For Biotech, a Loss of Patience and Funding

This should be the best of times for the biotechnology industry.

Dozens of new products that attack cancer cells, block viruses or slow arthritis have finally arrived on the market; scores of other promising treatments are being tested in patients and readied for regulatory approval; and the biggest firms are rewarding longtime investors with soaring stock prices.

But these are difficult days for smaller, emerging biotech companies--those that are cash-strapped and several years away from completing tests on their first marketable products. A shortage of capital poses a serious threat to the survival of many unproven firms, say investment analysts, industry consultants and corporate executives.

Private companies have been unable to go public, public companies have been blocked from selling stock to raise additional financing, and some investors are just losing patience with this high-risk industry in which many companies have failed to deliver.

And although the industry has seen cash dry up before, many observers believe this time is different--that biotech will never see the same level of investor support that sustained it in the past.

The problem is that only a few of the nation’s estimated 1,300 biotech companies are profitable. Most survive from one financing to the next based on investor hopes that one day they’ll hit it big.

Now a significant number are close to using up their cash reserves at a time when they are hard-pressed to find new money.

“Eighty-four of 345 public [biotech] companies have less than a year and a half of cash on hand; 54, less than a year,” said D. Theodore Berghorst, chairman and chief executive of Vector Securities, a Chicago-area investment bank that specializes in biotech and other health-related businesses. “Our worry is that a lot of these biotech companies will not get funded.”

Berghorst, along with many others, believes that the market has changed fundamentally. He says that cash-hungry companies will have little choice but to merge with better-financed biotech firms, form partnerships with major pharmaceutical companies or file for bankruptcy protection.

The industry is suffering also because of a consolidation of institutional investors and investment bankers, according to Berghorst and others. The result is fewer knowledgeable analysts who can gauge the eventual worth of an unproven technology and a lack of interest in investing in companies that are valued at less than $1 billion.

But to other observers, the current dry spell looks like others that have come before. They believe the window for biotech financing will eventually reopen as investors perceive the technology being developed by many smaller companies as undervalued.

“I probably have been through four up and down cycles in the business, and this is not the worst I’ve ever seen,” said James Blair, general partner at Domain Associates, a venture capital management firm with offices in Costa Mesa and Princeton, N.J., that focuses on biotech and health care. “The situation may not be nearly as profound as people make it out to be.”

Biotech executives also seem to be divided over which view is correct. “There are two reigning schools of thought among CEOs,” said G. Steven Burrill, who heads Burrill & Co., a San Francisco merchant bank. “One is the hunker-down theory that we in the biotech industry have been through these periods before. The second is the sea-change school of thought, that things are different.”

Waiting, and Spending

The factors behind the current squeeze don’t matter much to companies that need millions now to support their research and clinical trials.

DepoTech Corp. of San Diego, for example, has a promising method of encasing injectable drugs in microscopic capsules for slow release, a technology that has a variety of applications. As with all but a handful of biotech companies, it has yet to make a dime of profit. But it’s been burning through its cash reserves at the rate of $20 million a year.

The company had what it thought was a winner. After five years of development, it completed clinical trials of DepoCyt, a slow-release version of the anti-cancer drug cytarabine that was to be marketed in the United States by biotech giant Chiron.

Although the drug was aimed at just 20,000 patients with cancer that has spread to the brain, Food and Drug Administration approval would have assured profitability for the company. Further, it would have improved the outlook for DepoTech’s time-release version of morphine, DepoMorph, which is being tested on patients following hip-replacement surgery--a much larger potential market.

In December, however, an FDA scientific panel refused to endorse DepoCyt after objecting to the design of the study, even though agency officials had approved the design in advance.

In one day, DepoTech stock dropped from $13 to $4.11. (The company’s stock closed Friday at $2.59, down 9 cents, on Nasdaq. Although the company had $30 million in the bank, it needed additional cash for continued testing.

“The market, as everybody recognizes now, does not look favorably on biotech stocks,” said the company’s president, John P. Longenecker, referring to his company’s inability to raise capital this year. The only options available to the firm, he said, were “a merger-acquisition scenario or a major investment from a large corporate partner.”

This month, the firm agreed to be acquired by SkyePharma, a London-based drug-delivery company, in a share exchange worth $1.76 per DepoTech share--with the possibility of an additional $1.76 upon future FDA approvals.

The announcement of the deal came two weeks before an FDA advisory panel recommended approval of DepoCyt for treatment of leukemia and lymphoma patients. Generally, the FDA follows such recommendations, but is not bound to do so.

Kurt von Emster, who manages the Franklin Biotechnology Discovery mutual fund, points to DepoTech as an example of a stock that was undervalued by the market even when it stood a good chance of winning FDA approval for DepoCyt the second time around.

But the market has been so sour on small biotech issues that Von Emster himself has been refusing to consider initial public stock offerings from emerging companies.

“There are about 350 publicly traded biotech companies,” he said. “We’re better off with the evil we know than the evil we don’t, which is an IPO--unless there’s a very compelling IPO with well-advanced clinical studies.”

In an overview of the industry, Prudential Securities’ analyst Caroline L. Copithorne wrote that investors are showing little interest “in offerings of these generally small-market-cap, high-risk, unprofitable companies that may be returning for but one of many trips to the market.”

Vector Securities’ Berghorst points out that since the beginning of 1996, the Nasdaq biotechnology index has climbed a meager 19%--one-fourth the increase of the Standard & Poor’s 500 index. But it’s the larger companies that have made almost all of the gains--profitable firms like Biogen Inc., Immunex Corp. and Amgen Inc.

Take away the 10 largest companies, according to Berghorst’s figures, and the biotech sector lost 20% of its value during that period.

“Once a product is on the market, they generate tons of cash. You pay a lot upfront, but the payoff is a lot if you’re lucky,” Copithorne said in an interview.

Big Firms Have Edge

Some who follow the industry lament that investors have lost patience with companies that take so long to get their first product to market, and only after clearing regulatory hurdles. In contrast, Internet and software companies generally require less capital and are far quicker to generate sales from new products--and there is no equivalent of the FDA to block sales if questions arise about safety and effectiveness.

Biotech companies “have very long production development cycles, on average 12 years, on average $250 million,” said Lori Rafield, a principal at Patricof & Co. Ventures Inc.

But she, too, points out that the payoffs can be enormous. “When you hit with a product with 85% gross margins, you’re off to the races, and it doesn’t take a huge drug to do it.”

But few mutual funds or large institutional investors are showing much interest in the small companies that make up most of the sector.

“When you have $1.5 billion to put to work, you don’t want to futz around with a $150-million biotech company,” Rafield said. With these small firms, “not enough shares are trading hands so that people can get in and out of the stocks.”

And even companies that appear to be doing everything right and have secured adequate financing are frustrated to find their shares sliding in the current environment.

A case in point is Nanogen Inc., a small San Diego firm that is developing automated devices that can quickly detect the presence of certain microorganisms or chemicals. Initially, the technology will be marketed to research laboratories, but the company is already working closely with Becton Dickinson on rapid diagnosis of infectious diseases. The same technology can be used to look for deadly pathogens in meat or to perform genetic screening, said Nanogen Chairman and Chief Executive Howard C. Birndorf.

Birndorf says the company, which went public in April, would probably not have been able to do so in today’s climate. “I give thanks daily that we chose to do an IPO in the spring rather than the fall,” Birndorf told an audience last month at the annual meeting of Biocom, an industry trade group in San Diego.

But Birndorf, who has co-founded eight biotech companies, expressed dismay that Nanogen stock dropped precipitously from its initial $11 a share to less than $6, despite a series of positive developments. Among them: a cover story in the science journal Nature Biotechnology on the successful use of the firm’s automated device to detect E. coli bacteria in blood and a contract worth up to $7.6 million to develop a biological-warfare detection laboratory for the Navy. (On Friday, the stock closed at $5.31, down 31 cents, on Nasdaq.)

At the conference, Birndorf gave voice to the frustrations of the industry. “Good news is neutral,” he said. “Bad news is catastrophic.”

To boost their stock, he joked, companies should work the word “Internet” into their mission statements or add a “dot com” to their corporate names.

At the moment, Nanogen, whose cash hoard amounts to about $60 million, does not need additional financing. But Birndorf sympathizes with companies that do.

He said the current capital crunch “feels different” from those in the past and believes it could force a long-anticipated industry consolidation. “Now it’s got to happen,” he said, “or many of these companies will go under.”

Times staff writer Paul Jacobs covers biotechnology. He can be reached via e-mail at paul.jacobs@latimes.com.