Buy-Side Experts See Major Changes Afoot for Biotech Amid Financial Crisis

10/30/08

Unless there are more than seven figures in your personal net worth or you happen to manage a pension fund or the like, there are few chances to glean information from hedge fund managers and other buy-side experts who play the high-risk game of biotech investing.

Yet last week one of those rare opportunities presented itself to those of us who attended the Boston Biotech R&D Conference at Harvard Medical School, where local and national members of the buy-side set weighed in on the impact of the global financial crisis on the life sciences industry. To hear these insiders talk shop, the grim realities of the crisis will be felt in different ways at all levels of the industry—and we’ve already seen evidence of these market dynamics playing out in Boston, San Diego, and Seattle.

Here’s a taste of three potential or ongoing changes they discussed:

Economic Darwinism
Jay Markowitz, a health care analyst for Baltimore-based investment firm T. Rowe Price (NASDAQ:TROW), isn’t the first person to use the term “economic Darwinism.” And its clear that the new constraints on the availability of capital mean that some of the weaker life sciences companies won’t survive in the public markets. “I don’t think capital has been all indiscriminate until now,” Markowitz said, but the bar has been set higher than previous years for companies to get public funding.

Indeed, the bar is so high this year that hardly any companies are clearing it. In New England, for instance, with the exception of deals such as the public carve-outs of CPEX Pharmaceuticals, of Exeter, NH, (NASDAQ:CPEX) and Worcester, MA-based RXi Pharmaceuticals (NASDAQ:RXII), there hasn’t been a single traditional IPO among biotechs in 2008. And in an effort to avoid extinction while they’re waiting for the IPO window to reopen, some companies are taking on debt. Seattle-based biotech firm Omeros, for example, has agreed to borrow up to $20 million to fund clinical trials after filing earlier this year for an yet-to-be-completed initial offering.

Greater Clout for Pharma

As if their influence wasn’t already colossal, big pharmaceutical companies look to gain even more clout in partnership and acquisition talks with smaller firms in this financial climate.

“I just think that the pendulum has shifted over to Big Pharma because of biotech’s need for cash,” said Tom Brakel, of Federated Kaufman Funds, which is a unit of Pittsburgh-based Federated Investments. Brakel noted that the six largest pharmaceutical firms have about $83 billion in cash.

Last week, for example, we saw San Diego-based drug developer Phenomix cancel its plans for an $86.25 million IPO and then reveal a new partnership with New York drug maker Forest Laboratories that would bring Phenomix $75 million in initial fees.

“There are always going to be companies with great technology that will find a way to get capital, but it may not be through the public markets, and they may have to settle for less favorable terms in a partnership,” said Stephen DuBois, a portfolio manager for investment firm Camber Capital Management.

Consolidation, Consolidation
One potential outcome of the harsh economic situation and other factors will be a significant increase in consolidation in the life sciences industry, according to buy-side experts.

Health care analyst Andrea Bici, of London-based Schroder Investment Management, raised some eyebrows when she predicted that only 75 public biotechs—or roughly 25 percent of the current total—would be in business as independent firms five years from now. (Most of the portfolio managers predicted 70 percent to 80 percent of the companies would be standing in five years.)

Indeed, we’ve already seen some consolidation among cash-hungry biotechs over the past year or so. Needham, MA-based Avant Immunotherapeutics, for one, initiated a merger with Phillipsburg, NJ-based Celldex Therapeutics last year (the firm is now known as Celldex (NASDAQ:CLDX) and is headquartered in Needham). In as similar deal this summer, Bothell, WA-based Sonus Pharmaceuticals, which failed to clear late-stage clinical trials with a less toxic form of chemotherapy, completed a reverse merger with then-privately held Vancouver, British Columbia biotech firm OncoGenex Pharmaceuticals (NASDAQ:OGXI).

Though more tied to expirations of patents on major drugs than on the ailing economy, another factor behind consolidation will be major pharmas’ great appetites for drugs to fill their product pipelines through acquisitions. Adam Koppel, a director at Brookside Capital, a hedge fund affiliate of Boston-based investment firm Bain Capital, said: “Most of these companies have no innovation in their pipelines—they are starving.”

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