Biotech Train Heads for Gains

The biotechnology business has ridden a roller coaster in the financial markets for the past 18 months. The gyrations have been enough to make even the most stalwart investor swallow hard. Enthusiastic over the potential of human genome sequencing and depressed about the downturn in the dot-com markets, investors drove up values in biotech stocks by 300 percent and more. But by spring, the high-tech stocks' Titanic pitches had finally helped tow biotech stocks down by 50 percent. Now, with analysts forecasting an imminent upturn in the biotech and life science markets, it's time to get out the motion-sickness pills. The ride could have been even more dizzying. Compared to last year's sinking Internet stocks, the life science issues have fared well, even benefiting from high-tech woes by attracting public funding and private venture capital. Analysts still express concern, however. If wary investors don't turn back to biotech as fast as the experts think they should, or if the big pharmaceutical companies fail to achieve challenging goals in bringing to market new blockbuster drugs (that can generate $1 billion in sales), the slowdown may hinder smaller companies from raising capital to fund research and development, launch new products, or simply stay in business. Even if stock values rise, analysts still expect some jobs to be lost and others to be created as consolidations sweep the pharmaceutical and biotech sectors this year. While some biotech companies will go out of business, competitors eager to purchase talent and technologies at bargain prices will acquire other businesses. Large pharmaceutical companies will swallow up biotech firms to procure instant expertise in such critical areas as bioinformatics. Other, stronger biotech firms will stand their ground and generate revenue by licensing their technologies or creating alliances and collaborations with drug manufacturers. "The good news is, even with consolidation among those companies, there is real value," says Morrie Ruffin, vice president for business development with the Biotechnology Industry Organization (BIO) trade group in Washington, D.C. "And as these companies become larger and have staying power, there will be more jobs and the potential for more collaborations with smaller companies." Adds Franklin Berger, senior biotech analyst for J.P. Morgan in New York, "I don't know of another group besides biotech and pharmaceuticals that looks as exciting as they do right now." The Biotech Train Investors looking for a better ride than the dot-coms could offer headed to biotech stocks early in 2001. "Biotechnology has had a very significant run" this year, says Rachel Leheny, a biotech analyst for Lehman Brothers in New York. "It's really outperformed the market. And when the market turned toward the positive a few weeks ago, biotech really turned toward the positive, in some cases, by 30 to 40 percent. We think there's relative strength in biotech versus certainly some of the other growth sectors and probably the other health-care sectors," she says. The American Stock Exchange's Biotechnology Index, which comprises 16 biotech companies representing a cross section of the industry, achieved a six-month high in June, but in so doing, it only matched December's levels. Over the past 12 months, the technology-heavy Nasdaq lost 40 percent in value overall as the Amex biotech index grew by 14 percent. Last summer, the same index jumped nearly 300 percent above the previous year's totals. Biotech companies don't fare well with investors who pull out their funds when the profits rise too slowly. They prefer to rely on "patient money," that is, capital from investors who realize that therapeutics and drug development can be a long, expensive process and who are willing to wait. Bringing a drug to market often takes 10 years and costs $500 million or more. "The product cycles are very different for biotech compared to high-tech or other industries," says Emily Hall, a biotech analyst for Morningstar Inc. in Chicago. "It's almost like a cable company that has to lay down an infrastructure before doing business. They have to rely on funding from investors and the equity market to keep going before their products are in place to sell." Unlinking the Two Techs But in 2000, few biotechs attracted the long-term money they had yearned for from the fretful stock market. Partly because of naiveté, investors tended to view the biotech and high-tech sectors as being interchangeable if not identical. After the dot-com stocks peaked and started to fall in March 2000, many investors lost confidence in science and technology stocks, dragging down the value of biotech stocks, regardless of the companies' financial status or profit expectations. At the same time, other investors--joining the dot-com desertion--decided biotech would replace high-tech as the next new profit source. So those stocks got pushed up to higher values, even with the rest of the market in decline. "A lot of people mistakenly thought that genomics and biotech were another type of Internet," says Steven Newby, chief investment officer for GenomicsFund.com, a Gaithersburg, Md.-based mutual fund that invests solely in biotech stocks. By the end of the year, biotech companies across the board had raised more than $35 billion in all forms of financing--three times more than the amount raised during any previous year, according to a report by Ernst & Young.1 For the industry, this capital inflow has been both a curse and a blessing, says Kevin Tomaselli, vice president of discovery research and co-founder of Idun Pharmaceuticals Inc., a private startup in San Diego. "It's been a blessing because a lot of the money came into biotech once it was apparent that the dot-com boom was just a phenomenon," he says. "That drove the biotech frenzy a year ago, which was good for the industry. Now, the curse was that people moving into biotech bid it up too high, and it all had to go down." Perhaps the most dramatic example of this roller coaster phenomenon is industry giant Celera Genomics Group, a division of the Applera Corp. Celera saw its stock price jump from $8 per share in July 1999 to a whopping $276 in February 2000 as news of the company's pending success in sequencing the human genome gripped the nation's attention. In less than a year's time, however, the Rockville, Md. company's stock lost 90 percent, falling to about $28 per share (it lately has been trading in the mid-$40s range). "Some of the good [biotech stocks] declined 80 and 90 percent from the highs to the lows," Newby says. "That's pretty severe, especially for companies that have strong balance sheets and are debt-free." Most biotech stocks declined by about 50 percent during the latter half of 2000 through the first quarter of this year, as shown by the Nasdaq Biotechnology Index. Despite lowered stock prices, several of the biotech industry leaders are well positioned for success, with multiple new products under development and stores of cash, assembled during last year's market highs. "Every company that was worth its salt used that period of the rally in the biotech sector to raise cash," says BIO's Ruffin. Human Genome Sciences Inc. (HGS), for example, has more than $1.5 billion in cash, according to the GenomicsFund.com. The Rockville, Md., company has five drugs in various stages of clinical trials, including two produced with albumin fusion technology: Albuferon, for hepatitis C patients, went into Phase I trial in March; Albutropin, a long-acting recombinant growth hormone, was approved for Phase I trial in June. Another heavyweight, Millennium Pharmaceuticals Inc., which focuses on small-molecule biotherapeutic and predictive medicine products, has six drug candidates in clinical trials and many others at the preclinical stage, according to the GenomicsFund.com. Millennium, based in Cambridge, Mass., manages more than 20 pharmaceutical alliances and holds cash reserves of more than $1 billion. Celera Genomics also boasts more than $1 billion in cash reserves, which it may use to move its genomic treasures toward drug discovery and development, predicts Mebane Faber, chief technology officer for the GenomicsFund.com investment group, in a recent report.2 Adds investment chief Newby, "these companies were very astute when the market was strong a year or so ago and they sold some stock at very high levels and now have the cash to see them through the many years of discovery and development." Now is also a good time to be starting a biotech company because the venture capitalists (VCs) are looking for companies with real technology, says Lita Nelson, director of Massachusetts Institute of Technology's Technology Licensing Office. Now that the VCs "have lost their love for the 'dot-bombs,' it has been easier to get biotech companies started during the past six months than anytime in the past several years," she says. Technology transfer and licensing from universities to businesses also have been positive, Nelson says, largely due to the ease with which biotech firms are able to spin out from universities. Courtesy Oxford Bioscience PartnersAlan Walton But even if present biotech investments appear promising, the long-term outlook remains uncertain. Alan Walton, senior general partner for Oxford Bioscience Partners, a Boston-based venture capital fund that invests in biotechnology start-ups, says he doesn't expect to see a significant resurgence of biotechnology companies going public for a couple of years. Because of this, venture capitalists will be forced to do more follow-on investments, putting resources into existing enterprises to sustain them until they can attract public funding as the market rises. As times goes on, these investors will have less money available to support new ventures. "In the short run, it's great," Nelson says, "but the long run remains to be seen." So far, universities and nonprofit research institutions have not suffered from the downturn in the public equity markets. "There might be some downturn in industry-sponsored grants to universities. But this would be in the long-term, not the short-term," says MIT's Nelson. But since people generally want to donate appreciated stocks when they are at their highest valuations, endowments to universities and institutes may not experience their best years ever. As for the markets in general, "I think we are already seeing a rebound," Newby says. "The biotechs seem to be leading us out of the morass that we were in for some time." Ted Agres (tagres@usa.net) is a freelance writer in Washington, D.C. References 1.Ernst & Young, Convergence: The Biotechnology Industry Report, New York: Ernst & Young Inc., 2000. 2. M. Faber, Genomics Outlook 2001: The Post-Sequencing Era, Gaithersburg, Md.: GenomicsFund.com, 2001. Foundation Funding and the Stock Market Source: AAFRC Trust for Philanthropy/Giving USA Update 32, April 2001 Average Rate of Change, 1960-1999 = 9.2% Source: Giving USA Update, April 2001 AAFRC Trust for Philanthropy Through judicious investing, foundations can sufficiently shield themselves from the U.S. economic downturn--enabling sustained growth even as the economy stagnates, observers say. Although repeal of the estate tax, signed into law June 7, may create uncertainties that could hamper future fundraising, effects from the stock market decline should be minimal. Patrick Rooney, chief operating officer and director of research at the Center on Philanthropy (TCOP) at Indiana University, comments, "For the most part there is a tight connection between changes in the stock market and changes in giving." But, Rooney and others say that even though the dynamic has changed slightly, history is an indication that private donations will maintain growth despite the machinations of the market. The American Association of Fundraising Counsel (AAFRC) Trust for Philanthropy and TCOP estimated a 19.6 percent increase in giving by noncorporate foundations and a 12.1 percent increase in corporate giving from 1999 to 2000, both well over the yearly average since 1969.1 "What we expect to see, looking forward, is that growth will continue," says Steven Lawrence, director of research at the Foundation Center in New York City. "It's not going to grow at the double-digits rate that we've seen over the last five years, but foundations are going to maintain the high level of giving." Giving has doubled in the past five years and the number of grant-making foundations has doubled since 1985. As much as grant making has grown, however, says Rooney, "in the last couple of years, foundation giving has not kept pace with the stock market." Because many foundations have fewer technology holdings, they did not reap the full benefits of the exploding market. It stands to reason that giving won't follow as dramatically on the downswing, Rooney explains. But more research needs to be done, according to the charity analysts, especially in light of President George W. Bush's new tax reforms, which will phase out the estate tax over the next 10 years. Those with wealth, some fear, will no longer choose philanthropy as an alternative to giving the money to the government, and will instead pass on their entire inheritance to natural heirs. Repeal would, in effect, remove the incentive to give. Supporters of the repeal say it will encourage savings and increase after-tax and after-bequest wealth, therefore increasing the ability to give in future generations. Research done by the U.S. Department of the Treasury's Office of Tax Analysis shows that when children are better off financially, parents are more likely to give.2,3 Countering that is an older study from Cornell University, which found that entrepreneurs and those who created wealth gave six times as much as those who inherit it.4 According to the legislation repealing the estate tax, it will decrease incrementally over the next 10 years until it phases out completely in 2010. The following year, the repeal "sunsets" and unless new legislation is written, estate tax will revert to its current level. In the short term at least, Rooney says, "Repeal of the estate tax will have negative effects. I do think that the way it is structured right now is the worst of both worlds," he adds, pointing to the fact that repeal will end in 2011. "If you're trying to plan around that, Dr. Kevorkian may be very busy in 2010." --Brendan A. Maher References 1. The Center on Philanthropy at Indiana University, AAFRC Trust for Philanthropy, "Giving during recessions," Giving USA Update, Issue 2, 2001. 2. D. Joulfaian, Estate Taxes and Charitable Bequests by the Wealthy, NBER Working Paper 7663, April 2000. 3. E. Temple, and P. Rooney, "Financial Focus: The Estate Tax," The NonProfit Times, pg. 24, Nov 2000. 4. R.B. Avery, M.S. Rendall, Estimating the Size and Distribution of Baby Boomers' Prospective Inheritances, Working Paper, Department of Consumer Economics and Housing, Cornell University, 1990

Biotech Train Heads for Gains

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