Launching an IPO Involves Timing, Strategy

Even if you don't work for a company that is about to launch an initial public offering, the stock market can still be alluring as a personal investment opportunity. You know the science, so you should be able to pick the stocks, right? Not so fast, say the experts. No matter how good the science looks, market forces and poor management can drive a promising company--and its stock price--into the ground. Good management can make an average technology profitable, and poor management can make even the most stunning science look mediocre when it hits the marketplace. So when considering a company, see what you can find out about the history of its management and board. Have they built successful biotech companies before? Many executives have grown up along with the biotech industry and will sport a track record that could bode well for the stock. Keep an eye out for approaching mergers and consolidations that could drive up a stock's price, but beware the orphaned company whose stock flounders unnoticed. According to Peter Freudenthal, vice president and senior biotechnology analyst at BancBoston Robertson Stephens, New York, the market is beginning to reward bigger companies with late-stage products in the pipeline, leaving smaller companies based on platform technologies out of favor. That trend is reflected in the fact that the big biotechs such as Amgen, of Thousand Oaks, Calif., and Biogen Inc., of Cambridge, Mass.--with products well into the pipeline--tend to be the companies that have done well over the past year or so. Smaller companies with less capital behind them could become "biotech orphans"--as Freudenthal puts it--and they may be bought up or go out of business. Companies with less than two years of cash remaining "are going to have a difficult time surviving [independently] unless the market improves dramatically," he says. But despite its pitfalls, the biotechnology industry does enjoy some benefits. There are no price wars in medicine, and a Russian bankruptcy wouldn't have much impact. And Freudenthal and others remain high on biotech as an industry with unlimited growth potential. However, investing with discretionary money that you can afford to lose is the safest approach. --JK So you're the chief scientist at your own small biotech company and pondering how to raise more money for growth and profitability. Private investors aren't lined up around the corner to fund your next phase, and a government grant is out of the question. One logical step is to take your company public. For some firms, it's the best approach. For others, not. In the summer of 1997, with a steady business in licensing combinatorial chemistry discovery technology and a strong cash base, San Diego, Calif.-based CombiChem Inc. decided it was ready to do an initial public offering (IPO) to strengthen its financial base and become profitable. George Rathman Vince Anido But it didn't work out that way. The Securities and Exchange Commission was slow in acting on CombiChem's documents, and their December 1997 window closed as market conditions worsened. The market started to look better in April of this year, and the company finally went public on May 8, but the IPO raised $18 million instead of the $23 million they had sought. "The good news for us was that we had about $17 million in cash. It wasn't like we were starving," recalls Vince Anido, president and CEO of CombiChem. That illustrates perhaps the most valuable lesson to be learned when considering an initial public offering. Go when your cash position is strong. "Companies often go for an IPO because the venture capitalists are tired of not having liquidity, and it usually coincides with the corporate coffers having trickled down to nothing," says Gregory Went, executive vice president of CuraGen Corp., New Haven, Conn., which did very well in its March IPO. Desperate financial straits don't make for a good story to tell investors, and such companies require a forgiving marketplace to complete a successful IPO. CombiChem had the misfortune of going public during a volatile time, but even in the calmest seas, initial public offerings are fraught with peril. In the most difficult times, "you declare victory just because you got it done," says Glen Giovannetti, a partner in the life sciences industry group at Ernst & Young LLP, Palo Alto, Calif. The goal of an IPO is to introduce a stock price and to see it grow slowly but surely. That's a standard expectation, says George Rathman, CEO of ICOS Corp., Bothell, Wash., but it is rarely met. "I've never experienced it. It's like shooting par in golf-- no mortals that I know of shoot for par. You usually get erratic behavior." Rathman should know. He has been the president or CEO of two companies that went public, and on the board for three others. In the early 1980s, he watched Amgen Inc.'s stock start at 18 and drop to 3¾ by November 1984. "We didn't see the opening price again until three years later," he recalls. Lessons learned? ICOS stock also started at around 18 and shot up 50 percent in three months. "That wasn't good either, because we had a high we didn't see again for eight years." Some maintain that ICOS's bankers set the initial price too low, that its three-month increase was a correction that couldn't maintain itself. "That's garbage," says Rathman. "Nobody could have predicted [that increase]." But Amgen's mistake is easier to identify, says Rathman. The company didn't look closely enough at the banks they chose to underwrite the deal, he now contends. "They had great reputations but little experience in the biotech field, and we paid the price. They weren't very astute about where they placed our shares. They sold them to speculators." Such investors may be looking to make a fast return by initiating a run after the IPO and selling the stock soon after. That kind of activity can produce runs in positive or negative directions, but as Rathman's experience shows, runs are rarely good for the long-term health of a stock. And the first days after the offering are crucial. "There's a lot of psychology in the stock market--a lot of people watch even pennies off an IPO price. If it doesn't drop below its initial price after a few days, chances are that the stock is self-supporting. But if it loses even 25 cents, that can be a signal [to some investors] that it has lost its support and there may not be a floor" for the stock's value, says Rathman. There haven't been any IPOs at all among biotech companies over the past few months, and there aren't any in the pipeline to become public soon, says Giovannetti. For the moment, that leaves cash-starved companies with little recourse but to look for private financing, or to turn to other companies for support. But that isn't an easy road, either. The drop in public prices is beginning to trickle down into the private market, so that even so-called 'angel' investors--who purchase shares in privately owned companies to keep them going in times of need--won't pay the prices other companies have become used to getting. The answer? One possibility is to consolidate before heading to market, says Alan G. Carr, president of Hambrecht and Quist Capital Management Inc., Boston, Mass. He expects the current market woes to continue a process already begun--the merging and acquisition of biotech companies by larger biotechs and the pharmaceutical industry. "The country probably doesn't need 1,200 biotech companies," says Carr. The trouble is, many in the larger industries are going through their own restructuring and mergers, and during such tactical maneuvers they may have little concern for small biotech acquisitions. Still, to attract their attention, "you need a critical mass--a lot of small companies are one-trick ponies," says Peter Freudenthal, vice president and senior biotechnology analyst at BancBoston Robertson Stephens, New York office. "I like the amusement park analogy--would you go to a park with 20 or 30 rides or would you go to a Ferris wheel in the middle of nowhere?" A single technology could grow obsolete, or in a changing business climate its market could dry up, and those risks may dampen investors' enthusiasm. Although everyone expects the climate for biotech IPOs to improve in the coming year, not everyone sees it returning to the boom periods of 1992 and 1995-96, when rich IPOs were the norm. "There appear to be changes at a more fundamental level. There have been a lot of mergers in the last year or so, and the [investment institutions] that buy IPOs have also merged," says Giovannetti. Those moves have put additional pressure on institutional investors. "You've got a lot more money under management by a smaller number of people, and they can't take a lot of time to understand the companies. If they don't get it done quickly, they move on." When they do notice, "people are going to attack your rationale and your business approach, and even your character. [They will invent] all kinds of creative stories and half-truths. [But if going public is] the right financing decision, do it with everything you've got. Don't let the roadblocks stop you," says David M. Wurzer, CFO and executive vice president of CuraGen. And while you're at it, aim high, says Rathman. If you don't raise enough money to last you awhile, "you've used up your chit," he says, and a couple of years after the IPO you could find yourself in need of a cash infusion with few options left. The immediate future isn't bright, says Giovannetti, but it's bound to get better. "We are still bullish on [biotech] ... its ultimate value creation can't be disputed. [The concern is] trying to come up with tactics and strategies to bridge the gap when the market is not able to provide all the capital that's necessary. Biotechnology is going to be a huge industry in the next century." James Kling, a science writer based in Bellingham, Wash., can be reached online at http://nasw.org/users/jkling/.

Launching an IPO Involves Timing, Strategy

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