Innovate or Conserve Cash? The Growing Dilemma for Biotech Firms

8/16/11

There’s no doubt that managing a biotech company is an enduring challenge, even during less tumultuous economic times. Now, entrepreneurs are contending with resources that are incredibly tight, an economy that is unsettled, a stock market on a roller-coaster ride, and research and development budgets that are being slashed. The stewardship role entrusted to the management teams of biotech companies has become especially tricky as they are required to make tough choices that balance the needs of investors and the pursuit of scientific discovery. They must also manage the chaotic world of innovation within the regulatory boundaries of FDA approval process, and give freedom to creative scientists without letting go of the fiscal discipline.

So how are biotech companies handling the pressure? At BDO USA, our analysis of the 10-K SEC filings of publicly traded companies listed on the NASDAQ Biotechnology Index (NBI) over the last four years provides a window into the impact of the economic turmoil on biotech’s operations, and strategies that management teams are using to remain financially viable. For the purpose of the analysis, biotech companies were classified as “large” (between $50 million and $300 million in revenue) and “small” (less than $50 million in revenue).

Here are the major findings:

Cash is King

An assertion perhaps no more critical than in the biotech industry, where cash and liquidity are really strategic assets. No matter how talented and innovative a company’s research team is, or how promising the technology they are developing, all comes to naught if there is no ability to continue to fund such efforts and the company runs out of cash. According to our analysis, NBI constituents—despite the turbulent markets and global recession—managed to maintain a very stable level of cash: the equivalent, on average, of over 2.5 years of R&D spending. However, maintaining liquidity has come at the expense of spending on R&D, a trend also seen at big pharmaceutica companies. The good news is that despite two consecutive years of R&D cutbacks in 2009 and 2010, biotech companies still managed to achieve double-digit growth in average revenue.

Selective Innovation

But if R&D spending is dropping, it’s logical to ask whether the biotech sector is suffering a decline in its desire to pursue new drugs, and what this will mean for product development. Are biotech companies becoming less innovative? From our perspective, the answer appears to be no, at least not in the near future. Biotech companies appear to be maintaining their average headcount, which is encouraging, but the spending per employee has gone down. What appears to be happening is that management teams are being more selective—sometimes strategically and at other times due to necessity—by funding certain programs ahead of others.

In addition, the frequency and significance of strategic partnerships and collaborative arrangements between biotech companies and pharmaceutical companies have been increasing over the past years. This has enabled biotechs to fund some R&D activities from payments under such collaboration deals at times when they don’t have products that are being sold commercially. As such, collaborative arrangements have become an essential financial lifeline for biotechs.

However, a word of warning. As big pharma cuts back on their R&D spending due to significant pressure to show a return on their R&D spending, management teams of biotech companies should expect to see a higher level of diligence and scrutiny from pharma companies before they fund collaboration deals. Under such a scenario, a careful and objective analysis will be critical in determining which projects and R&D efforts have the best chances of success in getting through all stages of the multi-year product development cycle. The dilemma for management teams will be whether it is better to delay certain R&D projects to conserve cash for projects that may have a better chance of commercial success.

The Role of Capital Markets

When it comes to accessing capital markets for product development, equity remains the top source of financing, according to the 10-K analysis. In 2010, 51 percent of smaller companies were able to raise an average of $64 million equity financing. This shows a promising rebound as companies are approaching pre-recessionary levels—61 percent of smaller companies raised financing in 2007 and the average value was also $64 million. Therefore, investors continue to have an appetite for investments in the biotech sector, but have become more selective.

Backers of biotech companies make huge investments and clearly want to maximize returns on their investment. Maintaining a fine balance between innovative curiosity and creating meaningful opportunities to generate shareholder returns promises to become more and more challenging. Companies will need to remain flexible to innovate not only in core scientific areas but also in their business models and operational structure in order to thrive in changing market dynamics, and fulfill the critical mission of making a difference in the lives of people globally.

Aftab Jamil is a partner and national director of the Technology and Life Sciences Practice at BDO USA. Follow @

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