This time the biotech industry consolidation is for real. The gloomsayers who predicted an industry downsizing in the past were wrong, but this time they are right. The trillion dollar black hole of derivative speculation has curbed the appetite for risk and slowed venture funding in biotech. Potential funding for the life sciences is trapped in “upside-down” housing where the owner owes more than the house is worth, and toxic collateralized debt obligations (CDOs) in banks worldwide.
Moreover, the risk factors for biotechnology are as real as ever: political uncertainty, the impact of “binary events” like clinical trial results and FDA decisions on stock prices, generic/biosimilar competition, and the emergence of a national healthcare plan implying lower drug costs. The industry has navigated through troubled times and big issues before, but never in times of a financial meltdown.
The markets need to be cleared of securitized debt before risk capital can return to biotechnology. The past few years has seen the greatest misallocation of capital in the history of the modern U.S. economy so it will take time to get back to funding of real technology, products, and services.
The hardest hit companies in the current environment are public microcaps with weak balance sheets, development-stage biopharmaceuticals with longer-term clinical risk, and drug discovery start-ups. Many of these stocks are down 25% or more in Q1 2009.
M&A—Big Is Better
M&A activity is accelerating at the top end of the market such as the $68 billion Pfizer/Wyeth deal and the $48 billion Merck & Co. acquisition of Schering-Plough. Pfizer issued $13.5 billion of debt, three percentage points above treasuries to fund the acquisition. Barbara Ryan, senior pharmaceutical analyst with Deutsche Bank, believes these mega-mergers are positive for the companies in the face of generic competition as they strengthen balance sheets, cut costs, and presumably, improve the yield of basic research.
Eli Lilly CEO John Lechleiter told the Wall Street Journal on March 31 that he was “hungry” for buyouts up to the $15 billion range, emboldened by the acquisition of Imclone. According to data from BioCentury and Piper Jaffray, big pharma deals were up 15% in 2008.
On the other hand, mergers between smaller players, even those with technological synergies, may not fare as well due to long-term funding issues. A case in point is the reverse merger of the public company EPIX Pharmaceuticals with the private biopharmaceutical company Predix Pharmaceuticals. EPIX was the target as it had cash and a cardiovascular imaging agent stalled in the FDA. Predix had a drug discovery platform and a broad portfolio of CNS and cardiovascular candidates in the clinic that needed funding but the $40 million annual burn proved to be overwhelming in a bear market with no milestone catalysts. The stock now trades under a dollar and has a “going concern label” with negative shareholder equity.