drug market is forecast to experience a slowdown over the next five years and beyond, growing by only 1.6 percent in 2011–12.

For a decade, biotech has been the fuel for that pipeline. With their symbiotic partnerships, biotechs provided innovative therapeutics, and pharma offered funding, development, regulatory and manufacturing muscle. Big Pharma sought alliances rather than acquisitions. Licensing was a less expensive, less dilutive approach than acquisitions to building pipelines.

Now, with more than half of the public biotech companies having little cash reserve for growth and traditional funding sources like convertible debt placements constrained, Big Pharma may go “bargain basement” hunting over the next year, filling its dwindling Phase 2 and 3 pipeline with novel therapies at fire-sale prices. For those biotech companies who have the cash reserves to remain independent and self sustaining, licensing deals will continue to drive growth. For the less fortunate, “exits in extremity” may be the new watchword.

The drought in funding for private biotech companies adds to the agony. The number of IPOs, PIPEs, follow-on financings and convertible debt funding has been dropping steadily since the second quarter of 2008. Alarmingly, the number of private financings has also declined, as venture funds themselves have shrunk and the amount of fresh capital invested in these pre-revenue companies has imploded.

What do these seismic changes bode for biotech? Cash-constrained biotech companies will be cutting costs and reducing burn rates to conserve precious cash and human capital. Financings will come at a high price: dilution and loss of value. Only critical near-term programs will get funded, and perhaps promising discoveries will be abandoned in the wake of those companies jettisoning people and assets. For those who have adequate capital and promising Phase 2 and 3 products, values should improve. Early-stage therapeutic companies will forge alliances with a high opportunity cost, sacrificing market opportunity and independence for desperately needed funding, development and regulatory resources. Venture capitalists may be leaving the field of “big-play therapeutics” with large capital requirements in favor of tranched financings to curtail risk.

What remains in this nuclear winter is what has always remained. Good companies, with strong and disciplined management teams focused on capital efficiency who can build scalable enterprises. With large market opportunities involving an aging population requiring disease management and novel, personalized therapies, these will get funded — as they always have. Our future is our past.
 

John Hession is partner-in-charge in Cooley Godward & Kronish LLP’s Boston office. He can be contacted at 617-937-2312 or jhession@cooley.com.