Navigating JOBS, Wrangling Investors: A Biotech CFO Roundtable
In biotech, the visionary scientists and serial entrepreneurs often—arguably too often—get described as “rock stars.” The financial guys… well, not so much. But in a business where cash is constantly burned at the altar of R&D, and financial engineering can be as prized a skill as drug hunting, the CFOs perhaps deserve more time in the spotlight. On the private side, their companies are always fundraising. Then they’re “dual-tracking,” juggling the attractions of an IPO along with the possibilities of M&A. On the public side, they’re managing a variety of investor classes, including those who don’t know much about biotech but cycle in and out with the market tides.
A conference of biotech chief financial officers is meeting this week in San Francisco, and Xconomy had the chance to gather several of them for a discussion of the latest industry trends and burning issues. The participants were Robert Hoffman of San Diego’s Arena Pharmaceuticals (NASDAQ: ARNA), Shane Kovacs of PTC Therapeutics in South Plainfield, NJ (NASDAQ: PTCT), which received good news from European regulators soon after we talked; Lou Arcudi of Cambridge, MA-based Idera Pharmaceuticals (NASDAQ: IDRA), Ed Albini of Sutro Biopharma in San Francisco, and Craig Johnson, who was CFO of two San Diego-area biotechs, most recently TorreyPines Therapeutics, and is now an independent board member of several companies.
Xconomy: The IPO window is a constant topic of discussion, whether it’s wide open or narrowing as in recent weeks. But it seems the way biotechs go public has fundamentally changed because of the federal government’s JOBS [Jumpstart Our Business Startups] Act, which was signed into law two years ago. What’s the biggest adjustment companies have made because of its passage?
Shane Kovacs: I had experience as a banker taking companies public, both pre and post-JOBS Act. [PTC went public in June 2013.] Back in 2007-08 you didn’t want to get hung out to dry if the markets quickly pulled back and you had your filing sitting there. Now you can confidentially file. It allows you to do the work without anyone knowing you’re planning an IPO, then you can pop out with a month’s notice, effectively. It helps you time the biotech markets. It’s much more beneficial. As you seek investors and gauge levels of interest, as a banker and as a company, it helps you size the deals and set pre-money valuations. That’s been the main benefit. One other benefit of ‘test the waters’: For a lot of these [potential investors], it’s really beneficial for them to have two, three, or four meetings with you, rather than seeing you for the first time on the roadshow. They don’t necessarily want to meet with private companies if you’re not going public. But when they know it’s a ‘test the waters’ situation, they’ll take the meeting. They know you’ll be back and they might be participating in an offering.
X: Do you think the IPO market will be less feast-or-famine now? Will the windows be less extreme?
Craig Johnson: I don’t think one affects the other. We’ll still see windows open and close based on supply and demand in the market. But the confidential filing and stuff like that gives a lot more flexibility to the private company that could potentially go public. Ten years ago if you filed and didn’t make it out it was some sort of black mark. Even if there were good reasons, it was still a check against you.
SK: It’s a real benefit of filing confidentially. The downside, though, is the market has less visibility into how deep the IPO pipeline is. To play devil’s advocate, it could add to market swings. Maybe investors are investing in lower quality companies because they didn’t know the better quality companies were coming.
Ed Albini: As a private emerging growth company out there testing the waters, yes, you can get an audience with institutional investors if they know that you’re directed toward an IPO. The key for us is getting some informal feedback—as to valuation, potentially.
X: is it cheaper now to go public? Was Sarbanes-Oxley [financial regulation that passed in 2002 in reaction to the scandals at Enron, WorldCom, and elsewhere] really an impediment?
CJ: It was a necessary evil we all went through, but I don’t think it ever stopped anyone from going public. Still, the JOBS Act has been great for the companies I’ve worked with. It’s one of those things where government did it right for once; they’ve right-sized the reporting and regulatory requirements based on the size of the company.
X: Remember all the hand-wringing about the Big Pharma ‘patent cliff’? [The patent cliff is the period of several years this decade in which drug makers were scheduled to lose exclusive rights to many best-selling drugs. Here is one breakdown of the products going off-patent in 2014.] What bearing has it had on biotech companies?
SK: I think it still extends out a few more years. There have been different structural changes and strategies pursued, depending on which large company you’re talking about.
Robert Hoffman: For Arena and generally for biotechs, I think there was a benefit. If you had late stage assets, Pharma would pay up for them. Some companies are still struggling with the patent cliff, like AstraZeneca and Eli Lilly.
Lou Arcudi: [Pharmas were] trying to protect big markets or indications like oncology or hyperlipidemia. Now you’re seeing a refocus of energy on specific parts of those markets, to the benefit of a lot of biotech companies. We can now focus on certain indications within those broader areas and really prosper. Idera’s focus is rare B-cell lymphoma diseases. We’re not so much focused on partnerships, we’re focused on trying to deliver pinpoint to that patient population. This does give smaller companies doing orphan and breakthrough indications the opportunity to take [those drugs] to market themselves without relying on Big Pharma to fund those type of operations.
X: How does the influx of smaller biotechs onto the public market affect M&A conditions?
RH: I think it’s better because they have to disclose more information. If you’re private, there’s not necessarily a compelling reason to disclose good data in Phase 1, Phase 2, or further along. If you’re public you have to disclose information along the way. It’s much more transparent.
SK: That’s a great point.
X: Or to play devil’s advocate: perhaps the less transparency there is, the more competitive advantage the acquirer would have in picking up that program.
RH: I think it depends on the management team in place and whether they’re looking to partner. If Big Pharma calls on you and you’re not interested in taking a meeting because you’re moving the program independently and you have funding, then you’re not going to [disclose] much about it.
X: Among the total pool of investors, VCs are in shorter supply on the private side. But crossovers [who usually invest in public companies] are coming in to help on mezzanine rounds, while some VCs are now investing on the public side. Does it make your jobs more complicated to have these fluid definitions of which side an investor might be on?
EA: As a private company evaluating the public markets, I see crossover investors being beneficial. Now that we’re out talking to pure public and crossover investors, the key if you’re going to take crossover investors is to find a group that will help facilitate the IPO. The cash in buys you a little more time and you can keep building value before you go public, but also you’d like a group that will help facilitate the IPO. Some will stick with you longer, too. [Editor’s note: Albini’s company Sutro Biopharma closed a $26 million Series D round in December 2013 led by existing investors Alta Partners, Amgen Ventures, Celgene, Lilly Ventures, Skyline Ventures and SV Life Sciences.]
X: Once a biotech is public, what does that investor composition mean to its strategy?
SK: [PTC] closed a $65 million private round in February last year then went public four months later. Getting true crossover investors into a private round is tough and very story-specific. There are only a handful who will lead that mezzanine deal then bring in his group of buddies who trust him in terms of the level of diligence. The level of diligence, the credibility with public market guys: that’s immensely beneficial if you can get it done. They then cover your IPO at least 1x, or more hopefully. Even in a bad market your deal will get done, and it will get done no worse than flat to the post-money valuation on your final private round. They want to support it where they bought it. If companies can get the mezzanine done with true crossovers, it’s a good thing. But not everyone can get them.
X: In other words, it’s not just about having crossovers in the round, but having one as the standard-bearer.
SK: Once you get the lead, he’ll negotiate the term sheet and set the pricing on the private round. Everyone else will follow the lead. Getting that lead is the hardest thing to do.
X: Are there any cautionary tales when it’s not a good idea to recruit crossovers for that last mile?
CJ: To me crossovers are really public investors that dip down to private when it’s opportunistic. But when all hell breaks loose they’re back to investing in publics again. It’s great in neutral-to-hot market to get them to come in, there’s nothing wrong with them dipping into private to get a little extra return. If they’re already in and the market goes south, they’ll work to protect their investments. But if it goes south first and you’re looking to get crossovers in, I expect them to be very selective.
SK: I agree. I wouldn’t knock them, they’re taking on risk. Look at PTC: the company had $2 million on the balance sheet. No banker will tell you to go public and file an S-1 when you only have $2 million. They say you have to do a private [round], but your VCs are all tapped out, and even if they aren’t, they say they’ll pull together a $15 million round. But if you get good crossovers… we raised $65 million from crossovers. That’s a big chunk of dough. We then raised $144 million on the IPO. Six months prior, the management team wasn’t expecting anywhere near that. Part of it was market momentum getting better and better. But it was the process and order of operations we followed.
CJ: What [PTC] benefited from was a nice market. I’m not sure those same crossover guys would be there for your $65 million private round if they didn’t think they could get out. How long were they in, a year?
SK: No, four months. I hear you, but they came in in January  before the IPO market was wide open. They got in at $12 and we went public at $15.
X: What about longer-term investor behavior, perhaps something that has influenced companies that went public before the Great Recession?
RH: We went public in 2000. When there’s part of a market that’s hot, suddenly everyone’s interested. We’d get crossover funds, generalists, even people sitting down saying ‘I don’t know anything about your company but I know biotech’s really hot, so what can you tell me?’ Those are difficult meetings, but some of those guys go out and buy and support the stock.
X: We’ve fallen off the patent cliff, we’re working through health care reform. What other hurdles will the industry have to push through in the next five years?
RH: The Pfizer-AstraZeneca situation highlights the need for tax code reform. [Editor’s note: Pfizer abandoned its pursuit of an AZ takeover Monday.]
X: Are you talking about the rules for repatriation of foreign revenues?
RH: Repatriation as well as a tax code that’s favorable to organizations in the U.S. Let’s assume the transaction goes forward and Pfizer becomes a foreign-based company. You’ve had several transactions in the past: Elan, Jazz, Valeant, Actavis…
SK: All these companies are re-domiciling through inversion deals. That’s the flavor of the day.
CJ: This could be part of the patent cliff thing. [Pharma is saying] we’ve lost all this gross margin, but here’s a way to pick up our bottom line.
Table image courtesy of Ofer El-Hashashar via a Creative Commons license.