Biotech sector ponders potential 'bloodbath'

A large proportion of small public biotech companies now find themselves at serious risk of going out of business, with not enough cash to see them through the next 12 months and negligible prospects of refinancing. As banks have run out of lending money, as hedge funds and private equity investors have shut up shop and the public equity markets spiraled into a free fall, financing options for cash-hungry biotech companies have dwindled. By the end of November, total capital raised by the industry had fallen by 56% from the previous year, according to data from BioCentury. By the end of this year, the global biotech landscape could look vastly different from the past.
"The current crisis is unparalleled in its scope and severity," says Gautam Jaggi, senior manager at Ernst & Young Global Biotechnology, in New York, and it will lead to substantial consolidation, restructuring, layoffs and delistings (Box 1). According to the Biotechnology Industry Organization (BIO; Washington, DC), 180 quoted US biotech companies have less than a year's cash in hand—the level at which most CEOs, employees and investors find themselves swallowing hard and considering less palatable options for fueling a company. Of these, 120 have less than six months' breathing space.

Figure 1: Percentage of biotech firms operating with less than one year's cash.


Figure 2: Percentage of cash-poor microcaps in various regions.


"Some companies have already gone under as a result of the credit crunch, while others have had to scale back their research," says BIO president and CEO Jim Greenwood. Five US biotech companies sought bankruptcy protection during November alone, after October's high-profile default and bankruptcy of inflammatory disease research firm Atherogenics, located in Atlanta. Twenty-four small public biotech firms laid off workers in the eight weeks between November 1 and December 5, Greenwood adds.
What's more, average market valuations have collapsed. BIO reports that, as of November 24, valuations of small caps (it defines small cap as a market capitalization of less than $1 billion) were down 53% from their January 1, 2008, values. In fact, BIO says about 35% of the 270 US small-caps were trading at below cash in early December, meaning stock markets valued the firm at less than their cash on hand.
These depressed valuations mean acquisition opportunities for the larger pharma firms, which are looking for products and companies to plump up pipelines at bargain prices. Johnson & Johnson's purchase of New York–based Omrix, which makes human plasma-derived surgical products such as fibrin sealants, and thrombin, as well as immunoglobulins to treat immune deficiencies and infections is a case in point. The $438 million paid in November by the New Brunswick, New Jersey–based pharma occurred after Omrix's shares had fallen about 40% over the course of 2008.
But sitting on their slush funds, pharma is likely to wait some time longer before it pounces. Dennis Purcell, senior partner of venture capital (VC) firm Aisling Capital of New York, agrees big pharma is circling, but he doesn't expect the mass consolidation that some are predicting. Pharma companies typically do one deal at a time, he says, and "they are all going through strategic reviews of their own, aimed at narrowing down their therapeutic areas." Purcell expects investors in many cash-starved biotech firms to insist on survival at all costs, by trimming activities to match cash reserves and thereby living to fight another day. "Companies are taking pretty drastic measures: delaying projects, cancelling early-stage projects, putting capital where they get most bang for the buck," says Purcell.
The European scene, with its historically weaker financing infrastructure, is suffering even more than the US. Willy de Greef, head of the trade organization EuropaBio in Brussels, says next year could be a "bloodbath."
"[2008] was already not the best of years for new financing rounds, with fewer deals being done," says de Greef. "As for 2009, some of these companies are now in deep trouble. If the banks are beginning to put down the phone on the General Electrics and General Motors of this world, with their huge cash flows, what chance do we have in the biotech industry?" He adds that biotech is "going to be punished with oblivion for reasons over which they have exactly zero control."
The British government has already announced fiscal measures to boost innovative industries, whereas countries like Germany are hesitating but at least making encouraging noises. Meanwhile, UK biotech firms are taking matters into their own hands. Twenty-two leaders from its biotech sector signed a dossier sent to the UK Prime Minister and the Business Secretary. Entitled The UK Biotechnology Sector—Recommendations To Transform the Industry, the dossier calls for the creation of a national biomedical public-private partnership, including a National BioMedical Consolidation Fund and a National Super Growth Biomedical Fund—each worth at least £500 ($742.7) million.
In the US, BIO is lobbying Congress for emergency measures to stimulate biotech investment. It wants capital gains tax on invested funds to be temporarily cut or suspended and emerging companies to be allowed to receive a refund of their net operating losses to set them against research expenses. It also wants more flexibility on the use of R&D tax credits. But Greenwood insists BIO is not asking for a capital infusion.
"Entrepreneurs who go into biotech are survivors, they knew going in it was a highly risky enterprise," he says. "For the most part companies will survive, they will skinny down through the lean times and wait for the recovery."

Even if most of the industry weathers the storm, the effects could ripple out for years. If investors aren't funding today's startups, it could mean a lack of innovation and a dearth of early-stage products five years down the line. Aisling Capital's Purcell notes that venture capitalists' main priority now is to keep their existing portfolios healthy. "There is not enough capital for everybody in the portfolio, so VC companies are triaging to decide where to spend it where it makes most difference," he says. And that doesn't mean startups.
If every downturn has a recovery, then the biotech sector must simply hold on. But it will not come tomorrow, as most estimates put any reversal at least six months if not more than a full year away. Those companies not already affected are anticipating the blade (Box 3 and Figs. 3 and 4). However, E&Y's Gautam Jaggi believes that when the turn does come, it will be big: "There will be a lot of pent-up demand and investors will ultimately return to the IPO [initial public offering] market in a big way," he says. "There will be fewer biotech companies, but the survivors will be the stronger for it."