Newsletter from February 2003
by Raymond S. Fersko
To My Friends and Colleagues:
I have attached two short articles published in the latter part of 2002, including my own thoughts on the state of the biotech industry. I am also pleased to announce my intent to send a monthly letter reviewing current trends in biotech as I perceive them from my own vantage point.
I may wander off the subject from time to time to suggest some of my own ideas regarding other topics and encourage my readers to keep the discussion alive. For many years my friend Aram “Jack” Kervorkian, an American lawyer practicing and living in Paris, has been doing something like this. I do not have his talent but I hope my work will provide some worthwhile information and/or give my readers something to conjure. If I can achieve a small percentage of what he has achieved, I will be quite satisfied — as I have always thought Dostoevsky had it right when he said, “The joy is in the striving, not in the achievement.” I dedicate the first issue to Jack Kervorkian, who continues to inspire with his wit and wisdom.
The annual BIO CEO meeting starts this week in New York. As companies will make their pitches, many investors will look to bottom fish. IPO funding of biotech was dead in 2002. At this juncture, the BIO IPO market for 2003 does not look better. Like most industries, Biotech is effected negatively by the geopolitical uncertainty and the failure of the U.S., European and Japanese economies to get kick-started despite record low interest rates. Biotech share prices and valuations are down around 80% from their 2000 highs. Biotech is so dependant on continual funding that it is even more vulnerable than some other industries — at least they have products and not “burn rates”, as is the case with many biotechs.
The shakeout in the corporate world after Enron has not added to investor confidence and the ImClone scandal in the biotech industry is a further deterrent causing investors to sit out or limit their exposure. Negative considerations are that the government investigation into analyst conflicts is not over and new and more stringent securities laws will cause more companies to restate their earnings. Bristol-Myers Squibb is reportedly restating earnings for two years as an overvaluation of inventory may have caused it to overstate results. These are all negative factors for the industry to attract investors. Due diligence will always be a basis for an “out” up until deals close. Companies should not expect that deals will be completed on as favorable terms as were under discussion during the due diligence period.
The “irrational exuberance” that Chairman Greenspan saw in the public markets led to the overvaluations in the stock market and when the bubble burst the money vanished, as there were no hard assets or anticipated future value to prop up many of the highly speculative companies in the I.T. sector that are non-existent two-years later. The economies of the U.S. and Europe have lost so much value that it is not realistic to expect near term recovery of the biotech sector as a whole. There is a scarcity of new money for investment in biotech companies that were overvalued, unless the companies agree to drastically reduce the valuations. Even then investors remain skittish and have far more stringent criteria for investing and maintaining investments.
Nevertheless, biotechnology is not in the same category as the dot.coms, nor is there the excess capacity that continues to plague the communications industry.
The real circumstances that will shape the biotech industry in 2003 is the large number of biotechs with less than one year's cash remaining. Many of these companies have promising products that are either in the clinic or are ready for the clinic but are running out of money and have no choice but to sell-out to obtain infusions of cash to conduct the expensive clinical trials that are necessary to develop products for the market. Big deals like the recent Johnson & Johnson 2.4 billion acquisition of Scios will not be the norm. The norm will look more like the OSI Pharmaceuticals $32 million in stock purchase of Cell Pathways. OSI's major drug in development – the cancer drug Tarceva, which it is developing with Roche and Genentech, still has a lot of development hurdles. In the meantime Cell Pathways, out of cash, but with a marketed product for treating side effects of chemotherapy and another drug in late stage development helps OSI to define itself as a cancer company.
On Friday, February 21, 2003 NPS Pharmaceuticals and Enzon Pharmaceuticals agreed to merge. This should be the first of many similar transactions. NPS has no products on the market. Enzon has cash and sales and distribution expertise. It has marketed products and is profitable. NPS has the larger valuation. It has two drugs in phase III trials — Cinacalcet licensed to Amgen for hyperparathyroidism and Preos for osteoporosis. The jury is still out on the wisdom of this merger but with investors clenching their money tightly, mergers are necessary for companies without cash. Market valuations are so low that in some instances their cash is higher than the valuation. It is estimated that there are in excess of 150 biotechs with less than one year's funding at this time.
On another front, research tools (i.e. genomics, proteomics, bioinformatics) are operating by a rule of twos. They are taking twice as long to bring about intended results at twice the cost; nevertheless, they play an increasingly important role in speeding up the drug development process and reducing the risk of the process. Pharmaceutical companies with blockbuster products running out of patent term and larger biotech companies in similar straits will continue to enter into strategic alliances with tool companies in order to more quickly develop new products. The tool companies need to be with product companies to attract financing. The market seems to have very little tolerance for an industry whose technology changes so quickly. Standalone tool companies are viewed as too risky for an industry whose technology changes so quickly. By entering into strategic alliances with these tool companies, the larger product companies are outsourcing their own research and development, while hedging against failure and by limiting their exposure. If there is success everyone does well.
On the positive side, increased U.S. government funding of biomedical research continues to receive bipartisan support. This enables many small companies to stay alive by working on projects that may not be their first choice but are important and often provide a foundation for further developments on the technology the biotech company considers to be its core technology. This is not a long-term solution for these cash starved companies. Grants are available from the National Institute of Allergy and Infectious Diseases for projects aimed at developing therapeutics, vaccines, diagnostics and other resources for biodefence. The U.S. Army's Soldier and Biological Chemical Command is seeking proposals from biotech companies for the next generation of reagents, or substances used to detect the presence or amount of another substance. The Department of Homeland Security is the most obvious new source of money, and has its own Advanced Research Projects Agency aimed at defending the U.S. through research and development. Congress has authorized $500 million for the agency to spend this fiscal year.
Finally, the recent 20% gain in the Euro against the dollar with its low interest rates may make foreign investors shy away from dollar investments or they could find it cheaper and then more attractive to make US investments because the cost in dollars is low when exchanged with Euros. Currency hedging on both sides will probably be the norm. The increase in the Euro makes it harder for European companies to export their products outside the European community.
It is promising that the FDA is moving faster now with approvals and it finally has an able commissioner, Mark D. McClellan, M.D., Ph.D, at the helm.
Cordially,
Raymond S. Fersko