PRINT THIS PAGE Reengineering life sciences
05/10/2005. Source:Scottish Equity Partners.
Scottish Equity Partners puts the biotech funding model under the microscope. They find that while at the beginning of 2004, hopes were high for the biotechnology and life sciences sector, some were not quite so positive in their outlook. At the beginning of 2004, hopes were high for the biotechnology and life sciences sector. After going through the financial mill for several years, it was thought that the much anticipated upswing might finally be in sight. VC investments were on the increase and IPOs were finally back on the horizon.
But while many looked forward to a more prosperous time for the sector, others were not quite so positive in their outlook. Martijn Kleijgwegt, managing director of Amsterdam and Munich-based venture capital fund Life Science Partners, was quoted as predicting 2004 to be the last window of opportunity for biotech companies in Europe to go public for the next three years, according to his study of previous biotechnology IPO patterns.
Whether it was concern that he might be right, or the enforced wait of the previous years, there was definitely a rush to take advantage of the window when it did open. While companies like Ark Therapeutics, Basilea Pharmaceutica, Zentiva and BioMerieux on average did very well, only a few European life sciences companies managed to float before the window slammed shut in their faces.
SEP’s Healthcare and Life Sciences Director, Brian Kerr, points to several reasons for the fleeting recovery of the IPO market for European companies:
“The ‘window of opportunity’ phenomenon is partly a self-fulfiling prophecy. When people believe that they don’t have much time, they are forced into rushing out too soon. They feel the need to float when the market is ready, regardless of whether the company is actually ready for the market.
“That leads to too much competition on the one hand, and also the problem that the market may not like the general quality of what it sees coming forward, leading to demand dropping off. In the US, where the IPO market stayed open, they had a steady flow of companies at the right stage of development, rather than a glut of companies desperate for cash.”
Kerr believes that, although many might throw their hands in the air and say there is nothing that can be done about market factors like these, it is within the control of the biotech and investment communities to change market conditions in Europe and aim for the more stable US environment where the ups and downs are evened out and less dramatic.
According to Kerr, the seeds for this current scenario were sown in late 2000 when many VC investors swung from hardware and software investments to life sciences after the bottom fell out of the technology market.
More life sciences companies were funded than normal during that period. On the face of it, that seems like a good thing for the sector. However, with funding rounds for life sciences companies generally increasing in size each time, it led to a very cash-hungry environment.
Then in 2002-03, the lack of life sciences exits for VCs, meant VC investors started to run out of cash. So while demand for funds soared higher and higher, supply was dropping off. The only thing that could really save the situation was the opening up of the IPO market, creating a new pool of money for life sciences companies. Consequently, it was inevitable that there would be a race to float when there was even a glimmer of light at the end of the tunnel.
But that glimmer was snuffed out in the ensuing rush, which means that even the higher profile, more mature life sciences companies who were more than ready to IPO have lost their opportunity to get a good valuation in the short term. With such a depressing outlook for the sector, the question must be asked - what now for European biotech?
On the other side of the Atlantic, the last year has been much more positive. Even though the US market has not been immune to fluctuations, 29 new companies joined the publicly traded markets in 2004, raising nearly $1.8 billion between them, and biotech’s market capitalisation rose from $344 billion to $400 billion, according to Burrill and Company, a San Francisco based life sciences merchant bank.
“While many people believe we’re getting toward the end of the IPO window, I believe the IPO scene is going to be very robust in 2005,” said G. Steven Burrill, CEO of Burrill and Company.
“In all, more than 40 biotech IPOs are likely to get done in the US in 2005 and those offerings will do better than the ones which launched in 2004.”
On the surface, while comparison with the US is far from cheering, it does offer some cause for optimism according to Sam Fazeli, Senior Biotech Analyst at Nomura. In an interview with the online financial broadcaster, Cantos, he said:
“Return in the US has been higher, but what is interesting to look at is that the level that we are at now, from a number of other indicators, is at about the same stage that US biotech was at in around 1995-96 when the level of investment that had gone into US biotech versus the total market cap of the companies added together just began to turn. So we would hope that there is some truth in the view that going forward over the next few years that Europe would experience much the same as what they saw in the US.
“This is a sector much like when you drill for oil where you need a lot of luck. Unfortunately you cannot measure luck but what you can do is to try and see whether the factors that are required to get a successful sector are there already in Europe. We think most of them are.”
Fazeli does not believe, however, that an improvement in the prospects of the European biotech sector will be an automatic process, and that changes must be made within the industry to make it happen:
“Management is one of the key things to any biotech company - to any company, basically. The sort of thing we need in Europe, and that is slowly coming along, is the churning of experienced managers from successful companies into new ventures. For instance, the chief executive of Arakis used to be at a very well known US biotech company SEQUUS.
So he’s got the experience of the US biotech sector and he’s an experienced drug developer. These are the sort of things we need to see and we are seeing it slowly.”
Sam Fazeli also recommends that European companies get through to fund managers by showing that they have got a commercial attitude to business:
“What they should do is try and find some relatively low-hanging fruit, much like the early US biotechs did. So unless they are really lucky with a drug discovery that suddenly takes them to $500 million, they go after products which are maybe reformulations of an existing treatment.
“That means they can talk about early revenues which help support the development of the big ideas and that’s a much more interesting story than going to tell a fund manager that I have got a great idea, no idea whether it works but give me some cash please and I will come back in two years time and get some more off you. They don’t like that much!”
SEP’s Brian Kerr agrees with the benefit of having some revenue or a product nearing completion, pointing out that 80% of the US companies that achieved a post-IPO market cap of over $200 million in the last 18 months were at phase III or beyond.
“Biotech has always been a long term investment,” he said, “Experienced investors in the sector understand this, but fund managers and venture capital firms alike are perhaps rethinking at what stage in the development cycle is the best for them to invest because, with the best will in the world it doesn’t make economic sense to go in at too early a stage.
“The financial model for biotech is broken, and we need to re-think and re-engineer it so that it works again. It now takes an average of 9 years for a company to go from start-up to IPO in biotech. Comparing that with typical valuations in the US, even if a company floated for £60 million, it would have cost at least £45 million to fund it over that period. That doesn’t make sense - it doesn’t make money for investors and it doesn’t cover the high risk factor that has always characterised the life sciences market.
“The move now is definitely much more towards investing in companies at a later stage, with proven products. What we need to make sure is, that this is balanced with a commitment to staying with companies to a later stage again, beyond the exit point they may previously have aimed for, so they can list for much more money when the time comes.
“Our view is that companies in Europe tend to list too early. In the US, VCs recognise that they need to make the investment more secure for public investors. The market doesn’t want to take the same sort of risks as VCs. It needs to be a commercial enterprise from the day it floats, not a scientific R&D project.”
Kerr believes that the upheaval in the life sciences market over the last few years will lead to a fundamental shift in how companies plan their path from start-up to exit.
“Companies have to look at how they can cut down the length of time they need investment for, to attract investors back to the sector. Some companies may be looking at medical devices or other smart technology that needs a shorter development cycle. Others may look to working more on their R&D within the university or corporate environments so that more development time has gone into it before starting to fund-raise.
“The latest addition to the SEP life sciences portfolio, Rhytec, is a good example of both of these points. It is a start-up, but a corporate spin-out from the Gyrus Group, with a medical device nearly ready to be launched commercially.”
Kerr concludes: “We need to create a bigger, more stable, quality environment to invest in, with a nice steady market that grows consistently. Biotech is a long term game in more ways than one, and that means that investors and companies alike are going to have to rethink their approach to make that happen."
Scottish Equity Partners (SEP) is one of the largest independent private equity groups in the UK, and is currently investing from a venture capital fund in excess of £100 million, which is backed by leading UK and European institutional investors.
With offices in Glasgow and London, SEP is one of the most active venture capital investors in the UK and has a strong investment track record. Typically, we invest between £500,000 and £5 million or more, in financings of up to £30 million, in early stage and growing companies in the information technology, healthcare & life sciences and energy related technology sectors. For more details visit www.sep.co.uk
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