October 29, 2008
Broader Financial Turmoil Threatens Biotech’s Innovation and Cash
By ANDREW POLLACK
So many biotechnology companies talk about “extending the runway” these days, you might think they had entered the airline business.
But for them, runway refers to the time before a company runs out of money. And with financial markets in turmoil, the runways are looking dangerously short for many small biotechnology companies. A biotech crash, if it comes, could threaten an industry that plays a vital role in turning scientific advances into usable medicines.
“If you imagine a plane falling slowly to earth, the financial crisis just tipped the nose straight down,” said Andrew Baum, chief executive of SemBioSys Genetics in Calgary, Alberta, whose stock trades on the Toronto exchange.
SemBioSys, which hopes to use genetically engineered safflowers as a low-cost way to produce insulin and other drugs, said last week it would cut about 30 workers, or more than 40 percent of its work force. Even so, the company’s cash might last only until the middle of next year, Mr. Baum said.
Many other biotechnology companies are starting to cut their work forces and even eliminate research and drug development projects in a desperate effort to extend the runway. Some might have to sell themselves at a bargain price, like Avalon Pharmaceuticals did Tuesday to Clinical Data for $10 million in stock.
The problem is that newly risk-averse investors are shunning biotechnology stocks, which are among the riskiest investments around, because most experimental drugs fail.
Biotech companies accounted for 86, or 25 percent, of the 344 companies that, as of Oct. 9, were in danger of being delisted by Nasdaq because their share price was less than $1 or they failed to have an adequate market valuation.
One of those is DeCode Genetics, which has regularly made headlines for discovering genes linked to cancer, heart attacks and numerous other diseases. The company’s stock has fallen more than 90 percent in the last year to 29 cents a share.
Investors apparently are concerned that the company’s cash is running low and that it will have trouble paying a $230 million debt that comes due in 2011. It has not helped that DeCode is based in Iceland, which has suffered a financial collapse, and that it lost millions of dollars on investments in auction rate securities. The company is now planning to sell certain operations.
There are exceptions, of course. The big biotechnology companies, including Genentech and Amgen, have products on the market and are highly profitable. The biggest companies are in such strong financial shape, in fact, that their shares are roughly flat for the year, far better than stocks as a whole.
But most biotechnology companies — several hundred publicly traded ones and thousands more in private hands — are unprofitable and can sustain themselves only with periodic infusions of cash from willing investors or pharmaceutical companies. It can take hundreds of millions of dollars and 10 years or longer to bring a drug to market.
“For a biotech company, cash is a raw material,” said George Milstein, head of investment banking at Pacific Growth Equities, an investment bank specializing in health care.
Some 113 biotechnology companies, up from 68 in the first quarter, now have less than a year of cash at their current spending rates, according to Rodman & Renshaw, an investment bank. That is about one-third of the publicly traded biotech companies it tracks.
Lack of access to credit is not the main problem for small biotechnology companies, which are considered so risky that even in boom times they cannot borrow much money from banks.
Some, though, have issued securities convertible into common stock, which might have to be paid back in cash if the stock price falls below the conversion rate.
That happened to AtheroGenics after its drug for heart disease failed in a clinical trial. Paying off $30.5 million in notes that came due in September would have left it with little cash to test its drug as a treatment for diabetes. So it defaulted, entered bankruptcy and is now trying to sell itself or the drug.
For biotechnology companies, though, the main impact of the credit crisis involves the broader market. Some hedge funds have pulled out of biotechnology investing, while others have had to sell shares to cover losses elsewhere or to return money to their investors.
To be sure, the industry has been through funding droughts before, such as in 1998 and again in 2002, and most companies survive.
But this crisis comes as other factors were already souring investors on biotechnology. Drug development has become longer and more costly, in part because the Food and Drug Administration has become more demanding. And there is more pressure to cut drug prices.
So far this year, public and private biotechnology companies have raised $5.6 billion, according to the publishing company FDC-Windhover’s Strategic Transactions database. That is only one-third the amount in all of 2007 and likely to be the lowest amount since 2002.
It has been virtually impossible for biotech companies to go public this year. That deprives venture capitalists, who help start and nurture small companies, of one of the main ways of realizing a return on their investment. And it means they have to keep financing their companies longer. Those factors — plus the fact that some venture capitalists are investing in publicly traded biotechnology companies because their shares have become so cheap — mean there will be less money left for starting new companies.
When investors do invest, they are more often insisting on quick returns. Robert I. Blum, chief executive of Cytokinetics, a publicly traded company based in South San Francisco, Calif., said hedge funds had constantly pressed him to spend money only on the company’s drugs that were already in clinical trials and to abandon earlier-stage research aimed at finding new drugs.
“They were challenging us and critiquing us for still investing in research,” Mr. Blum said. He said such pressure threatened to dry up innovation.
Cytokinetics partially bowed to the pressure in September, cutting some of its early research and dismissing 45 employees, or 29 percent of its work force.
As a company’s cash and stock price diminish, raising money becomes even harder. Companies do not like to sell new stock cheaply because it dilutes existing shareholders. And potential new investors, sensing a company is desperate, drive a harder bargain. So do pharmaceutical companies, which are desperate for new drugs and have the cash to buy smaller biotechnology companies.
“I have a sense that Big Pharma is sitting on the sidelines waiting for them to hit bottom,” said Dennis Purcell, senior managing partner of Aisling Capital, a life-sciences investment firm.
Fund-raising would also get harder if Nasdaq carried through on its threat to delist biotech companies that have become penny stocks. But with so many companies in various industries in trouble, Nasdaq has now suspended enforcement of its delisting rules for three months, until Jan. 19.
Some companies are managing to get money. Phenomix, a San Diego company, put off trying to go public but licensed a diabetes drug to Forest Laboratories for an initial payment of $75 million. Ista Pharmaceuticals of Irvine, Calif., got a $65 million credit line from Deerfield Management and two other shareholders.
But risk aversion is spreading even to some companies not in immediate danger of running out of cash.
Despite having about $200 million on hand, Maxygen last week suspended work on its lead drug — aimed at protecting cancer chemotherapy patients from infections — rather than commit $100 million or so to move the drug through clinical trials. The company, based in Redwood City, Calif., said it would reduce its work force by 30 percent and would explore selling itself.
Russell Howard, the chief executive, said the company’s market valuation was only about $130 million. That is less than its cash on hand, meaning investors were placing no value on the drug or any of the company’s other programs.
“Why would you be investing more in this business,” he said, “if the market doesn’t care?”
Wednesday, October 29, 2008
at 9:02 AM