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Feature Articles : Oct 1, 2011 (Vol. 31, No. 17)

Tracking Operational Financing Trends

Analyzing the Rapid Worldwide Growth of the Bioindusty Spanning 30 Years
  • G. Steven Burrill

Biotechnology is an extraordinary industry that is characterized by long timetables and high financial risk. As as we look back over its history, it is safe to say that ready access to capital is one of the main reasons why it has grown to the global enterprise we have today.

Virtually all biotech companies in operation today owe their origins and ongoing development to the confidence that investors hold in their hopes, dreams, and aspirations.

As a result, the biotechnology industry has shown remarkable resilience. Biotech companies have always found creative ways to survive during periods of adversity. The industry has endured and grown even though conventional business wisdom has periodically called into question its ability to survive.

This has been particularly evident each time Wall Street has turned its back on biotechnology and the window for biotech IPOs has slammed shut. Confidence waned during those periods as capital became more expensive and difficult to obtain. As a result, the industry had to weather several severe market droughts (Figure 1).

Throughout this turmoil, biotechnology companies have evolved by leveraging the value of their technology, their entrepreneurial spirit, and management’s strength. Companies have also operated on the expectation that capital would be there to help them achieve their product-development milestones. Investors, for their part, have maintained their confidence in spite of the challenges and risks that need to be overcome.

Although financing has remained a constant throughout biotech’s history, business models have changed dramatically. At the dawn of the biotechnology industry, the benchmark for success for any early-stage company was the nurturing of a biological discovery through to market approval. The value of any company achieving this goal increased significantly, and its investors were rewarded for providing the risk capital that allowed the company to operate and prove its product was efficacious and safe.

By and large, the fledgling biotech industry was highly dependent on the pharmaceutical industry and its success measured, particularly by the capital markets, in terms of how many strategic alliances a biotechnology company had signed with big pharma.

This business model has worked well. Along with access to capital, the ability to partner with pharmaceutical companies that were willing to accept a significant share of the risk of their lead drug’s development in return for a healthy up-front cash payment and generous milestone payments rapidly entered into the must-have column for any biotech company’s ultimate success.

New Way to Finance

This traditional business model is fraught with challenges. The high cost and long timeline for drug development has challenged this mechanism for raising money. Venture investors don’t have the ability to provide round after round of financing and wait 10 to 15 years for a return.

The rules under which the industry has operated since its inception have been washed away by a confluence of global economic, policy, marketplace, and technological forces that are transforming the way in which companies need to operate to succeed. The collapse of the global financial markets and financial systems was a major force in reshaping the landscape.

The days of needing just a promising product past proof-of-concept trials in order to get an initial public offering complete are over. Companies need to have products on the market and predictable revenue before going public, thus eliminating technological, regulatory, and reimbursement risks.

With escalating R&D expenditures, a paucity of new drug approvals, increasing safety demands by regulators, and the loss of revenue to generics, the pharmaceutical industry has turned its focus toward biotechnology.

The business models that created value in the past are no longer effective in an increasingly risk-averse and competitive environment that includes governments focused on controlling healthcare costs, skittish investors, and demanding shareholders.

Massive Consolidation

As pharma companies face a loss of tens of billions of dollars in revenue (35% of their revenue base comes off patent in the next several years), there will be a substantial consolidation in the pharma industry. Big pharma will not be able to replace disappearing sales from its top products with what it has moving through its pipeline. Instead, it will trigger unseen levels of M&A activity that will seek to not only bolster P&Ls with new sources of revenue but also much greater operating efficiencies. Tens of thousands of jobs will be lost and not return.

A shift to partner-driven models—in which the pharmaceutical or biotechnology company relies on a potentially complex network of advisors, suppliers, service firms, academic centers, shared service relationships, and so on—is increasing as companies seek novel ways to trim operations down to the most profitable core.

Global Arbitrage

Biotechs also now need to look beyond their own borders to emerging markets for financing and market opportunities.

Smart companies will look outside their borders and think strategically about the different value their products may hold in different markets, particularly where the industry is in an earlier stage of development and acquiring critical technology may provide greater value to them.

Companies are now taking a variety of alternative approaches to access capital, such as turning to registered direct offerings, selling future product royalty streams, and selling options to promising compounds.

In addition, since biotech companies are competing in an investment-constrained environment they often only have sufficient funds to complete one phase of a project successfully before building the capabilities required to move their project through the next phase. This is why companies are beginning to adapt their business models to a more virtually integrated one.

A biotech start-up today, therefore, finds itself in an industry that is radically different than it was 30 years when many of biotech’s elite companies got their start. The world market for health and wellness has also undergone profound globalization. Companies are not simply setting up foreign subsidiaries to manage local activities such as clinical trials and marketing. Rather, they are reaching out through mergers, acquisitions, partnerships, and alliances to establish needed technologies and skill sets.

In addition, new international companies that blend talents and experiences from various parts of the world are being born. These global operations afford a number of advantages beyond the acquisition of complementary technologies including greater distribution and market access.

Global emerging markets, particularly in China, India, and Brazil, will grow faster than the U.S. and Europe. Increasing affluence, a growing middle class, and government policies will make healthcare big business in these countries.

The global nature of biotech will put pressure on the U.S. to maintain its dominance and we will see increasing evidence of other countries/regions taking the lead in some technologies and business sectors.

Return of the IPO Market

As the economy continues to improve, and investors become more willing to test the public equity markets again, IPO activity is picking up. The current environment now favors risk-mitigated companies rather than earlier-stage development companies. Capital markets both in the U.S. and globally have continued to strengthen, signaling a return of investor confidence.

The IPO window has remained open for almost 26 months (Figure 2), and the improving performance of the newly minted biotech IPOs during this period are reflective of biotech’s improving fortunes overall and the strengthening of the capital markets.

The average performance of the 29 biotechs listed in the Table was approximately 21% at the end of May 2011.

The IPO runway is also full, and it is likely we will see more biotech companies complete their IPOs in the coming months. To get the deals done, however, they may have to modify their pricing strategies and offer a larger number of shares.

Partnering Revenues

Biotech partnering transactions have become hot in parallel with the improving capital markets. The U.S. industry raised $30 billion through partnerships in 2010—about 10% less than the record total the previous year. Biotech companies continued to benefit from big pharma’s willingness to pay for its innovation.

Partnering revenues have now become a staple for many biotech companies and this situation is likely to remain, if not accelerate, in the years ahead as drug companies look to broaden product lines, replace revenues lost to patent expiration, and expand into emerging markets, where the industry growth rate is much higher than in developed nations.

Expect to see the biotech industry, as a whole, perform better in the months to come as the financing environment continues to improve. There will be no major slow down in big pharma’s appetite for biotech partnering.

Both big pharma and large biotech will compete for companies with advanced product pipelines and important technology. Partnership deals will reflect shared risk with smaller up-front payments and larger payouts on the achievement of milestones. Collaborations with emerging market players in China, India, and Latin America will also increase.

The business models that were used to create current value will not be effective going forward. The successful companies of tomorrow will be virtually oriented and globally focused. One thing is certain: the biotechnology industry is here to stay. There is still much more to come and be written about in the next 30 years.