European biotech – surviving the storm
pharmafile | October 22, 2003 | Feature | Research and Development |Â Â Europe, biotech, investmentÂ
Flexibility and constant adjustment are necessary to survive one of the toughest times in the history of the industry.
There have been casualties and further victims will fall before the waters calm, but there will also be survivors. Let us not forget that Europe is home to some excellent companies, world-beating science and first rate leaders, well prepared and ready to grasp the opportunities that undoubtedly exist.
The storm
By the end of 2002 the various biotech indices around the world had fallen below 1993 levels, having plunged around 80% from the peaks of 2000. The knock-on effect of this drop in valuations has been felt across the industry.
For those companies that did not take the opportunity to replenish their funds during the bumper fundraising period in 2000, cash constraints have started to bite – as with those that took the opportunity but subsequently did not prioritise the management of their cash burn.
Earlier hopes for IPO opportunities in the first half of 2002 faded by the middle of the year, and only €24 million was raised in IPOs over the year as a whole. The market for follow-on offerings has been similarly tight at just €182 million.
In terms of raising finance, have private companies dependent on venture funds fared any better than their publicly traded peers? The European industry received over €1.1 billion of venture investment in 2002, not far short of the €1.4 billion record set the previous year. Moreover, biotech garnered 26% of the venture investment in all industries across Europe, the joint highest proportion along with software.
However, venture capitalists are evidently focusing on later-stage opportunities, partly out of necessity due to the need to support their own portfolio companies in the absence of public equity sources, and partly in an attempt to reduce the risks associated with early-stage investments. This squeeze is now expected to harden following the acquisition of privately held Ribotargets by British Biotech. The deal values the private company at less than half the postmoney value achieved at the last funding round and sets a benchmark for Ribotargets' peer group.
If the executives of an early stage company do manage to persuade an investor to provide funding, the valuation is at rock bottom and the time taken to complete a fundraising is stretching out to beyond 12 months.
Whether an IPO is actually a viable exit route for investors is a matter of contention, with plummeting share prices and little liquidity it's probably not the sort of exit route most investors would want to take.
An alternative in the form mergers and acquisitions, also failed to materialise in 2002. The level of M&A activity was down to 29 deals from 55 the previous year with US buyers particularly conspicuous in their absence. The proportion of deals involving a US buyer has fallen from 63% to 41% and reflects a general unwillingness across all sectors to enter into a binding, long distance deal in these uncertain times, compounded by a desire to hold on to cash by not taking on another company's commitments and not paying out cash to shareholders.
One of the main consequences of the current adverse conditions has been a shrinking in the sector for the first time. The number of companies has fallen slightly, by 1%, and the total number of employees has declined by 6% as some businesses fold and others cut staff in order to preserve cash. Revenues in the privately held companies have also fallen, partly due to reluctance on the part of partners to enter into an arrangement with a company with a financially uncertain future, and partly as a result of retrenchment from non-core activities.
Charting a path
Despite this somewhat depressing scenario, there are ways to survive and even succeed in these difficult times.
The expression is rather hackneyed now, but it is no less true that cash does remain king in this industry. Mainstay strategies are therefore focused on alternative ways of obtaining or holding on to cash.
Grant funding is becoming increasingly available in large amounts and it is not clear that all companies have completely woken up to this yet. Cyclacel, based in Scotland, secured nearly €2 million in grants in 2002 and the EU 6th Funding Framework has vast resources to support research. The application process can be onerous, but no more so than working the VC circuit.
One area of M&A that is starting to be explored is the acquisition of a complementary cash-generating business, as opposed to a company with a particularly healthy bank balance. There are many smaller service-based companies in Europe with steady, or growing, net incomes which could cross-support drug discovery and development efforts and at least keep the wolf from the door. The advantage of buying the cash generating company over the one with the cash pile is that the latter would usually come with a high burn rate to eat into the funds or incur costs to exit.
If any good comes of the current downturn, it will hopefully be an increased focus on revenues and profits. Biotech companies today are subject to the same rules of business as any other enterprise and can no longer expect to set out with a business plan that shows ten years until it receives revenues and 15 or 20 years to profitability. Moreover, they must continue to focus on the customer and on the market place, watching where the market moves and adapting accordingly. A look at the top companies in the sector in 1997 compared to today shows just how the industry has changed. In 1997, only five of the top ten companies had products to sell and only four were profitable, the remainder being loss-making early stage companies. At the end of 2002, all of the top 10 companies had at least one product on the market or approved and seven of the ten are profitable. The days of a business model based on revenue streams in 10 to 15 years is over.
The mantra in recent years has been products, products, products, with the result that many companies in the sector are currently trying to in-license clinical stage therapeutics to expand their pipeline. While undoubtedly there are some good licensing agreements of this type to be had, companies will need to be certain they are not being left with the scraps that pharma and big biotech have discarded.
The fundamental principle of reducing risk by broadening the product pipeline remains intellectually attractive. Biotechnology has so far not significantly improved the odds of successfully taking a product through clinical trials. However adding more products, particularly in later stages, greatly increases the cash burn rate and risks loss of focus.
Many chief executives would say their company is the one that will beat the odds, because of superior drug discovery or development skills. Let's hope that is true, but the alternative approach is to start bringing some of the drug development companies together. Rather than adding the odd product to a pipeline, bring together two pipelines and cut administrative overheads drastically to produce a company with a broad pipeline and a lower combined cash burn. This is, of course, easier said than done but is something that the 50 or so pre-IPO companies in Europe should be seriously considering if they do not want history to repeat itself, amidst rumours of an IPO window opening briefly near the end of 2003 following recent market rallies.
History is certainly repeating itself at the moment. Looking back through the Ernst & Young 1991 and 1995 US Biotech reports the events, comment and analysis are strikingly similar to the situation today: valuations down, a funding wasteland and companies cutting back or going out of business.
The response at the time was to suggest that the FIPCO – Fully Integrated Pharmaceutical Company model that so many biotechs were pursuing then was no longer appropriate. Rather it was time for the emergence of the FIDDCO – Fully Integrated Drug Discovery Company. Instead of trying to take products through clinical trials, biotech companies should stick to what they do best: innovation and discovery, while pharma companies should concentrate on their core skills of drug development, and sales and marketing. Some would consider the model almost heretical now, given the focus on therapeutics in the biotech sector, but there is an old-fashioned attraction to the idea of an organisation just doing what it is best at.
Of course there are plenty of negatives, not least the fact that the biotech company would need a large number of pre-clinical licensing deals to be assured of later stage success, and the financial reward is dramatically lower in a pre-clinical deal compared to one in phase I or II. Furthermore, pharma companies are less willing to undertake very early licensing deals today, indeed why should they when biotech companies are happy to take on the early risk for them. So while there are certainly challenges to the FIDDCO model, in the current climate it still should not be dismissed out of hand.
Light on the horizon
While mired in the gloom, it is easy to ignore the success of European biotechnology. The net loss suffered by public companies increased dramatically in 2002 from €0.6 billion to €2.6 billion, but this is mostly due to Elans move from a €0.3 billion profit to a €2.4 billion loss over that period. Excluding Elan (and Serono due to its large impact) from the data shows how the net loss per company has rapidly declined over the last four years from €13 million to €7 million, as businesses have established a more fundamentally sound commercial footing and many have broken into profitability.
The first half of 2003 has seen some positive activity. Biopharmaceutical company Medpharma raised €8.8 million on AIM in May 2003. Also in May, Vernalis announced a placing to raise a further €25 million, and announced a merger with British Biotech in July, which had recently merged with Ribotargets in March. The new company, which will keep the name Vernalis, now has sufficient cash to develop their serotonin agonist Frova for new indications, and looks likely to continue the consolidation push sometime in the next six to 12 months. With a £40 million shopping budget, many public companies in Europe fit the bill.
Similarly, on the M&A front, Chiron completed the acquisition of Powderject
for £542 million in one of the biggest deals of 2003 so far. In June, Novuspharma, the only public biotech company in Italy, was acquired by the US company Cell Therapeutics for $218 million. The combined company is expected to reach profitability in 2005. The only other public biotech company in Italy, Biosearch Italia, was acquired by a US biotech Versicor in 2002.
In addition, the product pipelines continue to grow. European public biotechs now have over 50 products in phase III clinical trials. There is much expectation that the floodgates will open in the next few years and this may propel the industry into the next stage of its evolution. Based on attrition rates, we may expect to see 15 to 20 products reaching the market in the next few years, which is very positive news indeed. You only have to look at the spread of positive sentiment in the US in May, following the approval of Millenniums Velcade for multiple myeloma, AstraZeneca's cancer drug Iressa, and Genentechs double strike with anti-angiogenesis therapy, Avastin and asthma drug Xolair. Genentech's stock soared 65% following the news, and May saw gains for Incyte of 46%, Human Genome Sciences of 26% and Millennium of 41%.
The fact that drugs are emerging from the genomics sector is good news for all involved in genomics, which has become a swear word for many investors. For many of the big players in the genomics revolution, focus is now on translating the vast store of information into new drugs, with many companies downsizing their target identification process and pumping up their downstream activities.
Governments continue to view biotech very favourably, and one of the most important developments around Europe has been the change in tax regimes to encourage entrepreneurial activity. In addition, there is recognition that the biotech industry is built on the foundation of top quality academic research, resulting in a desperately needed increase in the amount of research funding after decades of decline.
Finally, in this the 50th anniversary of the discovery of the structure of DNA in Cambridge, it is important to recognise the incredibly strong heritage the industry has in European biological research. Aside from the DNA breakthrough, many of the most significant scientific breakthroughs have been made in Europe; from monoclonal antibody technology to cloning; from vaccination to gene therapy.
It is this tradition of innovation that has given birth to this industry and no doubt it will continue to create new and exciting companies. Building these into world beating businesses has been a challenge in the past. The current downturn is forcing discipline into the business models developed by these companies, which should create a stronger and more sustainable industry when the shadow finally does lift.
Sally Hewish is a senior audit manager at Ernst & Young and Barry Middleton the project manager and co-editor of Ernst & Young's Annual European Life Sciences Report, Endurance. The report can be ordered online at: www.ey.com/uk/healthsciences.
Related Content
Cellbyte raises $2.75m to fund pharma drug launch platform
Cellbyte has announced that it has raised $2.75m in seed funding for the streamlining of …
Lilly opens fourth US Gateway Labs site
Eli Lilly has opened its newest Lilly Gateway Labs (LGL) site in San Diego, California, …
LGC Group opens $100M Organic Chemistry Synthesis Centre of Excellence
LGC Group, a life sciences company, has opened its new Organic Chemistry Synthesis Centre of …
