Backing Out of Biotech : Health Care Reform Dampens Enthusiasm of Investors

Noting falling prices for biotechnology stocks, executives of San Diego-based Viagene in March scrapped a $25-million stock offering, froze hiring and shelved some of the company’s AIDS research until it can raise money elsewhere.

Similarly spooked was Sibia of La Jolla, which gave up on a public stock sale this year. Since then, executives have flown to Europe and Japan to try to hustle $15 million from institutional investors. They are resigned to signing away twice the equity they would have relinquished in a public sale.

“The health care reform cyclone has put a tremendous damper on investor attitudes about biotech. We are being unduly punished,” said Frank Kung, president of Genelabs Technologies in Redwood City, which sold stock to a German company in a private deal last month after also giving up on the stock markets. These cash-hungry companies fear that biotechnology’s current troubles are not just another cyclical slump, and that national health care reform will sour investors on biotech stocks for months, even years, to come.

Although published reports say President Clinton’s task force on health care reform is backing away from proposing strict price controls on drugs, they fear that the final plan will include some mechanism for putting serious restraints on drug prices.

Investors fear that biotech companies will have difficulty recouping profits from their enormous investments in developing drugs for market, they add.

Indeed, the 40% drop in biotech stocks since the Clinton Administration took office in January reflects that fear.

“Everybody’s a little squeamish about (investing in) the whole pharmaceuticals and health care industry because it still isn’t clear what’s going to happen,” said William T. Comer, president of Sibia, which is developing a treatment for epilepsy. “And until there’s some kind of clarification, especially in the pricing structure of drugs, you won’t see investors get excited about us.”

If the market fails to rebound soon, biotech executives say, there will be a fundamental transformation of the industry, with a trend toward consolidation accelerating. Additionally, they say, foreign drug firms will probably take an increasing share of the American-born industry as they sense there are bargains to be had.

Last week, Rhone-Poulenc Rorer, a French-owned maker of prescription and over-the-counter drugs, said it will pay $113 million for a 37% stake in Applied Immune Sciences, a Santa Clara biotech firm specializing in sophisticated cell and gene therapies. The principals in the deal said Friday that they have been talking since last fall and that the timing of the French company’s announcement was coincidental to the slump in stock prices.

Earlier in May, Boehringer Mannheim agreed to a $14-million deal to buy stock in Genelabs Technologies and finance some of the company’s research. Genelabs’ Kung conceded afterward that he would have driven a “much harder bargain in a more relaxed manner” with the German firm if the stock market had not soured.

Companies such as Genelabs have huge cash needs because of expensive drug development programs, in which they spend from $1 million to $4 million a month developing and testing drugs in labs and hospitals. And since most companies have no product sales and just 12 months to 15 months worth of operating capital in the bank, they are feeling increasing pressure to make deals with other U.S., Japanese and European investors.

“The airways from here to Japan are full of biotechnology executives trying to arrange investment deals,” said David Hale, chief executive of Gensia Pharmaceuticals in San Diego.

But the biotech companies are finding that these potential investors--mostly large domestic and foreign drug companies--are driving hard bargains.

“The possibility that introductory prices of biotechnology drugs may be subject to controls has caused some investors concern in terms of getting a satisfactory return on their extremely high-risk, early-stage investments,” said Steven C. Mendell, former chief executive at Xoma of Berkeley who left recently to start up Prizm Pharmaceuticals in San Diego.

Eli Lilly, which has invested in 40 biotechnology companies as a way of keeping an eye on emerging drug development, has tightened its standards to the point that it will no longer buy into a biotechnology company that has only one or two drugs in the pipeline, chief scientific officer Leigh Thompson said.

“There just aren’t many winners in the industry,” Thompson said on a recent visit to San Diego, where Lilly’s Hybritech biotechnology unit is based.

The irony is that up until six months ago, investors could not seem to get enough of biotechnology. Between January, 1991, and June, 1992, biotechnology companies raised about $6.5 billion in stock sales, nearly as much as in the entire previous decade, said Steven Burrill, national director of Ernst & Young’s biotechnology practice in San Francisco.

During that time, biotech stocks such as Gensia Pharmaceuticals, Immune Response and Synergen sold at stratospheric prices pushed up by the “feeding frenzy,” said Pat Sullivan, a Coopers & Lybrand partner in San Diego who handles biotech clients.

Now, with health care reform on the horizon, there is the perception that 1,200 biotech companies is too many and that the “process of natural selection” will soon accelerate, Thompson said.

Some see the stock market’s cooling off as simply a stage in the maturing of a still young industry--of a new “sense of realism” in the aftermath of the failure of three highly touted anti-sepsis drugs to gain FDA approval in the last year, said Jacqueline Siegel, chief financial officer at Isis Pharmaceuticals, a Carlsbad biotechnology company.

“There’s a growing awareness on the part of investors of what we go through to get these products developed,” said Howard E. Greene, chairman of Amylin Pharmaceuticals, a San Diego biotech company working on a treatment for diabetes. “Large drug companies have never talked about individual drug development. They don’t like to get up and make predictions until they have the new drug in the bag, so to speak.

“Only with the emergence of biotechnology has Wall Street got to watch, step by step with painful clarity, the difficult process of developing a drug,” Greene said.

Another indication of a maturing industry is that prospective investors are more discriminating.

“Whereas in the past you dazzled them with science or laboratory or animal experiments, now (potential investors are) focused on human clinical trial results,” Greene said.

And investors’ patience is shorter, Sibia’s Comer said. Companies hyping stock offerings a year ago were able to sell shares by projecting product sales by the end of the decade. “Now you have to have a reasonable chance of having a product on the market by 1996 or (companies trying to raise capital) have a tough sell to investors.”

Inevitably or not, the financial condition of many biotechnology companies will soon be critical unless the capital markets revive, Gensia’s David Hale said.

“If the condition persists, you are going to see some new companies shut down or end up in a fire sale of what’s left,” Hale said. “The concern I have is that biotechnology as an independent, viable industry will cease to exist.”

Biotech Slump A long slump in biotechnology stocks has caused biotech companies to avoid stock markets as a means of raising money. From a total of 70 biotech offerings in 1991, the number of issues declined to 40 in 1992 and has been declining since January as has the amount of money raised from stock offerings.

* Number of offerings in 1993 January: 13 February: 6 March: 6 April: 3 May: 2

* Millions of dollars raised in stock offerings in 1993 January: $382 February: $134 March: $100 April: $77 May: $31

Source: Hambrecht & Quist